DAL TILE INTERNATIONAL INC
S-1, 1996-06-03
STRUCTURAL CLAY PRODUCTS
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<PAGE>
 
     AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 3, 1996
                                                        REGISTRATION NO. 333-
 
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                ---------------
                                   FORM S-1
                            REGISTRATION STATEMENT
                                     UNDER
                          THE SECURITIES ACT OF 1933
 
                                ---------------
                          DAL-TILE INTERNATIONAL INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                                ---------------
         DELAWARE                    3253                    13-3548809
                              (PRIMARY STANDARD           (I.R.S. EMPLOYER
     (STATE OR OTHER              INDUSTRIAL           IDENTIFICATION NUMBER)
     JURISDICTION OF         CLASSIFICATION CODE
     INCORPORATION OR              NUMBER)
      ORGANIZATION)
 
                                ---------------
                               7834 HAWN FREEWAY
                              DALLAS, TEXAS 75217
                                (214) 398-1411
              (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
       INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
 
                                ---------------
                                CARLOS E. SALA
                            CHIEF FINANCIAL OFFICER
                          DAL-TILE INTERNATIONAL INC.
                               7834 HAWN FREEWAY
                              DALLAS, TEXAS 75217
                                (214) 398-1411
           (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
                  INCLUDING AREA CODE, OF AGENT FOR SERVICE)
 
                                ---------------
                       COPIES OF ALL COMMUNICATIONS TO:
       FREDERICK H. FOGEL, ESQ.                 JOHN T. GAFFNEY, ESQ.
    FRIED, FRANK, HARRIS, SHRIVER &            CRAVATH, SWAINE & MOORE
               JACOBSON                            WORLDWIDE PLAZA
          ONE NEW YORK PLAZA                      825 EIGHTH AVENUE
       NEW YORK, NEW YORK 10004             NEW YORK, NEW YORK 10019-7475
            (212) 859-8000                         (212) 474-1000
                                ---------------
       APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
     As soon as practicable after the effective date of this Registration
                                  Statement.
 
                                ---------------
  If any of the securities being registered on this form are being offered
pursuant to dividend or interest reinvestment plans, please check the
following box. [_]
  If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
  If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
  If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
  If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [X]
 
                        CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
                   TITLE OF EACH CLASS OF                         PROPOSED MAXIMUM            AMOUNT OF
                SECURITIES TO BE REGISTERED                  AGGREGATE OFFERING PRICE(1) REGISTRATION FEE(1)
- ------------------------------------------------------------------------------------------------------------
<S>                                                          <C>                         <C>
Common Stock, par value $.01 per share.....................         $149,500,000               $51,552
</TABLE>
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- -------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee
    pursuant to Rule 457(o).
 
                                ---------------
  THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
 
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<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
                               ----------------
 
                             CROSS REFERENCE SHEET
          PURSUANT TO ITEM 501 OF REGULATION S-K, SHOWING LOCATION IN
            PROSPECTUS OF INFORMATION REQUIRED BY PART I OF FORM S-1
 
<TABLE>
<CAPTION>
                                                       LOCATION OR CAPTION IN
        REGISTRATION STATEMENT ITEM AND HEADING              PROSPECTUS
        ---------------------------------------        ----------------------
 <C> <C>                                            <S>
 1.  Forepart of the Registration Statement and
      Outside Front Cover Page of Prospectus......  Forepart of the
                                                     Registration Statement;
                                                     Outside Front Cover Page
                                                     of Prospectus
 2.  Inside Front and Outside Back Cover Pages of
      Prospectus..................................  Inside Front Cover Page of
                                                     Prospectus; Outside Back
                                                     Cover Page of Prospectus
 3.  Summary Information, Risk Factors and Ratio
      of Earnings to Fixed Charges................  Prospectus Summary; Risk
                                                     Factors; Unaudited Pro
                                                     Forma Consolidated
                                                     Financial Information;
                                                     Selected Consolidated
                                                     Financial Data
                                                                              
 4.  Use of Proceeds..............................  Prospectus Summary; Use of
                                                     Proceeds                 
 5.  Determination of Offering Price..............  Risk Factors; Underwriting
 6.  Dilution.....................................  Risk Factors; Dilution
 7.  Selling Security Holders.....................  Not applicable
 8.  Plan of Distribution.........................  Outside Front Cover Page of
                                                     Prospectus; Underwriting
 9.  Description of Securities to be Registered...  Outside Front Cover Page of
                                                     Prospectus; Prospectus
                                                     Summary; Description of
                                                     Capital Stock
 10. Interests of Named Experts and Counsel.......  Legal Matters; Experts
 11. Information with Respect to the Company......  Outside Front Cover Page of
                                                     Prospectus; Prospectus
                                                     Summary; Risk Factors;
                                                     Refinancing; Use of
                                                     Proceeds; Dividend Policy;
                                                     Capitalization; Unaudited
                                                     Pro Forma Consolidated
                                                     Financial Information;
                                                     Selected Consolidated
                                                     Financial Data;
                                                     Management's Discussion
                                                     and Analysis of Financial
                                                     Condition and Results of
                                                     Operations; Business;
                                                     Management; Principal
                                                     Stockholders; Certain
                                                     Transactions; Description
                                                     of Capital Stock;
                                                     Description of Certain
                                                     Indebtedness; Shares
                                                     Eligible for Future Sale;
                                                     Available Information;
                                                     Index to Consolidated
                                                     Financial Statements
 12. Disclosure of Commission Position on
      Indemnification for Securities
      Act Liabilities.............................  Not applicable
</TABLE>
<PAGE>
 
                               EXPLANATORY NOTE
 
  This Registration Statement contains two forms of prospectus: one to be used
in connection with an underwritten public offering in the United States and
Canada (the "U.S. Prospectus") and one to be used in a concurrent underwritten
public offering outside the United States and Canada (the "International
Prospectus"). The U.S. Prospectus and the International Prospectus are
identical except for the front and back cover pages. The form of U.S.
Prospectus is included herein and is followed by the alternate pages to be
used in the International Prospectus. The alternate pages for the
International Prospectus included herein are each labeled "International
Prospectus Alternate Page". Final forms of each prospectus will be filed with
the Securities and Exchange Commission under Rule 424(b) under the Securities
Act of 1933, as amended.
<PAGE>

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A         +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE   +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY  +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT        +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR   +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE      +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE    +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF  +
+ANY SUCH STATE.                                                               +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

 
                   SUBJECT TO COMPLETION, DATED JUNE 3, 1996
PROSPECTUS
 
                                       SHARES                          [LOGO]
                          DAL-TILE INTERNATIONAL INC.
                                  COMMON STOCK
 
                                   --------
 
  All of the shares of Common Stock, $.01 par value per share (the "Common
Stock"), offered hereby are being sold by Dal-Tile International Inc. Of the
     shares of Common Stock offered hereby, a total of      shares are being
offered hereby for sale in the United States and Canada (the "U.S. Offering")
by the U.S. Underwriters (as defined) and a total of      shares are being
offered by the Managers (as defined) in a concurrent international offering
outside the United States and Canada (the "International Offering" and,
together with the U.S. Offering, the "Offerings").
 
  Prior to the Offerings, there has been no public market for the Common Stock
of the Company. It is currently anticipated that the initial public offering
price will be between $    and $    per share. See "Underwriting" for
information relating to the factors considered in determining the initial
public offering price.
 
  Application will be made to have the Common Stock listed on the New York
Stock Exchange under the symbol "   ".
 
                                   --------
 
  SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
 
                                   --------
 
THESE SECURITIES HAVE  NOT BEEN APPROVED  OR DISAPPROVED BY  THE SECURITIES AND
EXCHANGE COMMISSION OR  ANY STATE SECURITIES COMMISSION NOR  HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
    PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
     PROSPECTUS.  ANY   REPRESENTATION  TO  THE
      CONTRARY IS A CRIMINAL OFFENSE.
 
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                     UNDERWRITING
           PRICE TO DISCOUNTS AND  PROCEEDS TO
            PUBLIC  COMMISSIONS(1) COMPANY(2)
- ----------------------------------------------
<S>        <C>      <C>            <C>
Per Share    $           $             $
- ----------------------------------------------
Total(3)     $           $            $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
 (1) For information regarding indemnification of the U.S. Underwriters and
     the Managers, see "Underwriting".
 
 (2) Before deducting expenses estimated at $    payable by the Company.
 
 (3) The Company has granted the U.S. Underwriters a 30-day option to purchase
     up to        additional shares of Common Stock solely to cover over-
     allotments, if any. See "Underwriting". If such option is exercised in
     full, the total Price to Public, Underwriting Discounts and Commissions,
     and Proceeds to Company will be $   , $   , and $   , respectively.
 
                                   --------
 
  The shares of Common Stock are being offered by the several U.S. Underwriters
named herein, subject to prior sale, when, as and if accepted by them and
subject to certain conditions. It is expected that certificates for the shares
of Common Stock offered hereby will be available for delivery on or about
        , 1996, at the office of Smith Barney Inc., 333 West 34th Street, New
York, New York 10001.
 
                                   --------
 
SMITH BARNEY INC.
           DILLON, READ & CO. INC.
                      GOLDMAN, SACHS & CO.
                                                            MORGAN STANLEY & CO.
                                          INCORPORATED
 
        , 1996
<PAGE>
 
 
 
        [Photographs of residential and commercial applications of tile]
 
 
 
                               ----------------
 
  The Company has a number of trademarks and trade names, including
Daltile(TM), American Olean(R) and Homesource(TM).
 
                               ----------------
 
  IN CONNECTION WITH THE OFFERINGS, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
 
                                       2
<PAGE>
 
 
                               PROSPECTUS SUMMARY
 
  The following summary is qualified in its entirety by, and should be read in
conjunction with, the more detailed information and financial statements and
related notes thereto appearing elsewhere in this Prospectus. Industry data
used throughout this Prospectus were obtained from industry publications and
internal Company estimates that the Company believes to be reliable, but has
not independently verified. Unless the context otherwise requires, all
references to "Dal-Tile" herein refer to Dal-Tile International Inc. and all
references to the "Company" herein refer collectively to Dal-Tile and its
subsidiaries, including the operations of American Olean Tile Company, Inc.
which was acquired on December 29, 1995. Except where otherwise indicated, the
information in this Prospectus, including all share and per share amounts, (i)
assumes the U.S. Underwriters' over-allotment option is not exercised, and (ii)
reflects the conversion of all shares of all classes of the Company's currently
outstanding capital stock into      shares of Common Stock (the "Common Stock
Conversion"). See "Description of Capital Stock--Common Stock Conversion" and
"Underwriting".
 
                                  THE COMPANY
 
  The Company is the largest manufacturer, distributor and marketer of ceramic
tile in North America, and one of the largest in the world. The Company
produces and distributes a broad line of high quality wall tile and floor tile
products for both residential and commercial applications, marketed primarily
under its Daltile and American Olean brand names. The Company's strengths
include (i) the U.S. ceramic tile industry's broadest distribution system,
consisting of Company-operated sales centers, independent distributors and home
center retailers; (ii) leading brand names; (iii) North America's largest
ceramic tile manufacturing capacity, with low cost manufacturing plants in the
United States and Mexico; and (iv) the U.S. ceramic tile industry's most
comprehensive product offering, including glazed and unglazed ceramic tile,
stone products and installation materials and tools. From 1985 through 1995,
the Company's net sales have increased at a compound annual rate of 10.9%,
exclusive of the AO Acquisition described below.
 
  On December 29, 1995, the Company acquired American Olean Tile Company, Inc.
("AO") and certain related assets of the ceramic tile business of Armstrong
World Industries, Inc. ("AWI") (the "AO Acquisition"). As a result of the AO
Acquisition, the Company has increased its presence in all ceramic tile
applications and distribution channels and expects to achieve significant cost
savings. The Company believes, inclusive of AO, that it had an approximately
28% unit share of the 1.32 billion square feet of ceramic tile sold in the
United States in 1995, which was significantly greater than the Company's
nearest competitor. Pro forma for the AO Acquisition, the Company's net sales
and operating income for the fiscal year ended December 31, 1995 were $724.4
million and $117.2 million, respectively. See "Unaudited Pro Forma Consolidated
Financial Information".
 
INDUSTRY OVERVIEW
 
  Since 1991, U.S. ceramic tile sales (by unit volume) have increased from
approximately 916 million square feet to approximately 1.32 billion square feet
in 1995. The Company believes that ceramic tile consumption has increased due
to (i) increasing usage of tile, particularly floor tile, in remodeling and
redecorating applications; (ii) the development of new uses for tile such as
countertops and back splashes; (iii) increasing usage of tile in areas of the
home such as dens, patios, kitchens and foyers; and (iv) increasing usage of
tile in commercial applications such as restaurants, schools, hospitals,
hotels, airports and retail establishments. The Company expects these trends to
continue due to increasing consumer awareness of ceramic tile's aesthetic and
utilitarian advantages, as well as ceramic tile's relatively low cost over its
useful life.
 
  In recent years, ceramic tile has increased its share of the overall U.S.
floor covering market. While U.S. ceramic tile unit sales grew at a compound
annual rate of 9.5% from 1991 to 1995, carpet, resilient flooring and
 
                                       3
<PAGE>
 
wood flooring products increased 6.2%, 4.4% and 8.2%, respectively, during the
same period. Nevertheless, ceramic tile comprised only a small portion of the
approximately 23 billion square feet of U.S. floor covering sales in 1995. In
addition, despite a 39% increase in U.S. per capita ceramic tile consumption
from 1991 to 1995, the United States continues to lag significantly behind
overall Western European per capita consumption, which the Company believes is
an indication of growth potential in the U.S. ceramic tile business.
 
COMPANY ATTRIBUTES AND OPERATING STRATEGIES
 
  The Company believes that it is well positioned to capitalize on the growing
demand for ceramic tile. The following attributes and operating strategies have
enabled it to achieve its current market presence and should serve as a basis
for the Company's future growth and profitability:
 
 . Industry's Broadest Distribution Network. The Company's products are sold
  through (i) Company-operated sales centers; (ii) independent distributors;
  and (iii) home center retailers. The Company's sales center network consists
  of more than 235 Company-operated sales centers (after giving effect to the
  anticipated closing of redundant sales centers in connection with the AO
  Acquisition) in 44 states, which is the largest wholesale distribution
  network in the U.S. ceramic tile industry, serving customers in all 50
  states. The sales centers function as a "one-stop" source for ceramic tile,
  stone products and installation materials and tools ("allied products"),
  serving tile contractors, architects, design professionals, builders and
  developers. As a result of the AO Acquisition, the Company also markets its
  products to over 100 independent distributor locations for resale to
  approximately 5,000 retail outlets. In addition, the Company is the
  industry's leading supplier to the do-it-yourself ("DIY") and buy-it-yourself
  ("BIY") markets by supplying home center retailers, including The Home Depot,
  Lowe's, Menards and Payless Cashways. The home center retailer channel has
  provided the Company with new sources of sales over the past five years.
  Sales to both independent distributors and home center retailers are expected
  to present significant growth opportunities for the Company.
 
 . Leading Brand Names Marketed through Targeted Distribution Channels. The
  Company believes that it has two of the leading brand names in the U.S.
  ceramic tile industry--Daltile and American Olean--and has recently
  established the new Homesource brand name. The Company's strategy is to
  independently market each of its brands to create brand differentiation
  within its respective customer segments. Company-operated sales centers
  principally distribute the Daltile brand, while the American Olean brand is
  principally marketed through independent distributors. In addition to
  distributing the Daltile and American Olean brands, home center retailers
  distribute the newly established home center brand--Homesource.
 
 . New Product Development Driven by Technological Innovation. The Company
  believes that, due to technological innovations, the ceramic tile industry is
  increasing its fashion orientation, particularly in the floor tile market.
  The Company has developed capabilities to produce fashionable and innovative
  tile products and to simulate natural products such as stone, marble and
  wood. In order to capitalize on the increasing demand for, and high margins
  generated by, fashion-oriented tile products, the Company has (i) increased
  the number of new floor tile product introductions; (ii) focused on
  shortening product introduction cycle time; (iii) expanded its relationships
  with leading glaze and equipment manufacturers; (iv) focused on evolving
  consumer preferences to deliver products consistent with current design
  trends; and (v) increased its investment in research and development to
  further develop new products and manufacturing capabilities.
 
 . Broad and Differentiated Product Line. The Company offers the most
  comprehensive product line in the U.S. ceramic tile industry, including
  glazed floor tile, glazed wall tile, glazed and unglazed mosaic tile,
  porcelain tile, quarry tile, stone products and allied products. In addition,
  the Company believes that it produces the industry's largest offering of
  colors, textures and finishes and that its ability to efficiently manufacture
  the industry's largest offering of trim and angle pieces differentiates the
  Company from many
 
                                       4
<PAGE>
 
  of its competitors, including foreign ceramic tile manufacturers. Management
  believes that the Company's comprehensive product line, including its trim
  and angle pieces and fashion-oriented tile products, results in an average
  selling price for Company-produced tile higher than the industry average. The
  Company also sells products manufactured by third parties for resale,
  including ceramic tile and allied products, which constituted approximately
  30% of net sales in 1995, inclusive of AO. The Company also intends to
  increase the amount of Company-manufactured products as a percentage of net
  sales, which products historically have generated higher margins than
  products purchased for resale.
 
 . Low Cost Manufacturing. The Company believes it is one of the U.S. ceramic
  tile industry's lowest cost producers and has the largest manufacturing
  capacity in North America with an annual manufacturing capacity of
  approximately 311 million square feet. In addition, as a result of the AO
  Acquisition, the Company also has the contractual right to be supplied with
  an additional 24 million square feet of floor tile annually by a Mexican
  joint venture. The Company's manufacturing facility in Monterrey, Mexico
  represents approximately 40% of the Company's manufacturing capacity. In
  1995, the Company initiated full production at its newest facility, a highly
  automated wall tile plant in El Paso, Texas. Since 1991, the Company
  (exclusive of AO) has invested over $89.6 million in capital expenditures,
  including $62.6 million in new plants and state-of-the-art equipment to
  increase manufacturing capacity, improve efficiency and develop new
  capabilities. Over the next 18 months, the Company intends to further
  increase capacity at its existing floor tile factories in the United States
  and Mexico. The Company believes that additional manufacturing investments
  will continue to generate attractive rates of return due to the Company's
  economies of scale in manufacturing and its ability to leverage its broad
  distribution network.
 
SIGNIFICANT BENEFITS RESULTING FROM THE AO ACQUISITION
 
  In addition to providing the Company with one of the U.S. ceramic tile
industry's best known brands and product lines and a significantly increased
presence in the independent distributor channel, the AO Acquisition provides
the Company with the opportunity to achieve significant cost savings and sales
diversification.
 
 . Cost Savings. The Company expects to achieve significant cost savings as a
  result of the AO Acquisition by (i) consolidating manufacturing facilities,
  (ii) restructuring its sales organizations, and (iii) eliminating duplicative
  administration functions. The Company believes that the operational changes
  implemented to date will enable it to achieve annual cost savings of
  approximately $34.9 million (of which approximately $26.8 million is expected
  to be realized in 1996). These cost savings include $10.1 million
  attributable to reductions in depreciation and amortization expense pursuant
  to purchase accounting. In connection with these operational changes, the
  Company has recorded non-recurring pre-tax merger integration charges of $9.0
  million in the three months ended March 31, 1996 and $22.4 million in the
  fiscal year ended December 31, 1995. In addition to the operational changes
  implemented to date, the Company intends to implement additional cost saving
  initiatives, which the Company believes will enable it to realize significant
  additional cost savings.
 
  THE ANTICIPATED COST SAVINGS DESCRIBED HEREIN ARE BASED ON ESTIMATES AND
  ASSUMPTIONS MADE BY THE COMPANY THAT, ALTHOUGH CONSIDERED REASONABLE BY THE
  COMPANY, ARE SUBJECT TO SIGNIFICANT BUSINESS, ECONOMIC AND OTHER
  UNCERTAINTIES. THERE CAN BE NO ASSURANCE THAT SUCH COST SAVINGS WILL BE
  ACHIEVED OR THAT THE BENEFITS OF SUCH COST SAVINGS WILL NOT BE MITIGATED BY
  OTHER FACTORS AFFECTING THE COMPANY'S PERFORMANCE. SEE "RISK FACTORS--RISKS
  RELATED TO REALIZING BENEFITS FROM AO ACQUISITION".
 
 . Sales Diversification. As a result of the AO Acquisition, the Company is
  diversified both in its business mix and geographical presence. The Company
  believes that its sales are relatively evenly distributed between residential
  and commercial applications. In addition, AO's significant presence in the
  northeast and midwest regions of the United States complements the Company's
  long-standing presence in the west and sunbelt regions of the United States.
 
 
                                       5
<PAGE>
 
BACKGROUND
 
  The Company commenced operations in 1947 as the Dallas Ceramic Company and
established its first wall tile manufacturing facility and corporate
headquarters in Dallas, Texas. On January 9, 1990, AEA Investors Inc., a
privately held corporation headquartered in New York ("AEA Investors"),
arranged for Dal-Tile to acquire (the "AEA Acquisition") all the outstanding
capital stock of Dal-Tile Corporation, its affiliated companies and certain
related assets. After giving effect to the Offerings, AEA Investors, its
current and former management and its investor-stockholders (collectively, the
"AEA Shareholders"), will beneficially own   % of the outstanding Common Stock
(  %, if the U.S. Underwriters' over-allotment option is exercised in full).
 
  As part of the AO Acquisition, which was completed on December 29, 1995, AWI
received 37% of Dal-Tile's outstanding capital stock and paid the Company cash
in the amount of $27.6 million. After giving effect to the Offerings, Armstrong
Enterprises, Inc., a wholly owned subsidiary of AWI ("AEI"), will beneficially
own   % of the outstanding Common Stock (  %, if the U.S. Underwriters' over-
allotment option is exercised in full).
 
  Dal-Tile was incorporated under Delaware law in 1987. The principal executive
offices of the Company are located at 7834 Hawn Freeway, Dallas, Texas 75217.
Its telephone number at that address is (214) 398-1411.
 
                           FORWARD-LOOKING STATEMENTS
 
  This Prospectus includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934, as amended, and is
subject to the safe-harbor created by such sections. The Company's actual
results may differ significantly from the results discussed in such forward-
looking statements. Certain factors that might cause such differences include,
but are not limited to, the "Risk Factors" described herein.
 
                                  RISK FACTORS
 
  See "Risk Factors" for a discussion of certain factors that should be
considered in evaluating an investment in the Common Stock.
 
                                       6
<PAGE>
 
                                 THE OFFERINGS
 
Common Stock offered:
 U.S. Offering.............        shares (1)
 International Offering....        shares
                              ------
  Total...................         shares (1)
 
Common Stock to be
 outstanding after the
 Offerings..................
                                   shares (1)(2)
 
Use of proceeds.............  The net proceeds from the Offerings are estimated
                              to be approximately $120 million. Such net
                              proceeds will be used to repay outstanding
                              indebtedness in connection with the Refinancing
                              (as defined) and to pay related prepayment
                              premiums and fees and expenses.
 
                              In connection with the Refinancing, the Company
                              also contemplates entering into a new bank credit
                              agreement (the "New Bank Credit Agreement"),
                              consisting of a $275 million term loan (the "New
                              Term Loan"), and a $250 million revolving line of
                              credit (the "New Revolving Credit Facility").
                              After the Refinancing, the Company will have
                              remaining availability under the New Revolving
                              Credit Facility, which may be used for general
                              corporate purposes, including capital
                              expenditures.
 
                              The closing of the Offerings and the closing
                              under the New Bank Credit Agreement will be
                              contingent upon each other and are expected to
                              occur simultaneously. See "Refinancing", "Use of
                              Proceeds", "Capitalization" and "Description of
                              Certain Indebtedness".
 
Proposed New York Stock
 Exchange symbol............
 
 
- --------
(1) Does not include      shares of Common Stock that are subject to an over-
    allotment option granted by Dal-Tile to the U.S. Underwriters. See
    "Underwriting".
 
(2) Excludes      shares of Common Stock reserved for issuance upon the
    exercise of outstanding stock options granted to certain employees of the
    Company pursuant to the Company's stock option plans. See "Management--
    Executive Compensation" and "Description of Capital Stock--Common Stock
    Conversion".
 
                                       7
<PAGE>
 
          SUMMARY CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL DATA
 
  The following table presents summary consolidated historical, pro forma and
as adjusted financial data at the dates and for the periods indicated.
Operating results for the three months ended March 31, 1996 are not necessarily
indicative of the results that may be expected for the full year ending
December 31, 1996. The summary consolidated pro forma and as adjusted financial
data are provided for informational purposes only and do not purport to be
indicative of the results which actually would have been obtained had the AO
Acquisition, the Refinancing, or both, as the case may be, been completed on
the dates indicated and which may be expected to occur in the future. The
following data should be read in conjunction with "Selected Consolidated
Financial Data", "Unaudited Pro Forma Consolidated Financial Information",
"Risk Factors--Risks Related to Realizing Benefits from AO Acquisition",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Consolidated Financial Statements and related
notes thereto included elsewhere in this Prospectus (the "Consolidated
Financial Statements").
 
<TABLE>
<CAPTION>
                                                                           THREE MONTHS ENDED
                                 YEAR ENDED DECEMBER 31,                        MARCH 31,
                          --------------------------------------------    ------------------
                                                             PRO FORMA
                            1993         1994      1995       1995(1)       1995    1996(2)
                          ---------    --------  --------    ---------    --------  --------
                               (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                       <C>          <C>       <C>         <C>          <C>       <C>         
OPERATING DATA:
 Net sales..............  $ 440,573    $506,309  $474,812    $724,446     $119,353  $170,674
 Cost of goods sold.....    239,379     268,272   225,364     370,378       58,110    87,940
                          ---------    --------  --------    --------     --------  --------
 Gross profit...........    201,194     238,037   249,448     354,068       61,243    82,734
 Operating expenses (ex-
  cluding non-recurring
  charges)..............    157,314     169,720   172,493     236,832       44,666    59,510
                          ---------    --------  --------    --------     --------  --------
 Operating income before
  non-recurring charges.     43,880      68,317    76,955     117,236       16,577    23,224
 Non-recurring charges:
 Provision for merger
  integration charges...        --          --     22,430(3)      --           --      9,000(4)
 Provision for special
  charges...............     53,233(5)      --        --          --           --        --
 Write-down of goodwill.    214,235(6)      --        --          --           --        --
                          ---------    --------  --------    --------     --------  --------
 Operating income
  (loss)................   (223,588)     68,317    54,525     117,236       16,577    14,224
 Interest expense (net).     46,229      52,139    54,203      54,203       13,079    13,259
 Other (income) expense.      1,088      (1,341)   (2,994)     (2,994)      (1,600)     (531)
                          ---------    --------  --------    --------     --------  --------
 Income (loss) before
  income taxes..........   (270,905)     17,519     3,316      66,027        5,098     1,496
 Income tax provision
  (benefit).............     (3,225)     10,614     1,176      23,413        4,272       566
                          ---------    --------  --------    --------     --------  --------
 Net income (loss)......  $(267,680)   $  6,905  $  2,140    $ 42,614     $    826  $    930
                          =========    ========  ========    ========     ========  ========
AS ADJUSTED OPERATING
 DATA:
 Net income as adjusted.                                     $ 61,148(7)            $ 10,828(8)
                                                             ========               ========
 Net income per share as
  adjusted (9)..........                                     $                      $
                                                             ========               ========
 Weighted average shares
  outstanding as ad-
  justed (9)............
OTHER OPERATING DATA:
 Net sales (United
  States and Canada)....  $ 394,044    $457,715  $451,800    $701,434     $111,306  $165,489
 Net sales (Mexico).....     46,529      48,594    23,012      23,012        8,047     5,185
 Gross margin...........       45.7%       47.0%     52.5%       48.9%        51.3%     48.5%
 Operating margin before
  non-recurring charges
  ......................       10.0%       13.5%     16.2%       16.2%        13.9%     13.6%
 Depreciation and amor-
  tization..............  $  22,019    $ 17,020  $ 17,164    $ 20,962     $  4,302  $  5,390
 Capital expenditures...     17,066      14,160    29,392      38,964        5,505     5,673
</TABLE>
 
<TABLE>
<CAPTION>
                                                             MARCH 31, 1996
                                                        ------------------------
                                                         ACTUAL  AS ADJUSTED(10)
                                                        -------- ---------------
                                                         (DOLLARS IN THOUSANDS)
<S>                                                     <C>      <C>
BALANCE SHEET DATA:
 Working capital....................................... $165,141    $202,321
 Total assets..........................................  642,514     621,458
 Total debt............................................  523,534     415,487
 Stockholders' equity..................................   10,364     109,284
</TABLE>
 
                                            (footnotes appear on following page)
 
                                       8
<PAGE>
 
- --------
 (1) The summary pro forma operating data for the year ended December 31, 1995
     have been prepared to give effect to the AO Acquisition (including the
     benefits of certain cost savings initiatives) as if such transaction had
     occurred on January 1, 1995, and the elimination of a pre-tax $22.4
     million merger integration charge recorded by the Company as a result of
     the AO Acquisition. See "Unaudited Pro Forma Consolidated Financial
     Information" and "Risk Factors--Risks Related to Realizing Benefits from
     AO Acquisition".
 (2) The summary operating data for the three months ended March 31, 1996
     include the results of operations of AO and certain related assets of the
     ceramic tile business of AWI, but do not give effect to the anticipated
     benefits of certain cost savings initiatives in connection with the AO
     Acquisition which have been implemented to date.
 (3) In the fourth quarter of 1995, the Company recorded a pre-tax $22.4
     million merger integration charge for the revaluation of certain assets in
     connection with the AO Acquisition. See Note 6 to the Consolidated
     Financial Statements.
 (4) In the first quarter of 1996, the Company recorded a pre-tax $9.0 million
     merger integration charge for the closing of duplicative sales centers and
     distribution centers, the closing of certain manufacturing facilities and
     severance costs. See Note 7 to the Consolidated Financial Statements.
 (5) In the fourth quarter of 1993, the Company established provisions for a
     distribution enhancement program, revaluation of certain assets and
     severance costs for retiring employees. As a result, the Company recorded
     a pre-tax $53.2 million special charge in the fourth quarter of 1993. See
     Note 8 to the Consolidated Financial Statements.
 (6) In connection with a review of its operations during the fourth quarter of
     1993, the Company wrote off $214.2 million of goodwill related to the
     following business units: Ceramica Regiomontona, S.A. de C.V. ("Dal-Tile
     Mexico"), Materiales Ceramicos, S.A. de C.V. ("Materiales"), Dal-Minerals
     Company ("Dal-Minerals") and R&M Supplies Inc. ("R&M"). See Note 9 to the
     Consolidated Financial Statements.
 (7) Summary net income as adjusted for the year ended December 31, 1995 has
     been prepared to give effect to the AO Acquisition (including the benefits
     of certain cost savings initiatives) and the Refinancing as if such
     transactions had occurred on January 1, 1995, and the elimination of a
     pre-tax $22.4 million merger integration charge recorded by the Company as
     a result of the AO Acquisition. See "Refinancing", "Use of Proceeds",
     "Capitalization", "Unaudited Pro Forma Consolidated Financial Information"
     and "Risk Factors--Risks Related to Realizing Benefits from AO
     Acquisition".
 (8) Summary net income as adjusted for the three months ended March 31, 1996
     has been prepared to give effect to the Refinancing as if such transaction
     had occurred on January 1, 1996, and the elimination of a pre-tax $9.0
     million merger integration charge recorded by the Company as a result of
     the AO Acquisition. See "Refinancing", "Use of Proceeds", "Capitalization"
     and "Unaudited Pro Forma Consolidated Financial Information".
 (9) The summary net income per share as adjusted data are based on net income
     as adjusted and the weighted average number of shares of Common Stock
     outstanding during the period after giving effect to the Refinancing and
     the Common Stock Conversion. See "Unaudited Pro Forma Consolidated
     Financial Information", "Refinancing" and "Description of Capital Stock--
     Common Stock Conversion".
(10) The summary as adjusted balance sheet data have been prepared to give
     effect to the Refinancing as if it had occurred on March 31, 1996. See
     "Refinancing", "Use of Proceeds" and "Capitalization". In connection with
     the Refinancing, the Company will record an extraordinary charge of $21.1
     million, net of tax, for the write off of existing deferred financing
     fees, the Termination Fee (as defined), and prepayment premiums on certain
     debt to be repaid. This charge will be recorded in the Company's third
     quarter of 1996 upon completion of the Refinancing. See "Unaudited Pro
     Forma Consolidated Financial Information".
 
                                       9
<PAGE>
 
                                 RISK FACTORS
 
  In addition to the other information contained in this Prospectus,
prospective investors should carefully consider the following risk factors in
evaluating an investment in the shares of Common Stock offered hereby.
 
RISKS RELATED TO REALIZING BENEFITS FROM AO ACQUISITION
 
  The Company has taken and plans to take certain measures which are expected
to result in significant cost savings in connection with the AO Acquisition,
including (i) consolidating manufacturing facilities, (ii) restructuring its
sales organizations, and (iii) eliminating duplicative administrative
functions. There can be no assurance that the Company will achieve the cost
savings from the AO Acquisition that management expects or that such cost
savings will occur within the time frame contemplated. Realization of such
cost savings also could be affected by a number of factors beyond the
Company's control, such as general economic conditions, increased operating
costs, potential revenue instability arising from the cost savings initiatives
or otherwise, labor relations, the response of competitors or customers,
regulatory considerations and delays in implementation. In addition, certain
of the benefits from the AO Acquisition are dependent upon the Company taking
certain future actions. The Company has recorded non-recurring merger
integration charges of $22.4 million in the fourth quarter of the year ended
December 31, 1995, and of $9.0 million in the three months ended March 31,
1996. See Notes 6 and 7 to the Consolidated Financial Statements. The Company
could incur additional non-recurring merger integration charges which,
depending on the actions taken and the accounting period, could be material.
The allocation of the purchase price relating to the AO Acquisition also is
subject to final revision based upon additional information concerning asset
and liability valuations. In addition, there can be no assurance that net
sales and profitability historically attributable to AO and the Company will
be representative of the Company's performance during the completion of, and
following the integration of, their respective businesses.
 
  The Company manufactured inventory at certain AO plants prior to their
closure at the end of the first quarter of 1996. This higher cost inventory,
relative to inventory produced at the remaining plants, will negatively impact
the Company's gross margins in the second and third quarters of 1996 as it is
sold.
 
CYCLICAL BUSINESS
 
  The ceramic tile industry is highly dependent on residential and commercial
construction activity--new construction as well as remodeling--which is
cyclical in nature and is significantly affected by changes in general and
local economic conditions. These include interest rates, housing demand,
employment levels, financing availability, commercial rental vacancy rates and
consumer confidence. A prolonged recession in any of the residential or
commercial construction industries (new construction as well as remodeling)
could result in a significant decrease in the Company's operating performance.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations".
 
LEVERAGE
 
  Although the Offerings will decrease the Company's indebtedness and interest
expense, the Company will continue to be highly leveraged. At March 31, 1996,
on a pro forma basis after giving effect to the Refinancing, the Company's
consolidated indebtedness would have been $415.5 million and its stockholders'
equity would have been $109.3 million. On such a pro forma basis, this
indebtedness would have consisted of (i) $275.0 million of the New Term Loan,
(ii) $123.2 million of borrowings under the New Revolving Credit Facility, and
(iii) $17.3 million of other long-term indebtedness. The Company may incur
additional indebtedness in the future, subject to certain limitations
contained in the instruments governing its indebtedness. See "Refinancing",
"Use of Proceeds", "Capitalization", "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources" and "Description of Certain Indebtedness".
 
  The New Bank Credit Agreement will impose operating and financial
restrictions on the Company. There can be no assurance that the Company's
existing cash balances and cash flow from operations together with
 
                                      10
<PAGE>
 
borrowings available under the New Bank Credit Agreement will be sufficient to
meet all of its debt service requirements and to fund its capital expenditure
requirements for the foreseeable future.
 
  The degree to which the Company is leveraged has important consequences to
holders of Common Stock, including the following: (i) a substantial portion of
the Company's cash flow from operations will be required to be dedicated to
the payment of the Company's debt service obligations; (ii) the Company's high
degree of leverage will make it more sensitive to a downturn in general
economic conditions; (iii) the Company's substantial indebtedness may limit
its capacity to respond to market conditions (including its ability to satisfy
capital expenditure requirements) or to meet its contractual or financial
obligations; (iv) pursuant to the instruments governing its indebtedness, the
Company is subject to restrictive financial and operating covenants that could
limit its ability to conduct its business; and (v) the Company may be more
highly leveraged than other companies with which it competes, which may place
it at a competitive disadvantage. In addition, if and to the extent the
Company requires additional financing in the future for working capital,
capital expenditures or other purposes, the Company's leverage may impair its
ability to obtain such additional financing.
 
  To the extent that the Company's existing resources and future earnings are
insufficient to fund the Company's activities or to repay indebtedness
(including annual amortization payments under the New Term Loan), the Company
may need to raise additional funds through public or private financings. If
additional funds are raised through the issuance of equity securities, the
percentage ownership of the Company's stockholders at that time would be
diluted. Further, such equity securities may have rights, preferences or
privileges senior to those of the Common Stock. See "Description of Capital
Stock".
 
  Dal-Tile's 12% Senior Secured Zero Coupon Notes Due July 15, 1998 (the "Zero
Coupon Notes") are secured by a pledge of all the outstanding capital stock of
Dal-Tile's wholly owned subsidiary, Dal-Tile Group Inc. ("Dal-Tile Group").
 
COMPETITIVE INDUSTRY; EXCHANGE RATES
 
  The Company's products are sold in a highly competitive marketplace. In the
floor and wall covering businesses, the Company competes with vendors of
carpet, resilient flooring, wood flooring, laminates, marble, porcelain, wall
paper, paint and other products. With regard to ceramic tile sales, the
Company faces extensive competition from domestic and foreign manufacturers
and independent distributors. Although the Company is the largest
manufacturer, distributor and marketer of ceramic tile in North America,
certain of its U.S. competitors are subsidiaries of publicly held companies
that may have greater resources than the Company. In addition, some of the
Company's foreign competitors may be larger and have greater resources than
the Company. In 1995, approximately 59% of U.S. ceramic tile sales (by unit
volume) consisted of imports, including the approximately 12% of ceramic tile
sold in the United States that was manufactured by the Company in Mexico. In
general, the proportion of U.S. ceramic tile sales attributable to imports has
increased in recent years. Consequently, changes in exchange rates could
affect the Company's position with respect to its foreign competitors. See "--
Impact of Mexican Operations; Currency Fluctuations", "Ceramic Tile Industry"
and "Business--Competition".
 
IMPACT OF MEXICAN OPERATIONS; CURRENCY FLUCTUATIONS
 
  Approximately 40% of the Company's manufacturing capacity is owned and
operated by subsidiaries in Mexico. Accordingly, an event which has a material
adverse impact on the Company's Mexican operations may have a material adverse
impact on the operations of the Company as a whole. The marketing,
manufacturing and regulatory environments in Mexico differ somewhat from those
in the United States.
 
  The Company's operations are subject to fluctuations in Mexican foreign
currency exchange rates relative to the U.S. dollar. Because the Company
incurs more peso-denominated costs than revenues generated in pesos,
significant increases in the value of the peso relative to the dollar could
adversely affect the Company's results of operations. Additionally, the U.S.
dollar value of the Company's net sales in Mexico varies with peso exchange
rate fluctuations. The Company realizes transaction gains or losses based on
the settlement of peso-
 
                                      11
<PAGE>
 
denominated monetary liabilities versus the exchange rates at the time of
incurrence. In addition, non-cash increases or reductions to stockholders'
equity may occur as a result of translation of foreign assets and liabilities
into dollars.
 
  The Mexican peso has been subject to large devaluations in the past, and may
be subject to significant fluctuations in the future. During 1994, the Mexican
peso devalued 37% and during 1995, the peso devalued 36%. These devaluations
resulted in a reduction of stockholders' equity of approximately $33.8 million
and $22.3 million in 1994 and 1995, respectively, as a result of translating
peso-denominated assets and liabilities into dollars. Any future devaluation
of the peso against the dollar may affect the Company's results of operations
or financial condition and may affect the value of a holder's investment in
the Common Stock.
 
  Over the last few years, a program of reform has begun to modify the nature
of the Mexican government's role in the Mexican economy. Nevertheless, the
Mexican government continues to exercise a significant influence over many
aspects of the Mexican economy. Accordingly, Mexican government actions
concerning the economy could have significant effects on private sector
entities, including the Company. The Company cannot assure that future Mexican
governmental actions or future developments in the Mexican economy, including
a continued slowdown of the Mexican economy or the development of any social
unrest, over which the Company has no control, will not impair the Company's
operations or financial condition or adversely affect the market price of the
Common Stock.
 
TARIFFS AND CUSTOMS DUTIES
 
  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
ceramic tile from non-North American countries at 17%, to be reduced ratably
to 8 1/2% by 2005. 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 under NAFTA, 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 ceramic tile from Mexico of 13%, although these duties on imports
from Mexico are being phased out ratably under NAFTA over a 13-year period. It
is uncertain what ultimate effect NAFTA will have on the Company's results of
operations.
 
CONTROL BY CERTAIN STOCKHOLDERS
 
  After giving effect to the Offerings, the AEA Shareholders will beneficially
own   % of the outstanding shares of Common Stock (or   %, if the U.S.
Underwriters' over-allotment option is exercised in full), and AEI will
beneficially own   % of the outstanding shares of Common Stock (or   %, if the
U.S. Underwriters' over-allotment option is exercised in full). Pursuant to a
Shareholders Agreement dated as of December 29, 1995 (the "AEA/AWI
Shareholders Agreement"), among Dal-Tile, AEA Investors, AWI, AEI and
Armstrong Cork Finance Corporation, each of AEA Investors and AWI agreed to
vote its shares of Common Stock for (i) six directors designated by AEA
Investors, (ii) three directors designated by AWI, and (iii) the chief
executive officer of Dal-Tile. Acting pursuant to the AEA/AWI Shareholders
Agreement, AEA Investors and AWI have sufficient voting power to control the
election of directors. If AEA Investors and AWI otherwise act in concert, they
would have sufficient voting power to decide the results of other matters
submitted to a vote of stockholders. Furthermore, such control could preclude
any unsolicited acquisition of the Company and, consequently, adversely affect
the market price of the Common Stock.
 
                                      12
<PAGE>
 
DIVIDEND POLICY; RESTRICTIONS ON PAYMENT OF DIVIDENDS
 
  Following the completion of the Offerings, the Company intends to retain any
future earnings for use in its business. Additionally, payment of dividends by
Dal-Tile on the Common Stock is restricted under the terms of the indenture
(the "Zero Coupon Note Indenture") under which the Zero Coupon Notes were
issued. Therefore, Dal-Tile does not anticipate paying any cash dividends in
the foreseeable future.
 
  Dal-Tile is a holding company with no operations or significant assets other
than its investment in its wholly owned subsidiary, Dal-Tile Group, and its
49.99% interest in Recumbriementos Interceramic, S.A. de C.V. ("RISA"), a
Mexican joint venture with Internacional de Ceramica, S.A. de C.V. 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 New Bank Credit
Agreement will limit 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. If the need by
Dal-Tile for cash distributions from Dal-Tile Group should arise in the future
(for example, to repay indebtedness), there can be no assurance that Dal-Tile
Group will be permitted to make such cash distributions. See "Dividend Policy"
and "Description of Certain Indebtedness".
 
FORWARD-LOOKING STATEMENTS
 
  This Prospectus contains certain forward-looking statements concerning the
Company's operations, economic performance and financial condition, including,
in particular, the AO Acquisition, the integration of AO's operations into the
Company's existing operations and the Company's expectations of its future
performance on an operating basis as a result of the AO Acquisition. Such
statements are subject to various risks and uncertainties. Actual results
could differ materially from those currently anticipated due to a number of
factors, including those identified under this "Risk Factors" section and
elsewhere in this Prospectus.
 
REGULATIONS AND ENVIRONMENTAL CONSIDERATIONS
 
  The Company's operations are subject to various U.S. and Mexican
environmental statutes and regulations, including laws and regulations
addressing materials used in the Company's products. In addition, certain of
the Company's operations are subject to U.S. federal, state and local and
Mexican environmental laws and regulations that impose limitations on the
discharge of pollutants into the air and water and establish standards for the
treatment, storage and disposal of solid and hazardous wastes. Although the
Company believes it has made sufficient capital expenditures to maintain
compliance with existing laws and regulations, future expenditures may be
necessary as compliance standards and technology change. Unforeseen
significant expenditures required to maintain such compliance, including
unforeseen liabilities, could have an adverse effect on the Company's business
and financial condition.
 
  The Company has from time to time been, and presently is, the subject of
administrative proceedings, litigation and investigations relating to
environmental and related matters. Although management does not believe that
such proceedings, litigation and investigations will have a material adverse
effect on the Company, 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. See "Business--Environmental
Regulation".
 
ABSENCE OF PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
 
  There has been no public market for the Common Stock prior to the Offerings,
and there can be no assurance that a significant public market for the Common
Stock will develop or will continue after the Offerings. The initial public
offering price for the Common Stock will be determined by negotiations among
the Company, the Representatives (as defined) and the Managers (as defined),
and may not be indicative of the prices that may
 
                                      13
<PAGE>
 
prevail in the public market. See "Underwriting" for a discussion of factors
considered in determining the initial public offering price. There can be no
assurance that the market price of the Common Stock will not decline below the
initial public offering price. The Company believes that variations in the
Company's results of operations and other factors, including analyst estimates
and general economic conditions, may cause the market price of the Common
Stock to vary significantly. In addition, from time to time in recent years,
the securities markets have experienced significant price and volume
fluctuations that have often been unrelated or disproportionate to the
operating performance of particular companies. Following the Offerings, sales
or the expectation of sales of substantial amounts of Common Stock in the
public market also could adversely affect the prevailing market prices for the
Common Stock. See "Shares Eligible for Future Sale".
 
SHARES ELIGIBLE FOR FUTURE SALE
 
  Upon completion of the Offerings, the Company will have outstanding
shares of Common Stock (or    shares, if the U.S. Underwriters exercise their
over-allotment option in full), all of which will be freely transferable
without restriction or further registration under the Securities Act, except
for shares held by affiliates. The Company and stockholders of the Company
owning substantially all the outstanding Common Stock immediately prior to the
Offerings (the "Existing Stockholders") have agreed not to offer, sell,
contract to sell, or otherwise dispose of, any shares of Common Stock or any
securities convertible into or exchangeable or exercisable for Common Stock,
except in certain circumstances, for 180 days after the date of this
Prospectus without the prior written consent of Smith Barney Inc. Following
the Offerings, sales or the expectation of sales of substantial amounts of
Common Stock in the public market could adversely affect the prevailing market
prices for the Common Stock. See "Shares Eligible for Future Sale".
 
  In addition,      shares of Common Stock will be reserved for issuances
pursuant to the Company's stock option plans. These shares will be available
for sale in the public market from time to time upon registration or pursuant
to available exemptions from registration. See "Shares Eligible for Future
Sale" and "Management--Executive Compensation".
 
ANTITAKEOVER PROVISIONS
 
  Dal-Tile's Amended and Restated Certificate of Incorporation (the "Restated
Certificate of Incorporation") and Amended and Restated Bylaws (the "Restated
Bylaws") contain certain provisions that could make more difficult the
acquisition of Dal-Tile by means of a tender offer, a proxy contest or
otherwise. These provisions include advance notice procedures for stockholders
to nominate candidates for election as directors of Dal-Tile and for
stockholders to submit proposals for consideration at stockholders' meetings.
The ability of Dal-Tile to issue preferred stock, par value $.01 per share
("Preferred Stock"), in one or more classes or series, with such powers,
designations, preferences and relative, participating, optional or special
rights, qualifications, limitations or restrictions as may be determined by
the Board of Directors of Dal-Tile (the "Board of Directors"), also could make
such an acquisition more difficult.
 
  Dal-Tile is subject to Section 203 of the Delaware General Corporation Law
(the "DGCL"), which limits transactions between a publicly held company and
"interested stockholders" (generally, those stockholders who, together with
their affiliates and associates, own 15% or more of a company's outstanding
capital stock). This provision of the DGCL also may have the effect of
deterring certain potential acquisitions of Dal-Tile. See "Description of
Capital Stock--Preferred Stock" and "Description of Capital Stock--Possible
Antitakeover Effect of Certain Charter and Bylaw Provisions".
 
DILUTION
 
  Based upon the pro forma net tangible book value of the Company at March 31,
1996, investors in the Offerings will suffer an immediate and substantial
dilution of approximately $   in net tangible book value per share of Common
Stock. See "Dilution".
 
 
                                      14
<PAGE>
 
                                USE OF PROCEEDS
 
  The net proceeds from the Offerings (after deducting the underwriting
discounts and commissions and estimated offering expenses) are estimated to be
approximately $120 million ($  , if the U.S. Underwriters' over-allotment
option is exercised in full) assuming an initial public offering price of $
per share. Such net proceeds will be used by the Company to repay outstanding
indebtedness in connection with the Refinancing (as defined) and to pay
related prepayment premiums and fees and expenses. See "Refinancing" and
"Capitalization".
 
  For information with respect to the interest rates and maturity dates of the
Company's indebtedness, see "Refinancing" and "Description of Certain
Indebtedness".
 
 
                                      15
<PAGE>
 
                                  REFINANCING
 
  The Company is undertaking the Offerings and the other transactions
described below (the "Refinancing") as a refinancing plan designed to improve
its financial and operating flexibility, to reduce its interest expense and to
extend the amortization of its senior indebtedness.
 
  The Company plans to use the $27.6 million cash proceeds from the sale of
capital stock as part of the AO Acquisition to redeem $34.0 million aggregate
principal amount at maturity ($26.0 million aggregate accreted value at March
31, 1996) of the Zero Coupon Notes at a redemption price of 106% of their
accreted value on the redemption date (the "Redemption").
 
  The Company currently contemplates entering into the New Bank Credit
Agreement, consisting of the $275.0 million New Term Loan and the $250.0
million New Revolving Credit Facility.
 
  The Company intends to use the net proceeds of the Offerings and borrowings
under the New Bank Credit Agreement (i) to repay in full outstanding
borrowings by Dal-Tile Group under its existing bank credit agreement,
consisting of a $160 million revolving credit facility ($128.3 million
outstanding at March 31, 1996) (the "Existing Bank Credit Agreement"); (ii) to
repay $176 million of 10.625% Series A Notes due January 9, 2000 (the "Series
A Notes") and $100 million of 10.770% Series B Notes due January 9, 2002 (the
"Series B Notes") issued by Dal-Tile Group pursuant to a note agreement (the
"Series Note Agreement"); (iii) to repurchase (by tender offer, open market
purchases, privately negotiated transactions or a combination of the
foregoing, as the Company shall determine) the Zero Coupon Notes not acquired
in the Redemption (the "Zero Coupon Note Repurchase"); and (iv) to pay accrued
interest and estimated prepayment premiums for the Series A Notes, Series B
Notes and Zero Coupon Notes, and fees and expenses.
 
  The closing of the Offerings and the closing under the New Bank Credit
Agreement will be contingent upon each other and are expected to occur
simultaneously. The closing of the Offerings is not contingent upon
consummation of the Zero Coupon Note Repurchase. There can be no assurance
that 100% of the Zero Coupon Notes will be redeemed and acquired by the
Company in the Redemption and the Zero Coupon Note Repurchase or that the
terms of the Zero Coupon Note Repurchase will not vary from those assumed by
the Company herein. The Company intends to repay the Existing Bank Credit
Agreement and prepay the Series A Notes and the Series B Notes concurrently
with the closings of the Offerings and the New Bank Credit Agreement.
 
  The following table sets forth the estimated sources and uses of funds to be
used to effect the Refinancing, assuming that the Refinancing occurred on
March 31, 1996.
 
  SOURCES OF FUNDS:                                         (IN MILLIONS)
<TABLE>
   <S>                                                                 <C>
     Cash proceeds from sale of capital stock to AWI in the AO Acqui-
      sition.........................................................  $ 27.6
     New Term Loan...................................................   275.0
     New Revolving Credit Facility(1)................................   123.2
     The Offerings(2)................................................   120.0
                                                                       ------
       Total.........................................................  $545.8
                                                                       ======
 
  USES OF FUNDS:
     Redemption of Zero Coupon Notes.................................  $ 27.6(3)
     Zero Coupon Note Repurchase(4)..................................    76.0
     Prepayment of Series A Notes....................................   176.0
     Prepayment of Series B Notes....................................   100.0
     Repayment of indebtedness under Existing Bank Credit Agree-
      ment(5)........................................................   128.3
     Accrued interest and estimated prepayment premiums for Series A
      Notes, Series B Notes and Zero Coupon Note Repurchase, and fees
      and expenses(6)................................................    37.9
                                                                       ------
       Total.........................................................  $545.8
                                                                       ======
</TABLE>
 
                                      16
<PAGE>
 
- --------
(1) The New Bank Credit Agreement will provide for borrowings under the New
    Revolving Credit Facility of up to $250.0 million. The Company will have
    remaining availability under the New Revolving Credit Facility which may
    be used for general corporate purposes, including capital expenditures.
    See "Management's Discussion and Analysis of Financial Condition and
    Results of Operations--Liquidity and Capital Resources".
(2) Represents estimated net proceeds of the Offerings (after deducting
    estimated underwriting discounts and commissions and offering expenses
    payable by the Company of $10.0 million).
(3) Includes the prepayment premium of 6% of accreted value of the Zero Coupon
    Notes subject to the Redemption.
(4) Assumes that 100% of the Zero Coupon Notes remaining after the Redemption
    are acquired by the Company in the Zero Coupon Note Repurchase. There can
    be no assurance that all such Zero Coupon Notes will be so acquired by the
    Company or that the terms of the Zero Coupon Note Repurchase will not vary
    from those assumed by the Company herein.
(5) At March 31, 1996, the weighted average interest rate for outstanding
    indebtedness under the Existing Bank Credit Agreement was 7.9%. The
    Existing Bank Credit Agreement matures on the earlier of (i) January 9,
    1998 and (ii) the seventh day following a "Change of Control" as defined
    therein.
(6) Represents fees and expenses related to the foregoing transactions (other
    than the Offerings), including lender fees, legal, accounting and other
    professional fees, and a $4.0 million fee to AEA Investors in connection
    with the termination of the Company's management agreement with AEA
    Investors (the "Termination Fee").
 
  For further information with respect to the Company's indebtedness, see
"Description of Certain Indebtedness".
 
                                      17
<PAGE>
 
                                DIVIDEND POLICY
 
  Following the completion of the Offerings, the Company intends to retain any
future earnings for use in its business. Additionally, payment of dividends by
Dal-Tile on the Common Stock is restricted under the terms of the Zero Coupon
Note Indenture. As a result, Dal-Tile does not anticipate paying any cash
dividends in the foreseeable future.
 
  Dal-Tile is a holding company with no operations or significant assets other
than its investment in 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 New Bank Credit
Agreement will limit 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. If the need for
cash distributions from Dal-Tile Group should arise in the future (for
example, to repay indebtedness), there can be no assurance that it will be
permitted to make such cash distributions. See "Description of Certain
Indebtedness".
 
  In the absence of such restrictions or limitations, the declaration and
payment of dividends will be at the sole discretion of the Board of Directors
and subject to normal limitations under the DGCL. The timing, amount and form
of dividends, if any, will depend, among other things, on the Company's
results of operations, financial condition, cash requirements, plans for
expansion and other factors deemed relevant by the Board of Directors.
 
                                      18
<PAGE>
 
                                CAPITALIZATION
 
  The following table sets forth at March 31, 1996, (i) the historical
consolidated capitalization of the Company, and (ii) the consolidated
capitalization, as adjusted to reflect the Refinancing, including the sale by
the Company of    shares of Common Stock in the Offerings (assuming an
offering price of $    per share), and the application of the estimated net
proceeds therefrom. See "Refinancing", "Use of Proceeds", "Unaudited Pro Forma
Consolidated Financial Information", "Selected Consolidated Financial Data"
and "Description of Capital Stock--Common Stock Conversion".
 
<TABLE>
<CAPTION>
                                                           MARCH 31, 1996
                                                        ---------------------
                                                         ACTUAL   AS ADJUSTED
                                                        --------  -----------
                                                           (IN THOUSANDS)
<S>                                                     <C>       <C>
Current portion of long-term debt...................... $ 47,047   $  3,047
                                                        --------   --------
Long-term debt (excluding current portion):
  Zero Coupon Notes....................................  101,997        --
  Existing Bank Credit Agreement.......................  128,297        --
  New Term Loan........................................      --     275,000
  New Revolving Credit Facility........................      --     123,247
  Series A Notes.......................................  132,000        --
  Series B Notes.......................................  100,000        --
  Industrial Development Refunding and Revenue Bonds...    5,500      5,500
  Other................................................    8,693      8,693
                                                        --------   --------
    Total long-term debt...............................  476,487    412,440
                                                        --------   --------
      Total debt.......................................  523,534    415,487
                                                        --------   --------
Stockholders' equity:
  Preferred Stock, $.01 par value per share;
   shares authorized; no shares issued and outstanding.
  Common Stock, $.01 par value per share;      shares
   authorized;      shares issued and outstanding, ac-
   tual;      shares issued and outstanding, as ad-
   justed (1)..........................................
  Additional paid-in capital...........................  334,076    454,076
  Accumulated deficit.................................. (265,074)  (286,154)(2)
  Currency translation adjustment......................  (58,638)   (58,638)
                                                        --------   --------
    Total stockholders' equity.........................   10,364    109,284
                                                        --------   --------
      Total capitalization............................. $533,898   $524,771
                                                        ========   ========
</TABLE>
- --------
(1) Excludes     shares of Common Stock reserved for issuance upon the
    exercise of outstanding stock options granted to certain employees of the
    Company pursuant to the Company's stock option plans. See "Management--
    Executive Compensation" and "Description of Capital Stock--Common Stock
    Conversion".
(2) In connection with the Refinancing, the Company will record an
    extraordinary charge of $21.1 million, net of tax, for the write off of
    existing deferred financing fees, the Termination Fee and prepayment
    premiums on certain debt to be repaid. This charge will be recorded in the
    Company's third quarter of 1996 upon completion of the Refinancing. See
    "Unaudited Pro Forma Consolidated Financial Information".
 
                                      19
<PAGE>
 
                                   DILUTION
 
  At March 31, 1996, the net tangible book value of the Company was a deficit
of $177.7 million, or $    per share of Common Stock. The deficit in net
tangible book value per share represents the amount of total assets (excluding
intangible assets) less total liabilities, divided by the total number of
shares of Common Stock that will be outstanding upon consummation of the
Common Stock Conversion.
 
  After giving effect to the receipt of $120.0 million of estimated net
proceeds from the sale by Dal-Tile of    shares of Common Stock in the
Offerings, and the application of such estimated net proceeds as described
under "Use of Proceeds", the net tangible book value at March 31, 1996 would
have been a deficit of $57.7 million, or $    per share of Common Stock. This
represents an immediate increase in net tangible book value of $    per share
of Common Stock to the Existing Stockholders and an immediate dilution to new
investors in the Offerings of $    per share of Common Stock. The following
table illustrates such dilution:
 
<TABLE>
   <S>                                                                 <C> <C>
   Assumed per share initial price to public..........................     $
   Deficit in net tangible book value per share at March 31, 1996..... $
   Increase in net tangible book value per share attributable to new
    investors.........................................................
   Pro forma net tangible book value per share after the Offerings....
                                                                           ----
   Dilution per share to new investors................................     $
                                                                           ====
</TABLE>
 
  The following table sets forth, at March 31, 1996, the difference between
the Existing Stockholders and the new investors who purchase Common Stock in
the Offerings at an assumed initial public offering price of $   per share,
with respect to the number of shares purchased from the Company, the total
consideration paid and the average price per share paid:
 
<TABLE>
<CAPTION>
                                           SHARES          TOTAL
                                         PURCHASED     CONSIDERATION    AVERAGE
                                       --------------  --------------    PRICE
                                       NUMBER PERCENT  AMOUNT PERCENT  PER SHARE
                                       ------ -------  ------ -------  ---------
<S>                                    <C>    <C>      <C>    <C>      <C>
Existing Stockholders.................              %   $           %    $
New investors.........................                  $
                                        ---    -----    ----   -----
  Total (1)...........................         100.0 %  $      100.0 %
                                        ===    =====    ====   =====
</TABLE>
- --------
(1) Excludes     shares of Common Stock reserved for issuance upon the
    exercise of outstanding stock options granted to certain employees of the
    Company pursuant to the Company's stock option plans at an average
    exercise price of approximately $   per share. To the extent such options
    are exercised, there will be further dilution to new investors. See
    "Management--Executive Compensation" and "Description of Capital Stock--
    Common Stock Conversion".
 
                                      20
<PAGE>
 
            UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
 
  The unaudited pro forma consolidated financial statements presented below
reflect the effects of adjustments to the historical consolidated financial
statements of the Company and notes thereto necessary to give pro forma effect
to the AO Acquisition and the Refinancing, including the Offerings and the
application of the estimated net proceeds therefrom. The pro forma operating
data for the year ended December 31, 1995 give effect to the AO Acquisition,
including certain identified cost savings, and to the Refinancing, including
the Offerings and the application of the estimated net proceeds therefrom, as
if such transactions had occurred on January 1, 1995. The pro forma operating
data for the three months ended March 31, 1996 give effect to the Refinancing,
including the Offerings and the application of the estimated net proceeds
therefrom, as if such transactions had occurred on January 1, 1996. The pro
forma balance sheet data has been prepared as if the Refinancing, including
the Offerings and the application of the estimated net proceeds therefrom, had
occurred on March 31, 1996.
 
  Management believes that the assumptions used provide a reasonable basis on
which to present the pro forma financial data; however, such assumptions are
subject to significant business, economic and other uncertainties. The
unaudited pro forma consolidated financial statements are provided for
informational purposes only and should not be construed to be indicative of
the Company's results of operations or financial position had the AO
Acquisition and the Refinancing, including the Offerings, been consummated on
or as of the dates assumed, and are not intended to project the Company's
results of operations or its financial position for any future period or as of
any future date.
 
  The following Unaudited Pro Forma Consolidated Financial Information should
be read in conjunction with the Consolidated Financial Statements of the
Company, the consolidated financial statements of the Ceramic Tile Operations
of AWI and, in each case, the related notes, and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
in this Prospectus.
 
  The following assumptions have been utilized to determine the adjustments
included in the unaudited pro forma consolidated financial statements of the
Company:
 
    a. The AO Acquisition was accounted for by the Company as a purchase.
  Accordingly, the assets and liabilities acquired and assumed were adjusted
  to reflect their fair market values at the date of the AO Acquisition. Pro
  forma adjustments for the AO Acquisition represent the Company's
  preliminary determination of these amounts and are based upon available
  information and certain assumptions the Company considers reasonable. The
  final purchase price allocation for the AO Acquisition could differ from
  that set forth below.
 
    b. For purposes of the pro forma operating data for the year ended
  December 31, 1995, in addition to assuming the AO Acquisition occurred at
  the beginning of such period, the pro forma adjustments assume that the
  following cost savings initiatives also were undertaken at such time and
  that the estimated savings therefrom were realized for such period: (i) the
  elimination of duplicative manufacturing facilities and Company-operated
  sales centers; (ii) the reduction of duplicative sales organization staff;
  and (iii) the elimination of duplicative research and development programs;
  offset in part by increased costs in connection with management information
  systems and advertising. The estimated net savings of $34.9 million for the
  pro forma fiscal year ended December 31, 1995 (of which $10.1 million
  represents reductions in depreciation and amortization expense pursuant to
  purchase accounting) are reflected in the pro forma adjustments. The
  anticipated cost savings described herein are based on estimates and
  assumptions made by the Company that, although considered reasonable by the
  Company, are subject to significant business, economic and other
  uncertainties. There can be no assurance that such cost savings will be
  achieved or that the benefits of such cost savings will not be mitigated by
  other factors affecting the Company's performance. See "Risk Factors--Risks
  Related to Realizing Benefits from AO Acquisition".
 
 
                                      21
<PAGE>
 
    c. The pro forma adjustments assume that 100% of the Zero Coupon Notes
  were redeemed and acquired in the Redemption and the Zero Coupon Note
  Repurchase, respectively. There can be no assurance that 100% of the Zero
  Coupon Notes will be so redeemed and acquired by the Company or that the
  terms of the Zero Coupon Note Repurchase will not vary from those assumed
  by the Company herein. The closing of the Offerings is not contingent upon
  consummation of the Zero Coupon Note Repurchase.
 
    d. Assuming an initial public offering price of $    per share, the net
  proceeds to the Company from the Offerings are estimated to be $120 million
  (assuming the U.S. Underwriters' over-allotment options is not exercised),
  after deducting estimated underwriting discounts and commissions and
  offering expenses payable by the Company.
 
  In connection with the Refinancing, the Company will record an extraordinary
charge of $33.9 million ($21.1 million, net of tax) for the write off of
existing deferred financing fees, the Termination Fee and prepayment premiums
on certain debt to be repaid. This charge will be recorded in the Company's
third quarter of 1996 upon completion of the Refinancing.
 
 
                                      22
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
                 UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
 
                                 MARCH 31, 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                       REFINANCING       AS
                                           HISTORICAL  ADJUSTMENTS    ADJUSTED
                                           ----------  -----------    ---------
<S>                                        <C>         <C>            <C>
                  ASSETS
Current assets:
 Cash..................................... $  39,131    $ (27,575)(a) $  11,556
 Trade accounts receivable................   106,879          --        106,879
 Inventories..............................   121,876          --        121,876
 Prepaid expenses.........................     4,345          --          4,345
 Deferred tax asset.......................       --         8,826 (a)     8,826
 Other current assets.....................     9,483          --          9,483
                                           ---------    ---------     ---------
    Total current assets..................   281,714      (18,749)      262,965
 Property, plant and equipment, net.......   169,862          --        169,862
 Goodwill net of amortization.............   160,825          --        160,825
 Finance costs, net of amortization.......     6,307       (2,307)(a)     4,000
 Other assets.............................    23,806          --         23,806
                                           ---------    ---------     ---------
    Total assets.......................... $ 642,514    $ (21,056)    $ 621,458
                                           =========    =========     =========
   LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Trade accounts payable and accrued ex-
  penses.................................. $  47,290    $     --      $  47,290
 Accrued interest payable.................     7,928       (7,928)(a)       --
 Current portion of long-term debt........    47,047      (44,000)(b)     3,047
 Deferred income taxes....................     4,001       (4,001)(a)       --
 Other current liabilities................    10,307          --         10,307
                                           ---------    ---------     ---------
    Total current liabilities.............   116,573      (55,929)       60,644
Long-term debt............................   476,487     (108,047)(a)
                                                           44,000 (b)   412,440
Other long-term liabilities...............    38,022          --         38,022
Deferred income taxes.....................     1,068          --          1,068
                                           ---------    ---------     ---------
    Total liabilities.....................   632,150     (119,976)      512,174
Stockholders' Equity:
 Common stock and additional paid-in-capi-
  tal.....................................   334,076      120,000 (a)   454,076
 Accumulated deficit......................  (265,074)     (21,080)(a)  (286,154)
 Currency translation adjustment..........   (58,638)         --        (58,638)
                                           ---------    ---------     ---------
    Total stockholders' equity............    10,364       98,920       109,284
                                           ---------    ---------     ---------
    Total liabilities and stockholders'
     equity............................... $ 642,514    $ (21,056)    $ 621,458
                                           =========    =========     =========
</TABLE>
 
 
                                       23
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
               UNAUDITED PRO FORMA CONSOLIDATED INCOME STATEMENT
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                           DAL-TILE    CERAMIC TILE
                         INTERNATIONAL  OPERATIONS   PRO FORMA    PRO FORMA REFINANCING    PRO FORMA
                             INC.         OF AWI    ADJUSTMENTS   COMBINED  ADJUSTMENTS   AS ADJUSTED
                         ------------- ------------ -----------   --------- -----------   -----------
<S>                      <C>           <C>          <C>           <C>       <C>           <C>
Net sales...............   $474,812      $240,049     $ 9,585 (c) $724,446    $   --       $724,446
Cost of goods sold......    225,364       171,377      (7,263)(d)  370,378                  370,378
                                                      (19,100)(e)
                           --------      --------     -------     --------    -------      --------
 Gross profit...........    249,448        68,672      35,948      354,068                  354,068
Expenses:
 Transportation.........     33,535           --        9,585 (c)   43,120        --         43,120
 Selling, general and
  administrative........    134,193        61,723      (1,269)(d)  188,947                  188,947
                                                       (5,700)(e)
 Provision for merger
  integration charges...     22,430          (733)    (21,697)(f)      --         --            --
 Amortization of
  goodwill..............      4,765         1,522      (1,522)(g)    4,765        --          4,765
                           --------      --------     -------     --------    -------      --------
 Operating income.......     54,525         6,160      56,551      117,236                  117,236
Interest expense........     55,453         7,951      (7,951)(h)   55,453    (27,917)(j)    27,536
Interest income.........      1,250         1,292      (1,292)(h)    1,250        --          1,250
Other income, net.......      2,994           --          --         2,994        800 (k)     3,794
                           --------      --------     -------     --------    -------      --------
 Income (loss) before
  income taxes..........      3,316          (499)     63,210       66,027     28,717        94,744
Income tax provision....      1,176           509      21,728 (i)   23,413     10,183 (i)    33,596
                           --------      --------     -------     --------    -------      --------
 Net income (loss)......   $  2,140      $ (1,008)    $41,482     $ 42,614    $18,534      $ 61,148
                           ========      ========     =======     ========    =======      ========
 Net income per share...                                                                   $
                                                                                           ========
 Weighted average shares
  outstanding...........
</TABLE>
 
                                       24
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
               UNAUDITED PRO FORMA CONSOLIDATED INCOME STATEMENT
 
                   FOR THE THREE MONTHS ENDED MARCH 31, 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                         PRO FORMA
                                             HISTORICAL ADJUSTMENTS   AS ADJUSTED
                                             ---------- -----------   -----------
<S>                                          <C>        <C>           <C>
Net sales...................................  $170,674    $  --        $170,674
Cost of goods sold..........................    87,940       --          87,940
                                              --------    ------       --------
 Gross profit...............................    82,734       --          82,734
Expenses:
 Transportation.............................     9,957       --           9,957
 Selling, general and administrative........    48,362       --          48,362
 Provision for merger integration charges...     9,000    (9,000)(f)        --
 Amortization of goodwill...................     1,191       --           1,191
                                              --------    ------       --------
 Operating income...........................    14,224     9,000         23,224
Interest expense............................    13,843    (6,721)(j)      7,122
Interest income.............................       584       --             584
Other income, net...........................       531       200(k)         731
                                              --------    ------       --------
 Income before income taxes.................     1,496    15,921         17,417
Income tax provision........................       566     6,023 (i)      6,589
                                              --------    ------       --------
 Net income.................................  $    930    $9,898       $ 10,828
                                              ========    ======       ========
 Net income per share.......................                           $
                                                                       ========
 Weighted average shares outstanding........
</TABLE>
 
                                       25
<PAGE>
 
        NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
 
(a) To reflect the application of the estimated net proceeds from the
    Offerings, borrowings under the New Bank Credit Agreement and the cash
    received from AWI in connection with the AO Acquisition, and their
    application as follows:
 
  (1) To pay debt issuance costs related to new debt facilities ($4,000,000),
      net of the write down in debt issuance cost of prior debt facility
      ($6,307,000);
 
  (2) To pay accrued interest on the Series A Notes and the Series B Notes;
 
  (3) To reduce long-term indebtedness under the Zero Coupon Notes, the
      Series A Notes and the Series B Notes; and
 
  (4) To record an extraordinary charge ($33,900,000) ($21,080,000, net of
      tax) for the write off of existing deferred financing fees, the
      Termination Fee and prepayment premiums on certain debt to be repaid.
 
(b) To reclassify the appropriate current portion of long-term debt as a
    result of the New Bank Credit Agreement.
 
(c) To reflect freight costs of AO as a component of transportation expenses
    rather than as a component of net sales for consistent income statement
    presentation.
 
(d) To reduce depreciation expense to reflect the write-down to estimated fair
    value of AO assets acquired. The adjustment has been allocated between
    cost of goods sold and selling, general and administrative expenses.
 
(e) To record the estimated net cost savings of approximately $24.8 million
    (excluding $10.1 million attributable to reduction in depreciation and
    amortization expense described in Notes (d) and (g) pursuant to purchase
    accounting) associated with the following cost savings initiatives
    undertaken in connection with the AO Acquisition: (i) the elimination of
    duplicative manufacturing facilities and Company-operated sales centers;
    (ii) the reduction of duplicative sales organization staff; and (iii) the
    elimination of duplicative research and development programs; offset in
    part by increased costs in connection with management information systems
    and advertising.
 
(f) To eliminate pre-tax merger integration charges recorded by the Company
    associated with cost savings initiatives undertaken in connection with the
    AO Acquisition.
 
(g) To eliminate amortization of AO's historical goodwill and intangible asset
    balances.
 
(h) To eliminate interest income and expense related to investments and debt
    of AO not acquired or assumed in the AO Acquisition.
 
(i) Represents estimated pro forma net impact to tax expense resulting from
    the pro forma adjustments.
 
(j) To reduce interest expense as a result of the Refinancing. The Refinancing
    includes the entering into of the New Bank Credit Agreement with interest
    on borrowings thereunder based on a variable rate plus a margin. A 1/8%
    rise in the interest rate would have caused interest expense to increase
    by approximately $241,000 and $63,000 for the year ended December 31, 1995
    and the three months ended March 31, 1996, respectively.
 
(k) To reflect the elimination of the AEA Investors management fee.
 
                                      26
<PAGE>
 
                     SELECTED CONSOLIDATED FINANCIAL DATA
 
  The following table presents: (i) selected consolidated historical financial
data for, and at the end of, the years ended December 31, 1991, 1992, 1993,
1994 and 1995 derived from the Company's audited consolidated financial
statements for such periods; and (ii) selected consolidated historical
financial data for, and at the end of, the three months ended March 31, 1995
and 1996 derived from the Company's unaudited consolidated financial
statements for such periods. The unaudited consolidated financial statements
of the Company include all adjustments, consisting of normal recurring
accruals, which the Company considers necessary for a fair presentation of its
financial position at the end of, and the results of its operations for, those
periods. Operating results for the three months ended March 31, 1996 reflect
the results of operations of AO and certain related assets of the ceramic tile
business of AWI, which were acquired by the Company from AWI on December 29,
1995. Operating results for the three months ended March 31, 1996 are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 1996. The selected consolidated historical financial data
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Consolidated Financial
Statements.
 
<TABLE>
<CAPTION>
                                                                                 THREE MONTHS ENDED
                                     YEAR ENDED DECEMBER 31,                          MARCH 31,
                          ---------------------------------------------------    --------------------
                            1991      1992      1993         1994      1995        1995       1996
                          --------  --------  ---------    --------  --------    ---------  ---------
                                  (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                       <C>       <C>       <C>          <C>       <C>         <C>        <C>
OPERATING DATA:
 Net sales..............  $357,564  $398,017  $ 440,573    $506,309  $474,812    $ 119,353  $ 170,674
 Cost of goods sold.....   189,861   210,121    239,379     268,272   225,364       58,110     87,940
                          --------  --------  ---------    --------  --------    ---------  ---------
 Gross profit...........   167,703   187,896    201,194     238,037   249,448       61,243     82,734
 Operating expenses
  (excluding non-
  recurring charges)....   128,103   138,467    157,314     169,720   172,493       44,666     59,510
                          --------  --------  ---------    --------  --------    ---------  ---------
 Operating income before
  non-recurring charges.    39,600    49,429     43,880      68,317    76,955       16,577     23,224
 Non-recurring charges:
 Provision for merger
  integration charges...       --        --         --          --     22,430(1)       --       9,000(2)
 Provision for special
  charges...............       --        --      53,233(3)      --        --           --         --
 Write-down of goodwill.       --        --     214,235(4)      --        --           --         --
                          --------  --------  ---------    --------  --------    ---------  ---------
 Operating income
  (loss)................    39,600    49,429   (223,588)     68,317    54,525       16,577     14,224
 Interest expense (net).    47,172    43,571     46,229      52,139    54,203       13,079     13,259
 Other (income) expense.       575       653      1,088      (1,341)   (2,994)      (1,600)      (531)
                          --------  --------  ---------    --------  --------    ---------  ---------
 Income (loss) before
  income taxes..........    (8,147)    5,205   (270,905)     17,519     3,316        5,098      1,496
 Income tax provision
  (benefit).............     1,105     5,179     (3,225)     10,614     1,176        4,272        566
                          --------  --------  ---------    --------  --------    ---------  ---------
 Net income (loss)......  $ (9,252) $     26  $(267,680)   $  6,905  $  2,140    $     826  $     930
                          ========  ========  =========    ========  ========    =========  =========
OTHER OPERATING DATA:
 Net sales (United
  States and Canada)....  $315,360  $348,874  $ 394,044    $457,715  $451,800    $ 111,306  $ 165,489
 Net sales (Mexico).....    42,204    49,143     46,529      48,594    23,012        8,047      5,185
 Gross margin...........      46.9%     47.2%      45.7%       47.0%     52.5%        51.3%      48.5%
 Operating margin before
  non-recurring charges
  ......................      11.1%     12.4%      10.0%       13.5%     16.2%        13.9%      13.6%
 Depreciation and amor-
  tization..............  $ 22,746  $ 21,457  $  22,019    $ 17,020  $ 17,164    $   4,302  $   5,390
 Capital expenditures...     8,286    20,689     17,066      14,160    29,392        5,505      5,673
BALANCE SHEET DATA (AT
 END OF PERIOD):
 Working capital........  $106,780  $116,840  $ 119,109    $115,717  $152,128    $ 134,738  $ 165,141
 Total assets...........   715,814   718,987    512,830     488,417   672,393      484,282    642,514
 Total debt.............   444,669   456,003    492,137     492,753   527,816      508,583    523,534
 Stockholders' equity
  (capital deficiency)..   192,626   189,515    (77,449)   (103,823)    9,639     (119,885)    10,364
</TABLE>
- --------
(1) In the fourth quarter of 1995, the Company recorded a pre-tax $22.4
    million merger integration charge for the revaluation of certain assets in
    connection with AO Acquisitions. See Note 6 to the Consolidated Financial
    Statements.
(2) In the first quarter of 1996, the Company recorded a pre-tax $9.0 million
    merger integration charge for the closing of duplicative sales centers and
    distribution centers, the closing of certain manufacturing facilities and
    severance costs. See Note 7 to the Consolidated Financial Statements.
(3) In the fourth quarter of 1993, the Company established provisions for a
    distribution enhancement program, revaluation of certain assets and
    severance costs for retiring employees. As a result, the Company recorded
    a pre-tax $53.2 million special charge in the fourth quarter of 1993. See
    Note 8 to the Consolidated Financial Statements.
(4) In connection with a review of its operations during the fourth quarter of
    1993, the Company wrote off $214.2 million of goodwill related to the
    following business units: Dal-Tile Mexico, Materiales, Dal-Minerals and
    R&M. See Note 9 to the Consolidated Financial Statements.
 
                                      27
<PAGE>
 
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
OVERVIEW
  Historically, the Company has pursued a growth strategy focused on enhancing
its level of vertical integration through opening Company-operated sales
centers in the United States as outlets for Company-manufactured products and
products purchased for resale and increasing manufacturing capacity. Since
1994, the Company has introduced high-end floor tile products, initiated
targeted marketing programs and increased sales to home center retailers. Over
the past ten years, the Company's net sales increased at a compound annual
rate of 10.9% from $169.1 million in 1985 to $474.8 million in 1995, exclusive
of the AO Acquisition.
 
  In addition, the Company has benefitted from low cost manufacturing
facilities in Mexico and the United States. The Company has employed various
manufacturing and distribution strategies to further improve efficiencies,
including (i) investing in technologically advanced manufacturing equipment;
(ii) utilizing fast-fire kiln technology; (iii) establishing a network of
regional distribution centers ("RDCs") to improve customer service; (iv)
reducing the number of stock keeping units ("SKUs"); (v) increasing plant
specialization by product line; (vi) improving production planning and
logistics; and (vii) investing in management information systems. The Company
believes these steps have enabled the Company to streamline distribution,
improve customer service and maintain attractive margins.
 
  On December 29, 1995, the Company completed the AO Acquisition. As a result
of the AO Acquisition, the Company has increased its presence in all ceramic
tile applications and distribution channels and expects to achieve significant
cost savings by consolidating manufacturing facilities, restructuring its
sales organizations and eliminating duplicative administrative functions. See
"Risk Factors--Risks Relating to Realizing Benefits from AO Acquisition". The
Company believes, inclusive of AO, that it had an approximately 28% unit share
of the approximately 1.32 billion square feet of ceramic tile sold in the
United States in 1995, which was significantly greater than the Company's
nearest competitor. The Company has significantly increased its sales to
independent distributors as a result of the AO Acquisition. 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.
 
  As part of the AO Acquisition, AWI paid $27.6 million in cash to the
Company. The AO Acquisition was accounted for under the purchase method of
accounting. In exchange for the stock, cash and assets contributed as part of
the AO Acquisition, AWI received 37% of the issued and outstanding capital
stock of the Company. In connection with the AO Acquisition, the Company
recorded pre-tax merger integration charges of $9.0 million in the three
months ended March 31, 1996 and $22.4 million in the fiscal year ended
December 31, 1995. These charges were taken principally to write-down less
efficient and duplicative manufacturing equipment not needed in the combined
Company, reserve for closings of duplicative sales centers and distribution
centers, and provide for severance costs associated with the elimination of
overlapping positions. The Company manufactured inventory at certain AO plants
prior to their closure at the end of the first quarter of 1996. This higher
cost inventory, relative to inventory produced at the remaining plants, will
negatively impact the Company's gross margins in the second and third quarters
of 1996 as it is sold. The Company expects that results thereafter will
benefit from the Company's low-cost production and cost initiatives undertaken
in connection with the AO Acquisition. In connection with the Refinancing, the
Company will record an extraordinary charge of $21.1 million, net of tax, for
the write off of existing deferred financing fees, the Termination Fee and
prepayment premiums on certain debt to be repaid. This charge will be recorded
in the Company's third quarter of 1996 upon completion of the Refinancing. See
"Unaudited Pro Forma Consolidated Financial Information".
 
  The following is a discussion of the results of operations for the three
months ended March 31, 1996 compared with the three months ended March 31,
1995, the year ended December 31, 1995 compared with the year ended December
31, 1994 and the year ended December 31, 1994 compared with the year ended
December 31, 1993 for the Company.
 
  The Company's operating results for the three months ended March 31, 1996
reflect the results of operations of AO and certain related assets of the
ceramic tile business of AWI, which were acquired by the Company from AWI on
December 29, 1995. Because the Company's results for the three months ended
March 31, 1995 do not reflect the AO Acquisition, the results for such periods
are not directly comparable.
 
                                      28
<PAGE>
 
RESULTS OF OPERATIONS
 
  The following table sets forth certain operating data of the Company as a
percentage of net sales for the periods indicated below:
 
<TABLE>
<CAPTION>
                                                                     THREE
                                                                    MONTHS
                                               YEAR ENDED            ENDED
                                              DECEMBER 31,         MARCH 31,
                                            --------------------  ------------
                                            1993    1994   1995   1995   1996
                                            -----   -----  -----  -----  -----
<S>                                         <C>     <C>    <C>    <C>    <C>
Net sales.................................. 100.0%  100.0% 100.0% 100.0% 100.0%
Cost of goods sold.........................  54.3    53.0   47.5   48.7   51.5
                                            -----   -----  -----  -----  -----
Gross profit...............................  45.7    47.0   52.5   51.3   48.5
Operating expenses.........................  35.7    33.5   36.4   37.4   34.9
                                            -----   -----  -----  -----  -----
Operating income before non-recurring
 charges...................................  10.0    13.5   16.1   13.9   13.6
Non-recurring charges:
  Provision for merger integration charges.   --      --     4.7    --     5.3
  Provision for special charges............  12.1     --     --     --     --
  Write-down of goodwill...................  48.6     --     --     --     --
                                            -----   -----  -----  -----  -----
Operating income (loss).................... (50.7)   13.5   11.4   13.9    8.3
Interest expense (net).....................  10.5    10.3   11.4   11.0    7.8
Other (income) expense.....................   0.2    (0.3)  (0.6)  (1.3)  (0.3)
                                            -----   -----  -----  -----  -----
Income (loss) before income taxes.......... (61.4)    3.5    0.6    4.2    0.8
Income tax provision (benefit).............  (0.7)    2.1    0.2    3.6    0.3
                                            -----   -----  -----  -----  -----
Net income (loss).......................... (60.7)%   1.4%   0.4%   0.6%   0.5%
                                            =====   =====  =====  =====  =====
</TABLE>
 
 THREE MONTHS ENDED MARCH 31, 1996 COMPARED TO THREE MONTHS ENDED MARCH 31,
1995
 
  NET SALES. Net sales for the first quarter increased to $170.7 million in
1996 from $119.4 million in 1995, an increase of $51.3 million, or 43%. The
increase in net sales was due to the inclusion of AO's operations in the 1996
first quarter and increased shipments to home improvement centers. Sales in
Mexico (which accounted for 3% of consolidated sales in the first quarter of
1996) decreased approximately $3.0 million, principally as a result of
translating peso revenues at devalued exchange rates and general economic
conditions in Mexico.
 
  GROSS PROFIT. Gross profit increased $21.5 million, or 35.1%, to $82.7
million in the first quarter of 1996 from $61.2 million in the first quarter
of 1995 principally as a result of the increase in net sales. Gross margin
decreased in the first quarter of 1996 to 48.5% from 51.3% in the first
quarter 1995 due to lower gross margins associated with sales made to
independent distributors and unfavorable manufacturing variances in connection
with inventory reductions.
 
  EXPENSES. Expenses increased to $68.5 million in the first quarter of 1996
from $44.7 million in the first quarter of 1995 due to the inclusion of AO's
operations and $9.0 million of merger integration charges. Expenses as a
percent of sales increased from 37.4% in 1995 to 40.2% in 1996 principally as
a result of the 1996 merger integration charges. Excluding merger integration
charges, expenses decreased to 34.9% of sales due to consolidation savings
achieved by integrating sales forces, closing duplicative sales service
centers and consolidating administrative functions. Additionally as mentioned
above, sales made to independent distributors require lower operating expense
levels which offset the lower gross margins generated through this channel.
 
  MERGER INTEGRATION CHARGES. In the first quarter of 1996, the Company
recorded a pre-tax merger integration charge of $9.0 million for the closings
of duplicative sales centers, duplicative distribution centers, and certain
manufacturing facilities, as well as the incurrence of severance costs
associated with the elimination of overlapping positions. The majority of the
$9.0 million is a cash charge related to lease commitments associated with
closings of duplicative sales centers and RDCs extending beyond 1996.
 
                                      29
<PAGE>
 
  OPERATING INCOME. Operating income decreased to $14.2 million in the first
quarter of 1996 from $16.6 million in the first quarter of 1995 principally as
a result of merger integration charges. Operating income increased to $23.2
million in 1996, excluding non-recurring merger integration charges, as
compared to $16.6 million in 1995 as a result of the AO Acquisition and
related cost savings offset in part by lower gross margins. The operating
margin before non-recurring merger integration charges decreased principally
as a result of lower gross margins, offset in part by lower operating expenses
associated with sales to independent distributors.
 
  INTEREST EXPENSE (NET). Interest expense (net) of $13.3 million in the first
quarter of 1996 was comparable to interest expense in the first quarter of
1995 of $13.1 million.
 
  INCOME TAXES. The income tax provision reflects effective tax rates of 38%
and 84% for the three months ended March 31, 1996 and 1995, respectively. The
high effective rate in 1995 reflects the inability to record a tax loss
benefit in the United States due to the Company being in a net operating loss
carryforward position for U.S. federal income tax purposes.
 
  NET INCOME. Net income increased to $0.9 million in 1996 from $0.8 million
in 1995. Net income increased $5.7 million from $0.8 million in 1995 to $6.5
million in 1996, excluding the merger integration charges, principally as a
result of improvements in operating income (excluding merger integration
charges) offset in part by transaction gain reductions in 1996 as a result of
the stabilizing of the peso in the first quarter of 1996.
 
 YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
 
  NET SALES. Net sales for the year ended December 31, 1995 decreased to
$474.8 million from $506.3 million in 1994, a decrease of $31.5 million, or
6.2%. The consolidated decrease of $31.5 million is primarily the result of
the Mexican sales decline of $25.6 million as a result of translating peso
revenues into U.S. dollars at lower exchange rates and adverse economic
conditions in Mexico. Sales in the United States, which represented 94.0% of
total Company sales, decreased $6.6 million, or 1.5%, while sales to Canada,
which represented 1.0% of total Company sales, increased $0.7 million, or
13.0%. U.S. sales declined primarily as a result of decreases in the new
residential housing sector of tile applications. Although the Company's sales
were affected by the decline in the residential sector of tile applications,
the 1.5% U.S. sales decline was less than the 7.0% decline in U.S. housing
starts due to increased shipments to home center retailers, price increases,
the opening of 12 new sales centers in 1995, the introduction of new high-end
floor tile products, and increased sales in the commercial sector of tile
applications.
 
  GROSS PROFIT. Gross profit increased $11.4 million, or 4.8%, to $249.4
million in 1995, from $238.0 million in 1994. The $31.5 million decrease in
net sales was more than offset by a $42.9 million decrease in cost of sales
resulting in a $11.4 million gross profit increase. Gross profit as a
percentage of sales increased to 52.5% in 1995 from 47.0% in 1994. In 1995,
the increases in gross profits and gross profit margin reflected the benefits
of a new sales commission program which emphasized high margin products and
new products in high-end floor tile applications. Additionally, the Company
benefited from price increases in the United States, manufacturing
efficiencies and the favorable impact on manufacturing costs resulting from
the devaluation of the peso.
 
  EXPENSES. Total expenses in 1995 were $194.9 million, which included $22.4
million for merger integration charges described below, as compared to $169.7
million in 1994. Excluding merger integration charges, 1995 expenses were
$172.5 million, as compared to $169.7 million in 1994, an increase of 1.6%.
Expenses (excluding merger integration charges), as a percentage of sales,
increased to 36.4% in 1995 from 33.5% in 1994. The increase of $2.8 million
was the result of a $5.5 million increase in the first quarter offset by total
reductions of $2.7 million in the final three quarters. In the first quarter,
the Company was temporarily incurring excess costs to support duplicate
distribution functions until the RDCs and related systems were fully
implemented. Additionally, expenses increased in the first quarter due to new
marketing programs and the start-up of ten sales centers opened in the first
quarter of 1995. During the second quarter, management implemented a cost-
reduction program, which resulted in decreased expenses in the final three
quarters of 1995 compared to the final three quarters of 1994.
 
                                      30
<PAGE>
 
  MERGER INTEGRATION CHARGES. In the fourth quarter of 1995, the Company
recorded a pre-tax merger integration charge of $22.4 million for the
revaluation of certain assets in connection with the AO Acquisition. Also, in
connection with the AO Acquisition and the Company's merger integration plans,
the Company will close certain manufacturing facilities, as well as
duplicative sales service centers, and will discontinue the use of certain
equipment. The non-cash portion of the merger integration charges is
approximately $20.2 million and represents the write-down of less efficient
and duplicative equipment not needed in the combined Company. The cash portion
of the merger integration charges is approximately $2.2 million, which
primarily consists of leasehold commitments on equipment.
 
  OPERATING INCOME. Operating income decreased $13.8 million, or 20.2%, to
$54.5 million in 1995, from $68.3 million in 1994. The decrease was primarily
due to the merger integration charges of $22.4 million. Operating income
(excluding merger integration charges) increased to $77.0 million, or 12.7%,
in 1995 from $68.3 million in 1994 resulting in an increase in the operating
margin (excluding merger integration charges), to 16.2% in 1995 from 13.5% in
1994. The operating margin increased as a result of improvements in gross
profit, reflecting new high-end products, price increases, manufacturing
efficiencies, a new commission structure and the favorable cost effects
resulting from the devaluation of the Mexican peso.
 
  INTEREST EXPENSE (NET). Interest expense (net) increased by 4.0%, to $54.2
million in 1995 from $52.1 million in 1994 due to an increase in debt levels
during the year to finance the construction of the El Paso facility and other
expansions.
 
  INCOME TAX PROVISION. In 1995 and 1994, the income tax provision reflected
an effective tax rate of 35.5% and 60.6%, respectively. Inflationary
accounting required by Mexican tax law as a result of the 1995 peso
devaluation significantly reduced the effective tax rate in Mexico. This
reduction in the effective tax rate was offset primarily by the non-
deductibility for U.S. tax purposes of the Company's goodwill amortization,
resulting in an effective tax rate of 35.5%.
 
  The income tax provision for 1994 reflects a high effective tax rate due
primarily to the non-deductibility for U.S. income tax purposes of the
Company's goodwill amortization. Although the accreted interest on the Zero
Coupon Notes is not payable until their maturity date of July 15, 1998, the
interest expense is deductible for tax purposes.
 
  NET INCOME. Net income decreased $4.8 million, or 69.0%, to $2.1 million in
1995 from $6.9 million in 1994 due to merger integration charges. Excluding
merger integration charges, net income increased to $16.6 million, or 140.5%,
in 1995 from $6.9 million in 1994. The increase (excluding merger integration
charges) is primarily a result of the improved gross margins and to a lesser
extent the reduction in the effective tax rate in 1995 as compared to 1994.
 
  PESO-U.S. DOLLAR EXCHANGE RATE. During 1995, the Mexican peso suffered an
approximate 36% decline in value against the U.S. dollar. Since the Company
incurs more peso-denominated costs than revenues generated in pesos, the
effect on income from operations was favorable to the Company. Additionally, a
foreign transaction gain of $4.1 million was realized due to settling of peso-
denominated monetary liabilities in the United States after the devaluation.
The devaluation also resulted in a non-cash reduction in stockholders' equity
of approximately $22.3 million.
 
 YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993
 
  NET SALES. Net sales for the year ended December 31, 1994 increased to
$506.3 million, from $440.6 million in 1993, an increase of $65.7 million, or
14.9%. Same store sales (those sales centers open at least one full year)
increased 14.0% in 1994. Sales in the United States, which represented 89.5%
of total Company sales, increased $63.0 million, or 16.2%. The improvement in
U.S. sales is attributable to growth in overall tile applications, additional
penetration in existing markets, the continuing maturation of sales centers
opened in 1992 and 1993 and growth in shipments to home improvement centers.
In addition, the Company opened 12 new sales centers in the United States
during 1994. Sales in Mexico increased $2.1 million, or 4.4%. Mexican
operations
 
                                      31
<PAGE>
 
have been impacted by political and economic uncertainties, as well as
increased competition from domestic manufacturers.
 
  GROSS PROFIT. Gross profit increased $36.8 million, or 18.3%, to $238.0
million in 1994 from $201.2 million in 1993. Gross profit as a percentage of
sales increased to 47.0% in 1994 from 45.7% in 1993. In 1994, the increase in
the gross profit margin was due primarily to benefits from improved
manufacturing efficiencies and the peso devaluation.
 
  EXPENSES. Total expenses in 1993 of $424.8 million, which included $53.2
million and $214.2 million for special charges and write-down of goodwill,
respectively, decreased to $169.7 million in 1994 due to the non-recurrence of
the special charges and write-down of goodwill. Expenses increased 7.9%, to
$169.7 million in 1994 from $157.3 million in 1993, excluding special charges
and write-down of goodwill. This increase resulted from costs associated with
the 14.9% growth in sales associated with the six RDCs opened during the year
and start-up expenses incurred to open the 12 new sales centers. These
increases were partially offset by a decrease in amortization of goodwill due
to the write-down of goodwill in 1993. Expenses as a percentage of sales
decreased to 33.5% in 1994 from 35.7% in 1993 (excluding special charges and
write-down of goodwill). This decrease resulted primarily from increasing
sales in sales centers open at least one full year without a corresponding
increase in these sales centers' operating expenses.
 
  OPERATING INCOME. Operating income increased to $68.3 million in 1994 from
an operating loss in 1993 of $223.6 million. The increase was primarily due to
the non-recurrence of the special charges and write-down of goodwill.
Operating income increased to $68.3 million in 1994 from $43.9 million in
1993, resulting in an increase in the operating margin (excluding special
charges and write-down of goodwill) to 13.5% in 1994 from 10.0% in 1993. The
operating margin increased due to improvements in gross margins, operating
efficiency improvements at the store level and the decrease in amortization of
goodwill.
 
  INTEREST EXPENSE (NET). Interest expense (net) increased to $52.1 million in
1994 from $46.2 million in 1993, an increase of $5.9 million, or 12.8%, due to
higher interest rates and higher debt levels during the year.
 
  INCOME TAX PROVISION (BENEFIT). In 1994, the income tax provision reflects
an effective tax rate of 60.6% as compared to an income tax benefit in 1993 of
1.2%. The income tax provision for 1994 reflects a high effective tax rate due
primarily to the non-deductibility for tax purposes of the Company's goodwill
amortization. Although the accreted interest on the Zero Coupon Notes is not
payable until their maturity date of July 15, 1998, the interest expense is
deductible for tax purposes. In 1993, the lower than expected tax benefit was
due to the non-deductibility for tax purposes of the write-down and
amortization of goodwill and also due to the limitation for tax purposes of
the loss carryback for recognition of a tax refund.
 
  NET INCOME (LOSS). Net income increased $274.6 million, to $6.9 million in
1994, from a loss in 1993 of $267.7 million, as a result of the non-recurrence
of special charges and write-down of goodwill in 1993. Excluding the special
charges and write-down of goodwill, net income increased $13.8 million, to
$6.9 million in 1994, from a loss in 1993 of $6.9 million. Net income,
excluding special charges and write-down of goodwill, increased as a result of
increased operating income offset in part by increased interest expense.
 
  PESO-U.S. DOLLAR EXCHANGE RATE. During 1994, the peso declined 37% in value
against the U.S. dollar, with the largest decline in December, when the peso
decreased approximately 30% in value. Since the Company's Mexican subsidiaries
incur more peso-denominated costs than revenues generated in pesos (due to
dollar-denominated sales), the effect on income from operations was favorable
to the Company. Additionally, a foreign transaction gain of $2.3 million was
realized due to dollar-denominated monetary assets in Mexico exceeding dollar-
denominated monetary liabilities. The devaluation also resulted in a reduction
in stockholders' equity of approximately $33.6 million resulting from
translating peso-denominated assets and liabilities into dollars.
 
  SPECIAL CHARGES. During the fourth quarter of 1993, following a review of
its operations, the Company established provisions for a distribution
enhancement program, revaluation of certain assets, and severance costs
 
                                      32
<PAGE>
 
for retiring employees. As a result, the Company recorded a $53,233,000
special charge in the fourth quarter, which consisted of:
 
 
<TABLE>
      <S>                                                           <C>
      Distribution enhancement program............................. $23,350,000
      Asset revaluation............................................  25,155,000
      Severance costs..............................................   4,728,000
                                                                    -----------
                                                                    $53,233,000
                                                                    ===========
</TABLE>
 
  The primary components of the distribution enhancement program were
$3,800,000 for facility consolidations, $6,406,000 for costs associated with
inventory relocation, $5,795,000 for lease obligations related to excess
facilities, and $7,349,000 for costs associated with the fourth quarter 1993
study and implementation of this program.
 
  In connection with the review, inventories and property, plant, and
equipment were written down $25,155,000 in the fourth quarter of 1993. This
write-down consisted of a $17,000,000 reserve for inventories which under the
distribution enhancement program were not cost beneficial to relocate. The
remainder of the $25,155,000 charge consisted of write-downs of $8,155,000 for
manufacturing equipment which was replaced with more efficient technology.
 
  WRITE-DOWN OF GOODWILL. During the fourth quarter of 1993, management
reviewed the operations referred to above under "Special Charges". In
connection with this review, the Company assessed the carrying amounts of
goodwill at each of the Company's business units. As a result, the Company
recorded a $214,235,000 write-down of goodwill.
 
  The Mexican business units (Dal-Tile Mexico and Materiales) had not achieved
expected operating results, due primarily to large increases in capacity added
by other Mexican tile manufacturers in anticipation of strong growth in
Mexico. An oversupply of production capacity throughout 1993 resulted in
pricing pressures and a reduction of the Company's market share in Mexico.
Additionally, the Mexican economy retreated during 1993. Exports to the United
States market did not grow as expected due to downturns in the construction
industry and continued recessionary conditions in California.
 
  The Company's subsidiary, Dal-Minerals, owns the mineral rights to
significant reserves of talcose rock (talc). It was expected that the
Company's usage of talc would significantly increase and that alternative uses
of talc could be identified and economically exploited. The Company's use of
talc was not significantly increased and the Company was unable to develop
satisfactory alternative markets for talc.
 
  R&M, a distributor of refractories, projected its cash flows to
significantly decline as more efficient technology replaced the use of
refractories.
 
  Based on these assessments, management believed that goodwill was impaired
at the business units referred to above. As a result, the fair value of these
business units was estimated using independent firms and cash flow projections
and compared to the carrying values of related assets. Accordingly, in 1993,
the Company wrote-down related unamortized goodwill balances as set forth
below:
 
<TABLE>
      <S>                                                          <C>
      Dal-Tile Mexico and Materiales.............................. $ 97,658,000
      Dal-Minerals................................................   87,073,000
      R&M.........................................................   29,504,000
                                                                   ------------
                                                                   $214,235,000
                                                                   ============
</TABLE>
 
 
QUARTERLY RESULTS
 
  The following table sets forth certain unaudited quarterly operating results
for the quarter ended March 31, 1996 and the fiscal years ended December 31,
1995 and 1994. This information is unaudited but, in the opinion of the
Company's management, includes all adjustments necessary for a fair
presentation of the results of operations for such periods.
 
                                      33
<PAGE>
 
<TABLE>
                                         FIRST     SECOND    THIRD     FOURTH
                                        QUARTER   QUARTER   QUARTER   QUARTER
                                        --------  --------  --------  --------
                                               (DOLLARS IN THOUSANDS)
<S>                                     <C>       <C>       <C>       <C>
Year Ended December 31, 1996
  Net sales............................ $170,674
  Gross profit.........................   82,734
  Operating income before non-recurring
   charges.............................   23,224
  Gross margin.........................     48.5%
  Operating margin before non-recurring
   charges.............................     13.6%
Year Ended December 31, 1995
  Net sales............................ $119,353  $116,602  $117,991  $120,865
  Gross profit.........................   61,243    61,414    62,570    64,220
  Operating income before non-recurring
   charges.............................   16,577    19,380    20,493    20,505
  Gross margin.........................     51.3%     52.7%     53.0%     53.1%
  Operating margin before non-recurring
   charges.............................     13.9%     16.6%     17.4%     17.0%
Year Ended December 31, 1994
  Net sales............................ $117,177  $129,568  $132,077  $127,486
  Gross profit.........................   53,468    60,250    63,286    61,032
  Operating income before non-recurring
   charges.............................   14,299    18,566    18,644    16,808
  Gross margin.........................     45.6%     46.5%     47.9%     47.9%
  Operating margin before non-recurring
   charges.............................     12.2%     14.3%     14.1%     13.2%
</TABLE>
 
 
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
  In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("Statement 121"), which requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying value.
Statement 121 also addresses the accounting for long-lived assets that are
expected to be disposed of. The Company has adopted Statement 121 and, based
on current circumstances, such adoption will not materially impact the
Company's annual financial results.
 
  In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-
Based Compensation" ("Statement 123"), which provides an alternative to APB
Opinion No. 25, "Accounting for Stock Issued to Employees", in accounting for
stock-based compensation issued to employees. Statement 123 allows for a fair
value based method of accounting for employee stock options and similar equity
instruments. However, for companies that continue to account for stock-based
compensation arrangements under APB Opinion No. 25, Statement 123 requires
disclosure of the pro forma effect on net income and net income per share of
its fair value based accounting for those arrangements. These disclosure
requirements are effective for fiscal years beginning after December 15, 1995,
or upon initial adoption of Statement 123, if earlier. The Company continues
to evaluate the provisions of Statement 123 and has not determined whether it
will adopt the recognition and measurement provisions of Statement 123, which
adoption the Company believes will not materially impact the Company's
financial results.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  Historically, the Company's principal sources of cash were from operating
activities and bank borrowings. Cash used in operating activities was $21.0
million for the three months ended March 31, 1996 and cash provided by
operating activities was $6.0 million for the same period in 1995. Cash was
used in the three months ended March 31, 1996, principally to fund payments of
trade accounts payable as a result of the timing of payments to vendors,
capital expenditures and the payment of the $17.0 million semiannual interest
due in respect to the Series A Notes and the Series B Notes. Cash provided by
operating activities was $40.7 million in 1995 compared to $31.5 million in
1994. Cash flow from operations was the primary source of cash.
 
 
                                      34
<PAGE>
 
  On January 9, 1990, as part of the AEA Acquisition, the Company entered into
the Series Note Agreement with respect to the Series A Notes and the Series B
Notes and the Existing Bank Credit Agreement. The Series A Notes and the
Series B Notes had an aggregate outstanding balance of $276.0 million on March
31, 1996. The Series A Notes and Series B Notes are payable in annual
installments with the first installment of $44.0 million having been due on
January 9, 1996 with additional annual installments, continuing through
January 9, 2002. On January 9, 1996, the Company paid $44.0 million in
principal on the Series A Notes and $17.0 million in interest on the Series A
Notes and the Series B Notes; the payments were funded from cash and
borrowings under the Existing Bank Credit Agreement. Interest payments in an
amount equal to approximately $14.7 million on July 9, 1996, and declining
thereafter with each principal payment, are payable in respect of the Series A
Notes and Series B Notes on January 9 and July 9 of each year.
 
  On August 11, 1993, Dal-Tile issued $133.2 million principal amount at
maturity of the Zero Coupon Notes (which are due July 15, 1998) from which it
received gross proceeds of approximately $75.0 million and net proceeds of
approximately $71.1 million after deducting fees and expenses. The net
proceeds were used to make an equity contribution to Dal-Tile's wholly owned
subsidiary, Dal-Tile Group, which used such amounts to reduce the outstanding
principal amount under the Existing Bank Credit Agreement. The Zero Coupon
Note Indenture prohibits Dal-Tile from paying dividends on the Common Stock.
 
  Amounts available for borrowing under the Existing Bank Credit Agreement are
limited to the lower of the commitment amount and a borrowing base amount
calculated based on certain levels of inventories and accounts receivable. On
March 31, 1996, the borrowing base calculation did not restrict the Company's
availability under the Existing Bank Credit Agreement of $160 million.
Outstanding borrowings at March 31, 1996 were $128.3 million, and additional
availability was $31.7 million. Under the Existing Bank Credit Agreement, a
commitment fee of 0.5% per annum of the unused line of credit is payable
monthly. Outstanding borrowings under the Existing Bank Credit Agreement are
payable in full on January 9, 1998. Dal-Tile's subsidiaries currently are
prohibited from paying dividends or making loans or advances to Dal-Tile. Dal-
Tile's subsidiaries also are prohibited from incurring additional debt and are
required to maintain certain minimum levels of net worth (as defined in the
Existing Bank Credit Agreement) and working capital and to satisfy a minimum
quick ratio requirement as part of the Existing Bank Credit Agreement. The
Company was in compliance with such covenants at March 31, 1996.
 
  In connection with the AO Acquisition, the Company received $27.6 million in
cash, which is included in the March 31, 1996 Consolidated Financial
Statements as cash. The Company had an additional $11.5 million in cash
balances, for total cash balances of $39.1 million at March 31, 1996.
 
  The Company's liquidity requirements arise primarily from working capital
needs, which consist principally of inventory and accounts receivable, capital
expenditures and debt service. Cash used in financing activities was
approximately $7.2 million for the three months ended March 31, 1996, which
reflected borrowings under the Existing Bank Credit Agreement to repay $44.0
million in principal under the Series A Notes and $17.0 million in interest on
the Series A Notes and the Series B Notes. Cash provided by financing
activities was $24.2 million for the year ended December 31, 1995 (excluding
$27.6 million from proceeds of the sale of capital stock to AWI), which
primarily reflects borrowings under the Existing Bank Credit Agreement and, to
a lesser extent, vendor borrowings to finance certain machinery and equipment
at the new El Paso wall tile manufacturing facility plant. Cash used in
financing activities was $8.4 million for the year ended December 31, 1994,
which reflected repayments under the Existing Bank Credit Agreement.
 
  The Company is undertaking the Refinancing to improve its financial and
operating flexibility, to reduce its interest expense and to extend the
amortization of its senior indebtedness.
 
  The Company plans to use the $27.6 million cash proceeds from the AO
Acquisition to redeem $34.0 million aggregate principal amount at maturity
($26.0 million aggregate accreted value at March 31, 1996) of the Zero Coupon
Notes at a redemption price of 106% of their accreted value on the redemption
date.
 
  Additionally, the Company expects to enter into the New Bank Credit
Agreement contemporaneously with the closing of the Offerings. The Company
will use the net proceeds of the Offerings and the borrowings under the New
Bank Credit Agreement: (i) to effect the Zero Coupon Note Repurchase; (ii) to
repay in full outstanding
 
                                      35
<PAGE>
 
borrowings by Dal-Tile's wholly owned subsidiary, Dal-Tile Group, under the
Existing Bank Credit Agreement; (iii) to repay $176.0 million of the Series A
Notes and $100.0 million of the Series B Notes; and (iv) to pay accrued
interest and estimated prepayment premiums on certain debt to be repaid, the
Termination Fee of $4.0 million and fees and expenses. In connection with the
Refinancing, the Company will record an extraordinary charge of $21.1 million,
net of tax, for the write off of existing deferred financing fees, the
Termination Fee and prepayment premiums on certain debt to be repaid. This
charge will be recorded in the Company's third quarter of 1996 upon completion
of the Refinancing. See "Unaudited Pro Forma Consolidated Financial
Information".
 
  The New Term Loan will be $275.0 million and the New Revolving Credit
Facility will be $250.0 million. Loans under the New Bank Credit Agreement
will bear interest at variable rates. The Company will be required to make
annual amortization payments in respect of the New Bank Credit Agreement. See
"Refinancing", "Capitalization" and "Description of Certain Indebtedness--New
Bank Credit Agreement".
 
  The Company believes that existing cash balances and cash flow from
operating activities together with borrowings available under the New Bank
Credit Agreement will be sufficient to fund future working capital needs,
capital spending requirements and debt service requirements of the Company in
the forseeable future.
 
  Capital expenditures were $14.2 million and $29.4 million for the years
ended December 31, 1994 and 1995 respectively, and were $5.7 million for the
three months ended March 31, 1996. The expenditures during 1995 were used to
fund the El Paso plant, routine capital expenditures and leasehold
improvements of new sales centers. The expenditures during 1996 were used to
fund routine capital improvements. During 1996 and 1997 the Company plans to
spend approximately $50.0 million (of which $5.7 million has been expended
through March 31, 1996) and $50.0 million, respectively, to expand its
manufacturing capacity, improve manufacturing efficiencies, upgrade its
research and development facilities, integrate the Company's and AO's
management information systems, make leasehold improvements at certain sales
centers and fund routine capital maintenance. During the first quarter of
1996, the Company incurred cash costs of $6.1 million in connection with the
AO merger integration. The Company estimates cash AO merger integration costs
of approximately $17.0 million pertaining to severance and lease commitments
for manufacturing, distribution and corporate facility consolidations, as well
as elimination of duplicate and overlapping positions. The Company believes
cash generated from operations and availability under the New Bank Credit
Agreement will be sufficient to fund expansion of its manufacturing facilities
and merger integration costs.
 
  In 1994, the Company began implementation of its distribution enhancement
program. This program centered around the six RDCs which began operations in
1994. During 1995, the costs associated with this program were completed.
Costs of $10.8 million relating to the completion of the RDC infrastructure
and consolidation with the Company sales centers were fully implemented. In
addition, costs of $1.4 million relating to severance payments for executives
and other employees were incurred in 1995. The AO Acquisition has prompted the
Company to reevaluate the RDC system, including location of the RDCs and
product flow through the RDCs. As a result of this evaluation, the Company
anticipates closing two RDCs.
 
  The peso devaluation and economic uncertainties in Mexico are not expected
to have a significant impact on the Company's liquidity. Since the Company has
no peso-based borrowings, high interest rates in Mexico are not expected to
directly affect the Company. The Company may encounter changes in its credit
terms to Mexican customers; however, the consolidated impact is not expected
to be material. Since the Company's Mexican subsidiaries incur more peso-
denominated costs than revenues generated in pesos, the effect of any peso
devaluation on income from operations has been favorable to the Company.
 
  The Company is involved in various judicial and administrative proceedings
relating to environmental matters. The Company is currently engaged in
environmental investigation and remediation programs at certain sites relating
to activities prior to the AEA Acquisition and AO Acquisition, respectively.
The Company maintains a reserve for remediation relating to environmental
conditions and activities existing prior to the AEA Acquisition and is
entitled to indemnification with respect to certain expenditures incurred in
connection with environmental matters. It does not expect the ultimate
liability with respect to such investigation and remediation activities to
have a material effect on the Company's liquidity and financial condition. In
addition, with respect to the investigation and remediation programs relating
to environmental conditions and activities prior to the AO
 
                                      36
<PAGE>
 
Acquisition, the Company believes that, based on currently available
information and the terms and conditions of AWI's indemnification obligations
under the AO Acquisition Agreement (as defined below), any liability of AO
that is reasonably likely to arise with respect to such sites would not result
in a material adverse effect on the Company. See "Business--Environmental
Regulation".
 
  The United States is a party to GATT. Under GATT, the United States
currently imposes import duties on ceramic tile from non-North American
countries at 17%, to be reduced ratably to 8 1/2% by 2005. 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, NAFTA was approved by Mexico, the United States, and Canada. 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 of
settlement of, and remedies for, trade disputes arising under NAFTA, 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 ceramic tile from Mexico of 13%,
although these duties on imports from Mexico are being phased out ratably
under NAFTA over a 13-year period. 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 increase selling prices
and enhance productivity to offset increases in costs resulting from inflation
in the United States and Mexico. Inflation has not had a material impact on
the Company's results of operations during the years ended 1993, 1994 and
1995. Approximately 80.0% of the Company's inventory is valued using the LIFO
inventory accounting method. Therefore, current costs are reflected in cost of
sales rather than in inventory balances. The impact of inflation in Mexico is
uncertain at this time.
 
 
                                      37
<PAGE>
 
                             CERAMIC TILE INDUSTRY
 
  Since 1991, the U.S. ceramic tile industry has grown at a faster rate than
overall U.S. construction activity. The Company believes that such growth is
attributable primarily to ceramic floor tile's increasing share over other
types of floor coverings and expects this trend to continue. Within the U.S.
floor covering business, ceramic floor tile principally competes with carpet,
resilient flooring, wood flooring, marble and other stone products. Within the
U.S. wall covering business, ceramic tile principally competes with paint,
wall paper, laminates, fiberglass, corian, marble, granite and wood paneling.
Since 1991, U.S. ceramic tile sales (by unit volume) are estimated to have
increased at a compound annual rate of 9.5% from approximately 916 million
square feet in 1991 to approximately 1.32 billion square feet in 1995. During
this same period, the U.S. new construction market increased at a 6.9%
compound annual rate. Despite an increase of approximately 39% in U.S. per
capita ceramic tile consumption from 3.6 square feet in 1991 to 5.0 square
feet in 1995, the United States continues to lag significantly behind the per
capita ceramic tile consumption in Western Europe.
 
  In 1995, the Company believes that a majority of U.S. ceramic tile sales (by
unit volume) was comprised of floor tile and that floor tile has been steadily
increasing its share of U.S. ceramic tile sales since 1991. U.S. ceramic tile
unit volume grew at a compound annual rate of 9.5% from 1991 to 1995,
primarily as a result of ceramic floor tile increasing its share of the new
residential and residential remodeling segments relative to other flooring
products. Over the same time period, unit volume sales for carpet, resilient
flooring and wood flooring products increased at compound annual rates of
6.2%, 4.4% and 8.2%, respectively, while the approximately 23 billion square
foot U.S. floor covering market increased at a compound annual rate of 5.9%. A
high percentage of U.S. ceramic floor tile sales are contributed by imported
products. The Company believes that the large percentage of ceramic floor tile
imports into the United States primarily is attributable to the relative cost
position of, and style and design innovation by, European producers. In the
Company's opinion, these advantages have narrowed as a result of an increasing
focus on style and design by American manufacturers, as well as the
introduction in the United States of new technology such as fast-fire kilns
and glaze application equipment which have significantly improved floor tile's
fashion orientation. This technology also has served to lower manufacturing
costs through reduced cycle times, increased yields and improved labor
productivity.
 
  The U.S. wall tile segment consists primarily of 4 1/4 and 6 inch square
tile and a variety of complementary trim and angle pieces. Domestic tile
manufacturers represent the majority of the U.S. wall tile segment. Although
there is no technological or economic barrier to entry in the U.S. wall tile
segment, the Company believes that foreign manufacturers generally have not
developed the manufacturing capabilities necessary to produce a competitive
wall tile product offering. Traditionally, foreign applications have not
utilized the breadth of trim and angle pieces of comparable U.S. applications.
In addition, wall tile manufacturers must develop capabilities to achieve
consistent color shades for both different production runs and the
corresponding trim and angle pieces to be utilized in a specific application.
As the number of colors, textures and finishes in a product offering
increases, this manufacturing process becomes more complex, particularly in
terms of color shading consistency.
 
  Ceramic tile is used for residential and commercial applications (new
construction as well as remodeling). Glazed wall tile is used for interior
walls, shower walls, countertops, vanity tops, ceilings and kitchen
backsplashes, as well as light duty residential floors. Ceramic floor tile is
common in commercial and residential floors, walls, countertops, patios and
exterior cladding. Unglazed mosaic tile typically is applied in commercial
walls and floors, as well as in decorative murals and logos. Glazed mosaics
are commonly used in light usage areas as a complement to the unglazed mosaic
products, kitchen backsplashes, shower walls, and as a decorative accent
blended into unglazed mosaics. Both glazed and unglazed mosaic tile are also
commonly used in bathrooms for residential and commercial purposes.
 
  The U.S. ceramic tile industry is highly fragmented at both the
manufacturing and distribution levels. In 1995, approximately 59% of U.S.
ceramic tile sales consisted of imports, including the approximately 10% of
ceramic tile sold in the United States that was manufactured by the Company in
Mexico. Historically, U.S. tile imports were principally from Italian
manufacturers, as well as from Mexican, Spanish and Brazilian
 
                                      38
<PAGE>
 
manufacturers. In recent years, Mexican manufacturers (including the Company)
have increased their export sales to the United States because of weakness in
the Mexican economy and improvement in their relative cost position due to the
devaluation of the peso. The United States currently imposes import duties on
ceramic tile from Mexico of 13%, although these duties on imports from Mexico
are being phased out ratably under NAFTA over a 13-year period. Under GATT,
the United States currently imposes import duties on ceramic tile from non-
North American countries at 17%, to be reduced ratably to 8 1/2% by 2005.
 
  The ceramic tile industry distributes its products through three distinct
distribution channels which, in general, target specific applications. The
industry's largest distribution channel is the independent distributor channel
consisting of both independent ceramic tile wholesalers and floor covering
wholesalers which comprised approximately 49% of U.S. ceramic tile sales in
1995. This channel is highly fragmented, with over 20,000 distributors,
including many single store locations. Foreign manufacturers primarily utilize
this distribution channel to access U.S. consumers of ceramic tile. The
independent distributor's largest selling product is floor tile and this
channel primarily targets residential remodeling and new residential
construction applications. Ceramic tile manufacturer-operated sales centers
represented approximately 33% of U.S. ceramic tile sales in 1995. Sales
centers primarily serve residential new construction applications, as well as
commercial new construction and remodeling applications. The home center
retailer distribution channel comprised approximately 18% of U.S. ceramic tile
sales in 1995. Home center retailers primarily serve residential remodeling
applications. In addition, the Company believes that home center retailers
have increased consumer awareness and accessibility of ceramic tile.
 
  On large commercial and residential projects, ceramic tile manufacturers
often seek to work directly with architects, builders, developers and design
professionals on aesthetic, technical and service considerations in an attempt
to obtain specifications for use of their products. On smaller residential and
commercial projects, consumers typically contact tile contractors for product
and installation advice. Ceramic tile contractors often influence purchasing
decisions and, in the Company's opinion, seek to purchase from a supplier with
high quality standards, a broad product line, local distribution and
competitive prices.
 
 
                                      39
<PAGE>
 
                                   BUSINESS
 
  The Company is the largest manufacturer, distributor and marketer of ceramic
tile in North America, and one of the largest in the world. The Company
produces and distributes a broad line of high quality wall tile and floor tile
products for both residential and commercial applications, marketed primarily
under its Daltile and American Olean brand names. The Company's strengths
include (i) the U.S. ceramic tile industry's broadest distribution system,
consisting of Company-operated sales centers, independent distributors and
home center retailers; (ii) leading brand names; (iii) North America's largest
ceramic tile manufacturing capacity, with low cost manufacturing plants in the
United States and Mexico; and (iv) the U.S. ceramic tile industry's most
comprehensive product offering, including glazed and unglazed ceramic tile,
stone products and installation materials and tools. From 1985 through 1995,
the Company's net sales have increased at a compound annual rate of 10.9%,
exclusive of the AO Acquisition described below.
 
  On December 29, 1995, the Company acquired AO and certain related assets of
the ceramic tile business of AWI. As a result of the AO Acquisition, the
Company has increased its presence in all ceramic tile applications and
distribution channels and expects to achieve significant cost savings. The
Company believes, inclusive of AO, that it had an approximately 28% unit share
of the 1.32 billion square feet of ceramic tile sold in the United States in
1995, which was significantly greater than the Company's nearest competitor.
Pro forma for the AO Acquisition, the Company's net sales and operating income
for the fiscal year ended December 31, 1995 were $724.4 million and $117.2
million, respectively. See "Unaudited Pro Forma Consolidated Financial
Information".
 
COMPANY ATTRIBUTES AND OPERATING STRATEGIES
 
  The Company believes that it is well positioned to capitalize on the growing
demand for ceramic tile. The following attributes and operating strategies
have enabled it to achieve its current market presence and should serve as a
basis for the Company's future growth and profitability:
 
 . Industry's Broadest Distribution Network. The Company's products are sold
  through (i) Company-operated sales centers; (ii) independent distributors;
  and (iii) home center retailers. The Company's sales center network consists
  of more than 235 Company-operated sales centers (after giving effect to the
  anticipated closing of redundant sales centers in connection with the AO
  Acquisition) in 44 states, which is the largest wholesale distribution
  network in the U.S. ceramic tile industry, serving customers in all 50
  states. The sales centers function as a "one-stop" source for ceramic tile,
  stone products and allied products, serving tile contractors, architects,
  design professionals, builders and developers. As a result of the AO
  Acquisition, the Company also markets its products to over 100 independent
  distributor locations for resale to approximately 5,000 retail outlets. In
  addition, the Company is the industry's leading supplier to the DIY and BIY
  markets by supplying home center retailers, including The Home Depot,
  Lowe's, Menards and Payless Cashways. The home center retailer channel has
  provided the Company with new sources of sales over the past five years.
  Sales to both independent distributors and home center retailers are
  expected to present significant growth opportunities for the Company.
 
 . Leading Brand Names Marketed through Targeted Distribution Channels. The
  Company believes that it has two of the leading brand names in the U.S.
  ceramic tile industry--Daltile and American Olean--and has recently
  established the new Homesource brand name. The Company's strategy is to
  independently market each of its brands to create brand differentiation
  within its respective customer segments. Company-operated sales centers
  principally distribute the Daltile brand, while the American Olean brand is
  principally marketed through independent distributors. In addition to
  distributing the Daltile and American Olean brands, home center retailers
  distribute the newly established home center brand--Homesource.
 
 . New Product Development Driven by Technological Innovation. The Company
  believes that, due to technological innovations, the ceramic tile industry
  is increasing its fashion orientation, particularly in the
  floor tile market. The Company has developed capabilities to produce
  fashionable and innovative tile products and to simulate natural products
  such as stone, marble and wood. In order to capitalize on the increasing
  demand for, and high margins generated by, fashion-oriented tile products,
  the Company has (i)
 
                                      40
<PAGE>
 
  increased the number of new floor tile product introductions; (ii) focused
  on shortening product introduction cycle time; (iii) expanded its
  relationships with leading glaze and equipment manufacturers; (iv) focused
  on evolving consumer preferences to deliver products consistent with current
  design trends; and (v) increased its investment in research and development
  to further develop new products and manufacturing capabilities.
 
 . Broad and Differentiated Product Line. The Company offers the most
  comprehensive product line in the U.S. ceramic tile industry, including
  glazed floor tile, glazed wall tile, glazed and unglazed mosaic tile,
  porcelain tile, quarry tile, stone products and allied products. In
  addition, the Company believes that it produces the industry's largest
  offering of colors, textures and finishes and that its ability to
  efficiently manufacture the industry's largest offering of trim and angle
  pieces differentiates the Company from many of its competitors, including
  foreign ceramic tile manufacturers. Management believes that the Company's
  comprehensive product line, including its trim and angle pieces and fashion-
  oriented tile products, results in an average selling price for Company-
  produced tile higher than the industry average. The Company also sells
  products manufactured by third parties for resale, including ceramic tile
  and allied products, which constituted approximately 30% of net sales in
  1995, inclusive of AO. The Company also intends to increase the amount of
  Company-manufactured products as a percentage of net sales, which products
  historically have generated higher margins than products purchased for
  resale.
 
 . Low Cost Manufacturing. The Company believes it is one of the U.S. ceramic
  tile industry's lowest cost producers and has the largest manufacturing
  capacity in North America with an annual manufacturing capacity of
  approximately 311 million square feet. In addition, as a result of the AO
  Acquisition, the Company also has the contractual right to be supplied with
  an additional 24 million of square feet of floor tile annually by a Mexican
  joint venture. The Company's manufacturing facility in Monterrey, Mexico
  represents approximately 40% of the Company's manufacturing capacity. In
  1995, the Company initiated full production at its newest facility, a highly
  automated wall tile plant in El Paso, Texas. Since 1991, the Company
  (exclusive of AO) has invested over $89.6 million in capital expenditures,
  including $62.6 million in new plants and state-of-the-art equipment to
  increase manufacturing capacity, improve efficiency and develop new
  capabilities. Over the next 18 months, the Company intends to further
  increase capacity at its existing floor tile factories in the United States
  and Mexico. The Company believes that additional manufacturing investments
  will continue to generate attractive rates of return due to the Company's
  economies of scale in manufacturing and its ability to leverage its broad
  distribution network.
 
SIGNIFICANT BENEFITS RESULTING FROM THE AO ACQUISITION
 
  In addition to providing the Company with one of the U.S. ceramic tile
industry's best known brands and product lines and a significantly increased
presence in the independent distributor channel, the AO Acquisition provides
the Company with the opportunity to achieve significant cost savings and sales
diversification.
 
 . Cost Savings. The Company expects to achieve significant cost savings as a
  result of the AO Acquisition by (i) consolidating manufacturing facilities,
  (ii) restructuring its sales organizations, and (iii) eliminating
  duplicative administration functions. The Company believes that the
  operational changes implemented to date will enable it to achieve annual
  cost savings of approximately $34.9 million (of which approximately $26.8
  million is expected to be realized in 1996). These cost savings include
  $10.1 million attributable to reductions in depreciation and amortization
  expense pursuant to purchase accounting. In connection with these
  operational charges, the Company has recorded non-recurring pre-tax merger
  integration charges of $9.0 million in the three months ended March 31, 1996
  and $22.4 million in the fiscal year ended December 31, 1995. In addition to
  the operational charges implemented to date, the Company intends to
  implement additional cost saving initiatives, which the Company believes
  will enable it to realize significant additional cost savings.
 
THE ANTICIPATED COST SAVINGS DESCRIBED HEREIN ARE BASED ON ESTIMATES AND
ASSUMPTIONS MADE BY THE COMPANY THAT, ALTHOUGH CONSIDERED REASONABLE BY THE
COMPANY, ARE SUBJECT TO SIGNIFICANT BUSINESS, ECONOMIC AND OTHER
UNCERTAINTIES. THERE CAN BE NO ASSURANCE THAT SUCH COST SAVINGS WILL BE
ACHIEVED OR THAT THE BENEFITS OF SUCH COST SAVINGS WILL NOT BE MITIGATED BY
OTHER FACTORS AFFECTING THE COMPANY'S PERFORMANCE. SEE "RISK FACTORS--RISKS
RELATED TO REALIZING BENEFITS FROM AO ACQUISITION".
 
                                      41
<PAGE>
 
 . Sales Diversification. As a result of the AO Acquisition, the Company is
  diversified both in its business mix and geographical presence. The Company
  believes that its sales are relatively evenly distributed between
  residential and commercial applications. In addition, AO's significant
  presence in the northeast and midwest regions of the United States
  complements the Company's long-standing presence in the west and sunbelt
  regions of the United States.
 
DISTRIBUTION, SALES AND MARKETING
 
  The Company distributes its products through three separate distribution
channels consisting of (i) Company-operated sales centers, (ii) independent
distributors, and (iii) home center retailers. The Company has organized its
business 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.
 
  The Company has a network of regional distribution centers located
strategically throughout the United States in order 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 RDCs enhance the Company's ability to plan and schedule
production and to manage its inventory requirements.
 
 COMPANY-OPERATED SALES CENTERS
 
  The Company primarily distributes its Daltile brand products through its
network of more than 235 Company-operated sales centers in North America
(after giving effect to the anticipated closing of redundant sales centers in
connection with the AO Acquisition) in 44 states, which is the largest
wholesale distribution network in the U.S. ceramic tile industry, serving
customers in all 50 states. For the fiscal year ended December 31, 1995,
approximately 87% of the Company's net sales (exclusive of AO net sales) were
made through its sales center distribution system in the United States and
Canada. Giving effect to the AO Acquisition on a pro forma basis would have
reduced the sales center contribution to approximately 80% of net sales in
1995 due to the addition of AO's network of independent distributors and AO's
sales to home center retailers.
 
  In addition to sales center staff, this distribution channel is supported by
a dedicated sales force of over 100 people, which the Company believes is the
largest sales organization in the U.S. ceramic tile industry. In addition, the
Company's Daltile brand has the industry's largest dedicated group of sales
representatives for the architectural community. The architectural community
exercises significant influence over the specification of products utilized in
commercial applications.
 
  The Company has designed each sales center to serve as a "one-stop" source
that provides its customers with one of the U.S. 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, stone
products and allied products. In addition to products manufactured by the
Company, the sales centers carry a selection of other products to provide
customers with a broader product line. The sales centers range in size from
2,000 to 30,000 square feet, with a typical center occupying approximately
12,000 square feet. The sales centers consist of a showroom dedicated to
displaying the Company's 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 Company's sales
centers generally are located in light industrial areas rather than retail
areas and generally occupy moderately priced leased space under short-term
leases.
 
  The Company has expanded its sales center distribution system from 152 U.S.
sales centers in 1991 to more than 270 U.S. sales centers, which includes 60
sales centers acquired in the AO Acquisition, as of December 31,
 
                                      42
<PAGE>
 
1995. The Company is in the process of consolidating its sales center network
and expects to operate over 235 sales centers by early 1997. Beginning in
1997, 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, the Company closes sales centers in locations where economic and
competitive conditions have changed.
 
 INDEPENDENT DISTRIBUTORS
 
  As a result of the AO Acquisition, the Company significantly expanded its
presence in the independent distributor channel, which represented
approximately 49% of U.S. ceramic tile sales (by unit volume) in 1995. The
independent distributor channel is the largest channel for ceramic floor tile
and is expected by the Company to present a significant growth opportunity for
the Company. The Company has a dedicated business unit, which includes 11
regional sales managers, to serve the particular requirements of this channel.
The Company currently distributes the American Olean brand through
approximately 100 independent distributors, who service approximately 5,000
retail outlets. The Company's strategy is to increase its presence in the
independent distributor channel, particularly in floor tile products.
 
  Sales within Mexico are made primarily through a network of independent
retailers who are principally supplied by the Company's Monterrey, Mexico
manufacturing facility.
 
 HOME CENTER RETAILERS
 
  The Company also is the U.S. ceramic tile industry's largest supplier to the
DIY and BIY markets by supplying home center retailers, such as The Home
Depot, Lowe's, Menards and Payless Cashways, serving over 950 home center
retail outlets nationwide. The home center retailer channel has provided the
Company with new sources of sales over the past five years, having grown from
a nominal amount in 1991 to approximately $62 million in 1995 on a pro forma
basis inclusive of AO. Sales to home center retailers are expected to continue
presenting significant growth opportunities for the Company.
 
ESTABLISHED BRANDS AND SPECIAL MARKETING PROGRAMS
 
  The Company believes that it has two of the leading brand names in the
ceramic tile industry--Daltile and American Olean--and has recently
established the new Homesource brand name. Daltile and American Olean have
each been marketed for more than 30 years and have achieved high brand
recognition among customers.
 
  The Company-operated sales centers distribute the Daltile brand, which was
repositioned in the marketplace in 1996. This repositioning included the
introduction of an updated product array, a new logo, new sampling materials
and a fully integrated marketing program. The product offering was streamlined
based on the Company's assessment of the needs of professional installers,
designers, architects and builders, as well as a review of competitive product
offerings. The marketing program includes advertising to targeted customer
segments, public relations support, merchandising (displays/sample boards,
chip chests), literature/catalogs and an internet website. Through its Daltile
brand, the Company provides the most comprehensive product offering in the
U.S. ceramic tile industry.
 
  The American Olean brand consists of a full product offering and is
distributed primarily through independent distributors. The brand is supported
by a fully integrated marketing program, including trade publication
advertising, consumer advertising, public relations efforts, cooperative
advertising programs for dealers and distributors, displays, merchandising
(sample boards, chip chests), and literature/catalogs.
 
  In addition to distributing the Daltile and American Olean brands, home
center retailers distribute a newly established home center brand--Homesource.
The Homesource brand includes a targeted product offering, customized point of
sale displays and merchandising, cooperative advertising support, literature/
catalogs and sampling materials.
 
 
                                      43
<PAGE>
 
   The Company also has special marketing programs with strong established
brands, including Kohler for bathroom and kitchen fixture color coordination
and Laura Ashley for home furnishing accessories coordination. Through such
programs, the Company develops ceramic tile products and merchandising
programs to complement these other product lines. The Company believes its
brands and the special marketing programs increase the value of its tile
products through differentiation.
 
PRODUCTS AND PRODUCT DEVELOPMENT
 
  The Company manufactures and sells different types of ceramic tile in
various sizes and styles for commercial and residential use, as well as
related trim and angle pieces. The Company also sells stone and quarry-related
products and allied products purchased from third-party manufacturers.
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 the fiscal year ended December 31, 1995, approximately 70% of Company
net sales (exclusive of AO 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 Japan. This
percentage would not have materially changed in 1995 as a result of the AO
Acquisition. 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
the floor tile market. The Company has developed capabilities to produce
fashionable and innovative tile products and to simulate natural products such
as stone, marble and wood. In order to capitalize on the increased demand for,
and high margins available from, fashion-oriented tile products, the Company
has (i) increased the number of new floor 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) increased its investment in research and development to
further develop new products and manufacturing capabilities.
 
CUSTOMERS
 
  The Company's core customers consist of large and small tile contractors,
architects, design professionals, builders, developers, independent
distributors and flooring dealers. The Company also sells to the DIY and BIY
market through relationships with home center retailers, such as The Home
Depot, Lowe's, Menards and Payless Cashways, and is a significant supplier to
this channel. The Company has a broad and diversified customer base,
consisting of more than 30,000 active accounts in the United States.
 
  The Company also 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 and Mobil service stations.
 
  The Company does not rely on any one customer or group of customers for a
material amount of its net sales. The Company's largest customer for the
fiscal year ended December 31, 1995 accounted for approximately 7% of net
sales (inclusive of AO net sales), and the Company's ten largest customers
accounted for less than 10% of net sales (inclusive of AO net sales) in such
period.
 
MANUFACTURING
 
  The Company operates 11 manufacturing facilities with an aggregate annual
manufacturing capacity of 311 million square feet. Since 1991, the Company
invested, exclusive of AO, over $89.6 million in capital expenditures,
including $62.6 million new plants and state-of-the-art equipment to increase
manufacturing capacity, improve efficiency and develop new capabilities.
During such period, manufacturing capacity expanded from 203 million square
feet in 1991 to 311 million square feet in 1995. As a result of the AO
Acquisition, the Company also has a 49.99% interest in RISA, a Mexican joint
venture with Internacional de Ceramica, S.A. de
 
                                      44
<PAGE>
 
C.V., which, pursuant to contractual arrangements, will supply the Company, at
the Company's option, with up to 24 million additional square feet of floor
tile annually.
 
  The Company believes it is one of the industry's low cost producers. The
Company's largest manufacturing facility, which represents approximately 40%
of the Company's annual manufacturing capacity, is located in Monterrey,
Mexico. The Company's newest manufacturing plant is a state-of-the-art wall
tile facility in El Paso, Texas with capacity of 20 million square feet. The
Company believes that its El Paso facility is one of the lowest cost wall tile
facilities in the United States, primarily as a result of the facility's high
kiln recovery and high productivity rates. The Company's manufacturing
organization also creates additional competitive advantages for the Company
due to its ability to manufacture a differentiated product line consisting of
the industry's broadest product offering 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, seeking opportunities to specialize its factories
by product line and continuing investments in manufacturing technology to
lower its costs, develop new capabilities and expand capacity.
 
  The following table summarizes the products currently manufactured at the
Company's facilities:
 
<TABLE>
<CAPTION>
      FACILITY              PRODUCT TYPE
      --------              ------------
      <S>                   <C>
      Fayette, AL (1)...... Unglazed quarry tile
      Pocatello, ID........ Glazed porcelain tile
      Lewisport, KY (1).... Unglazed quarry tile
      Monterrey, Mexico.... Glazed wall tile; Glazed floor tile; Glazed mosaics
      Olean, NY (1)........ Unglazed ceramic mosaic tile
      Gettysburg, PA....... Glazed and unglazed mosaic tile
      Jackson, TN (1)...... Glazed mosaic tile
      Conroe, TX........... Glazed floor tile
      Dallas, TX........... Glazed wall tile
      El Paso, TX.......... Glazed wall tile
      Coleman, TX.......... Unglazed quarry tile
</TABLE>
- --------
(1) Acquired as part of the AO Acquisition.
 
  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. Throughout its history, the Monterrey facility has
produced ceramic tile which meets U.S. quality standards as defined by the
American National Standards Institute. The Monterrey location contains five
distinct manufacturing facilities, three of which produce ceramic tile, one of
which produces frit (ground glass) and one of which produces refractories.
 
  As a result of the AO Acquisition, the Company has evaluated all of its
manufacturing facilities and has begun to consolidate its manufacturing
network. The Company consolidated its wall tile production at the end of the
first quarter of 1996 by closing its Lansdale and Jackson wall tile
facilities. See "Risk Factors". In addition, the Company plans to consolidate
a portion of its mosaic tile production in late 1996.
 
RAW MATERIALS
 
  The Company 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.
 
  The Company owns long-term talc mining rights in Texas which satisfy nearly
all of the Company's talc requirements. Talc represents the Company's largest
tonnage raw material requirements. The Company owns
 
                                      45
<PAGE>
 
long-term clay mining rights in Kentucky which satisfy nearly all of the
Company's clay requirements for producing unglazed quarry tile.
 
  The Company purchases a number of different grades of clay for the
manufacture of its 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. The Company purchases pure nepheline syenite 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, the Company could use feldspar in its production of mosaic
tile, which can be purchased from a number of sources at comparable cost.
 
  The Company uses glazes on a significant percentage of its manufactured tile.
Glazes consist of a mixture of frit (ground glass), zircon, stains and other
materials, with frit representing the largest ingredient. The Company
manufactures approximately 64% of its frit requirements.
 
  The Company 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
 
  As a result of the AO Acquisition, the Company will combine two independent
systems into one fully integrated system. To facilitate the integration of the
two systems, the Company has engaged the services of a major systems
integration firm to assist in the planning, training and conversion process.
The integration is anticipated to be completed in 1997.
 
COMPETITION
 
  Sales of the Company's products are made in a highly competitive marketplace.
The Company encounters competition from domestic and foreign tile
manufacturers, as well as from manufacturers of products which serve as an
alternative to tile. Certain of the Company's domestic competitors are
subsidiaries of publicly held companies that may have greater resources than
the Company. Competition in the tile industry is based on price, customer
service, quality and design. 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 particular, although certain major tile manufacturers operate
sales centers, none approach the extent of the Company's system. In addition,
as part of the AO Acquisition, the Company now utilizes a network of
independent distributors for the American Olean brand products. The Company's
competitors--domestic and foreign--which do not have extensive sales center
networks, rely primarily on independent distributors, including the Company's
sales center network, and home center retailers. In 1995, approximately 59% of
U.S. ceramic tile sales (by unit volume) consisted of imports, including the
approximately 10% of ceramic tile sold in the United States that was
manufactured by the Company in Mexico. In general, the proportion of U.S.
ceramic tile sales attributable to imports has increased in recent years.
Consequently, changes in exchange rates could affect the Company's position
with respect to foreign competitors.
 
  The Company's 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,
porcelain, 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.
 
                                       46
<PAGE>
 
EMPLOYEES
 
  At March 31, 1996, the Company employed approximately 7,100 persons. At
March 31, 1996, approximately 2,400 of the Company employees were employed by
its Mexican subsidiaries. Approximately 11% of the Company's employees in the
United States are represented by unions. Approximately 84% of the Company's
employees in Mexico are represented by a union under a collective bargaining
agreement. This agreement expires in 1997. The Company has not experienced a
work stoppage in Mexico in over 15 years and has experienced only one brief
work stoppage in the United States over the past 15 years. 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, Homesource and Dal-Monte, 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 U.S. 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 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 their glazing operations. The Company's facilities
located in the United States have discontinued the use of lead compounds in
glaze materials. 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 in 1990. 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 environmental remediation programs 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. An additional $300,000 of assessed penalties under the 1991
Order has been deferred pending the timely and satisfactory completion of the
technical recommendations in the 1991 Order. The Company's closure plan for
Elam has been approved by the TNRCC and closure is currently underway. The
Company estimates that such closure will cost approximately $5.5 million. The
Company expects to recover at least 50% of such 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.
Pleasant Run has been remediated in accordance with a TNRCC-approved closure
plan. In 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
$1.36 million.
 
 
                                      47
<PAGE>
 
  The remediation described above followed a related criminal investigation
which led to the indictments and, in 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, certain other
parties, including 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 currently is in the process
of completing a remedial investigation with respect to the Walton site. 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 recommendations 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 preliminary estimates, that
the remediation may cost between approximately $10 million and $14.7 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 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 1994, the Company settled this
action by agreeing to remediate soil contamination on the plaintiffs' property
and agreeing to pay approximately $500,000.
 
  On May 20, 1993, the Company entered into an agreement with 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
approximately $12 million already paid, until such total excess expenditures
reach a formula amount (currently estimated to be approximately $18 million),
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
(including substantially all its expenditures in connection with the
settlements described above) have been covered by the Settlement Agreement,
and the Company has the right to recover at least 50% of future related
expenditures pursuant to the Settlement Agreement. The Company believes that
it has established adequate reserves on its Consolidated Financial Statements
in connection with these matters. 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
 
                                      48
<PAGE>
 
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 believes that its manufacturing facilities are in substantial
compliance with current environmental laws and regulations. The Company's
manufacturing facilities generate wastes regulated under the Resource
Conservation and Recovery Act and other U.S. federal and state laws. The
Company also generates non-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. The Company in its ordinary course of business treats
its costs incurred in connection with ongoing environmental compliance matters
as ordinary expenses.
 
  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 facility
continues 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.
 
  The Company has established an environmental compliance group reporting
directly to the Chief Executive Officer to help ensure that the Company
remains in compliance with environmental laws and regulations and to oversee
remediation activities.
 
GEOGRAPHIC LOCATION
 
  Financial information by geographic location for the three years ended
December 31, 1995 is set forth in Note 14 to the Consolidated Financial
Statements included elsewhere in this Prospectus. See also "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources".
 
PROPERTIES
 
  The Company owns or leases manufacturing, distribution, office and sales
facilities in the United States, Canada and Mexico, as described below.
 
                                      49
<PAGE>
 
 MANUFACTURING, DISTRIBUTION AND OFFICE FACILITIES
 
  The Company owns or leases 17 manufacturing, distribution and office
facilities. The location of, use of, and the floor area of, such facilities
are described as follows:
 
<TABLE>
<CAPTION>
LOCATION                             USE                  SQ. FEET  LEASE/OWNED
- --------                             ---                  --------- -----------
<S>                  <C>                                  <C>       <C>
Fayette, AL......... Manufacturing                          276,467    Owned
Hayward, CA......... Distribution Center                     90,400   Leased(1)
Los Angeles, CA..... Distribution Center                    100,000   Leased(1)
Jacksonville, FL.... Distribution Center                    104,000   Leased(1)
Pocatello, ID....... Manufacturing                           91,580   Leased(1)
Indianapolis, IN.... Distribution Center                     87,050   Leased(1)
Lewisport, KY....... Manufacturing                          270,836    Owned
Baltimore, MD....... Distribution Center                     83,800   Leased(1)
Monterrey, Mexico... Manufacturing, Distribution & Office 1,114,175    Owned
Olean, NY........... Manufacturing                          278,417    Owned
Gettysburg, PA...... Manufacturing                          218,609    Owned
Lansdale, PA........ Distribution Center & Office         1,196,051    Owned
Jackson, TN......... Manufacturing & Distribution           655,211    Owned
Coleman, TX......... Manufacturing                           62,603    Owned
Conroe, TX.......... Manufacturing                          208,059    Owned
Dallas, TX.......... Manufacturing, Distribution & Office   753,536    Owned
El Paso, TX......... Manufacturing                          161,714    Owned
</TABLE>
- --------
(1) The leases for the Hayward, CA; Los Angeles, CA; Jacksonville, FL;
    Pocatello, ID; Indianapolis, IN; and Baltimore, MD facilities expire on
    March 31, 1999; March 31, 2002; May 31, 1999; April 16, 1997; May 31,
    2000; and June 30, 2001, respectively, and are subject to renewal options.
 
 SALES CENTERS
 
  The Company owns eight sales centers aggregating 156,386 square feet. Their
location and floor area are as follows:
 
<TABLE>
<CAPTION>
                                                   SQUARE
            LOCATION                                FEET
            --------                               ------
            <S>                                    <C>
            Phoenix, AZ........................... 15,320
            Escondido, CA......................... 14,207
            Denver, CO............................ 22,500
            St. Louis, MO......................... 17,375
            Houston, TX........................... 21,250
            Richardson, TX........................ 23,777
            San Antonio, TX....................... 15,520
            Salt Lake City, UT.................... 26,437
</TABLE>
 
  In addition, the Company leased 266 sales centers as of March 31, 1996
aggregating approximately 3.0 million square feet pursuant to leases that
extend for terms on average of three-to-five years with expiration dates
primarily from 1996-2000.
 
  For a description of the Company's aggregate rental expenses with respect to
its operating leases, see Note 13 to the Consolidated Financial Statements
included elsewhere in this Prospectus relating to commitments and
contingencies.
 
LEGAL PROCEEDINGS
 
  In addition to the proceedings described under "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.
 
                                      50
<PAGE>
 
                                  MANAGEMENT
 
DIRECTORS AND EXECUTIVE OFFICERS
 
  The directors and executive officers of Dal-Tile are set forth below.
Certain of the executive officers hold positions with Dal-Tile Corporation or
Dal-Tile Mexico, each a subsidiary of Dal-Tile. 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
              ----               ---          -----------------------
 <C>                             <C> <S>
 Charles J. Pilliod, Jr. .......  77 Chairman of the Board
 Howard I. Bull.................     President and Chief Executive Officer and
                                  56  Director
 E. Mandell de Windt............  75 Director
 Drew Lewis.....................  64 Director
 George A. Lorch................  54 Director
 Vincent A. Mai.................  56 Director
 Frank A. Riddick III...........  39 Director
 Robert J. Shannon, Jr. ........  48 Director
 Henry F. Skelsey...............  38 Vice President and Director
 John M. Goldsmith..............  33 Vice President and Director
 William R. Bronson.............  53 Vice President, Information Systems
 James E. Eckelberger...........  57 Vice President, Logistics
 David F. Finnigan..............  39 Vice President, Sales Center Operations
 William R. Hanks...............  42 Vice President, Manufacturing
 Matthew J. Kahny...............  35 Vice President, Independent Distributor
                                      Operations
                                     Vice President and Chief Operating
 Barry J. Kulpa.................  47  Officer
 Carlos E. Sala.................  36 Vice President, Chief Financial Officer
                                      and Treasurer
 Javier Eugenio Martinez Serna..  45 Vice President, Mexico Operations
 Thomas Scott Smith.............  48 Vice President, Human Resources
 Harold G. Turk.................  50 Vice President, Home Center Services
</TABLE>
 
  Charles J. Pilliod, Jr., Chairman of the Board of Directors--Mr. Pilliod has
been the Chairman of the Board of Directors since October 1993 and a Director
since March 1990. From October 20, 1993 through April 14, 1994, he also served
as President and Chief Executive Officer of the Company. 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. and serves as the Chairman of the Board of Directors of CasTech Aluminum
Group Inc.
 
  Howard I. Bull, President and Chief Executive Officer and Director--Mr. Bull
has been President and Chief Executive Officer and a Director of the Company
since April 15, 1994. Prior to joining the Company, Mr. Bull spent ten years
with Baker Hughes Incorporated, a worldwide diversified oil services company,
where he became Chief Executive Officer for Baker Hughes Drilling Equipment
Company. Additionally, he served York International Corporation, a worldwide
manufacturer and distributor of air conditioner and refrigeration equipment,
as President of its Applied Systems Division and Air Conditioning Business
Group. Mr. Bull is a director of Marine Drilling Companies, Inc.
 
  E. Mandell de Windt, Director--Mr. de Windt has been a Director since March
1990. From March 1990 through October 1993, he was Chairman of the Board of
Directors. Mr. de Windt is the retired Chairman and Chief Executive Officer of
Eaton Corporation, a diversified manufacturing concern. He is currently a
Director and Chairman of the Executive Committee of Birmingham Steel Corp.
 
 
                                      51
<PAGE>
 
  Drew Lewis, Director--Mr. Lewis has been a Director of the Company since
March 1990. Mr. Lewis is currently Chairman, President and Chief Executive
Officer of Union Pacific Corp., a transportation, natural resources and
environmental services concern. He served as U.S. Secretary of Transportation
between 1981 and 1983. Mr. Lewis is also a director of Ford Motor Company,
AT&T Corp., American Express Co., FPL Group, Inc., Gannett Co., Inc. and Union
Pacific Resources Group Inc.
 
  George A. Lorch, Director--Mr. Lorch has been a Director of the Company
since December 29, 1995. Mr. Lorch has been Chairman and Chief Executive
Officer of AWI, a stockholder of Dal-Tile, since April 1994. Mr. Lorch was an
Executive Vice President of AWI from March 1988 to September 1993 and served
as President and Chief Executive Officer of AWI from September 1993 to April
1994. Mr. Lorch is also a director of Stanley Works, Household International
and R.R. Donnelley & Sons Company.
 
  Vincent A. Mai, Director--Mr. Mai has been a Director of the Company since
October 1989. Mr. Mai has been the President and Chief Executive Officer of
AEA Investors, a stockholder of Dal-Tile, since April 1989. For the preceding
15 years, he was a Managing Director of Lehman Brothers Inc., an investment
banking firm. Mr. Mai also is a director of the Federal National Mortgage
Association.
 
  Frank A. Riddick III, Director--Mr. Riddick has been a Director of the
Company since December 29, 1995. Mr. Riddick has been Senior Vice President,
Finance and Chief Financial Officer of AWI, a stockholder of Dal-Tile, since
April 1995. Previously, he held the following positions with FMC Corporation,
a chemicals and machinery company: Controller, May 1993-March 1995 and
Treasurer, December 1990-May 1993.
 
  Robert J. Shannon, Jr., Director--Mr. Shannon has been a Director of the
Company since December 29, 1995. Mr. Shannon currently is President,
International Floor Products Operations of AWI, a stockholder of Dal-Tile.
From March 1992 through December 29, 1995, Mr. Shannon was President of AO,
then a subsidiary of AWI. During 1991, Mr. Shannon was General Manager,
Worldwide Gasket Products, of AWI.
 
  Henry F. Skelsey, Vice President and Director--Mr. Skelsey has been a Vice
President and a Director of the Company since October 1989. Mr. Skelsey has
been a Managing Director of AEA Investors, a stockholder of Dal-Tile, since
March 1988. Prior to his association with AEA Investors, Mr. Skelsey was a
Vice President in the Merchant Banking division of Lehman Brothers Inc., an
investment banking firm. Mr. Skelsey is also a director of Teltrend Inc.
 
  John M. Goldsmith, Vice President and Director--Mr. Goldsmith has been a
Vice President and a Director of the Company since April 1996. Mr. Goldsmith
is a Principal of AEA Investors, a stockholder of Dal-Tile, 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.
 
  William R. Bronson, Vice President, Information Systems--Mr. Bronson has
been Vice President, Information Systems of the Company since January 1996.
From July 1994 to January 1996 he was the Vice President, Logistics for the
Company. From August 1990 to July 1994 he was a Business Unit Manager for
Tandem Computers, Inc., a manufacturer and distributor of computer systems.
 
  James E. Eckelberger, Vice President, Logistics--Mr. Eckelberger has been
Vice President, Logistics since February 1996. From March 1994 until February
1996, Mr. Eckelberger was Vice President-Logistics of B.J.'s Wholesale Club, a
wholesale-retail membership club for consumer goods. From September 1992 until
January 1994 he was the Vice President-Logistics for Pace Membership
Warehouse, a wholesale-retail membership club for consumer goods. From 1988-
1992 Mr. Eckelberger was commanding officer (CEO) of the U.S. Navy's Aviation
Supply Office.
 
  David F. Finnigan, Vice President, Sales Center Operations--Mr. Finnigan has
been Vice President, Sales Center Operations since January 1996. From 1990
through December 29, 1995, Mr. Finnigan was at AO, then a subsidiary of AWI,
where he became Vice President-Sales.
 
 
                                      52
<PAGE>
 
  William R. Hanks, Vice President, Manufacturing--Mr. Hanks has been Vice
President-Manufacturing 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 the Company's floor covering
products manufacturing facility.
 
  Matthew J. Kahny, Vice President, Independent Distributor Operations--Mr.
Kahny has been Vice President, Independent Distributor Operations since
January 1996. From July 1983 through December 29, 1995, Mr. Kahny served at
AO, then a subsidiary of AWI, where he became Business Team Manager, Floor
Tile Products.
 
  Barry J. Kulpa, Vice President and Chief Operating Officer--Mr. Kulpa has
been a Vice President and the Chief Operating Officer of the Company since
July 1994. Prior to joining the Company, Mr. Kulpa was Chief Financial Officer
for David Weekley Homes, a national homebuilder in Houston, Texas. Prior to
that, Mr. Kulpa spent ten years with Baker Hughes Incorporated, a worldwide
diversified oil services company, where he held various Vice President
positions, concluding with Vice President-Operations, Hughes Tool.
 
  Carlos E. Sala, Vice President, Chief Financial Officer and Treasurer--Mr.
Sala has been a Vice President and the Chief Financial Officer of the Company
since March 1991. Previously, he was Vice President of International
Operations since March 1990. Prior to his association with the Company, he was
a Mergers & Acquisitions Manager at Ernst & Young, an independent accounting
firm, from 1988 to 1990. Mr. Sala is a certified public accountant.
 
  Javier Eugenio Martinez Serna, Vice President, Mexico Operations--Mr.
Martinez has been Vice President, Mexico Operations since August 1995. Prior
to August 1995, he was a director of Materiales since December 1985.
 
  Thomas Scott Smith, Vice President, Human Resources--Mr. Smith has been Vice
President, Human Resources since January 1996. From October 1993 to December
1995 Mr. Smith was President, Grant T.F.W. Industries of Energy Ventures, a
tubular goods manufacturer for the oil and gas drilling industry. For 21 years
prior to October 1993, Mr. Smith was at Baker Hughes, Incorporated, a
worldwide diversified oil services company, where he served as a Vice
President-Manufacturing, a General Manager and the Director of Human
Resources.
 
  Harold G. Turk, Vice President, Home Center Services--Mr. Turk has been a
Vice President, Home Center Services of the Company since January 1996. In
1995, he was Executive Vice President of Field Operations; in 1994, he was
Executive Vice President of Marketing; and, since April 1991, he was Executive
Vice President of Sales and Marketing, Western Region. Mr. Turk was a Vice
President of Warehouse Administration and Sales of the Company from 1976 to
1991.
 
                               ----------------
  Pursuant to the AEA/AWI Shareholders Agreement, AEA Investors and AWI agreed
to cause the Board of Directors of the Company to be comprised, as of December
29, 1995, of six individuals designated by AEA Investors, three individuals
designated by AWI and the Chief Executive Officer of Dal-Tile. The six
individuals designated by AEA Investors are: Messrs. Pilliod, de Windt, Lewis,
Mai, Goldsmith and Skelsey. The three individuals designated by AWI are:
Messrs. Lorch, Riddick and Shannon. The rights and obligations of AEA
Investors and AWI so to designate directors are subject to change in the event
of certain circumstances, more particularly described in the AEA/AWI
Shareholders Agreement.
 
 
                                      53
<PAGE>
 
EXECUTIVE COMPENSATION
 
 SUMMARY COMPENSATION TABLE
 
  The following table sets forth certain information with respect to the
annual and long-term compensation of the Company's Chief Executive Officer,
each of the Company's four other most highly compensated executive officers,
and the former President of the Company's Mexican subsidiaries, in each case,
for the fiscal years ended December 31, 1993, 1994 and 1995:
 
                          SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                                   LONG TERM
                                   ANNUAL        COMPENSATION
                                COMPENSATION        AWARDS
                              ----------------- ---------------
                                                  SECURITIES
   NAME AND PRINCIPAL                             UNDERLYING     ALL OTHER
        POSITION         YEAR  SALARY   BONUS   OPTIONS/SARS(1) COMPENSATION
   ------------------    ---- -------- -------- --------------- ------------
<S>                      <C>  <C>      <C>      <C>             <C>
Howard I. Bull.......... 1995 $400,000 $180,000     $     0       $ 56,517(3)(4)
 President and Chief
 Executive Officer(2)    1994  284,615  325,000      35,000         30,776
Harold L. Turk.......... 1995  291,749   98,460           0        746,401(6)(7)(8)(4)
 President of Mexican
 subsidiaries(5)         1994  468,000  299,500           0         90,698
                         1993  468,000  247,000           0         79,617
Barry J. Kulpa.......... 1995  282,600  117,450           0          5,577(4)
 Vice President and
 Chief Operating
 Officer(9)              1994  132,501   89,436      10,000         44,772
Harold G. Turk.......... 1995  253,850   60,245           0         11,580(10)(4)
 Vice President, Home
 Center Services         1994  240,000  156,250           0          6,868
                         1993  244,615  125,000           0          6,971
Carlos E. Sala.......... 1995  215,000   89,100           0              0
 Vice President, Chief
 Financial Officer and   1994  200,000  144,000           0             91
 Treasurer               1993  178,365   90,000           0            284
William R. Hanks........ 1995  173,078   70,875           0              0
 Vice President,
 Manufacturing           1994  139,248   85,000           0            175
                         1993   81,538   32,000           0            150
</TABLE>
- --------
(1)  The number of securities underlying the options will be increased to give
     effect to the Common Stock Conversion.
(2) Mr. Bull was appointed to his position as President and Chief Executive
    Officer on April 15, 1994.
(3) The amount shown includes $48,825 of relocation expenses incurred in
    fiscal year 1995 by Howard I. Bull which were reimbursed by the Company.
(4) The amounts shown include paid vacation for fiscal year 1995 to Howard I.
    Bull, in the amount of $7,692; Barry J. Kulpa, in the amount of $5,577;
    Harold G. Turk, in the amount of $4,904; and Harold L. Turk, in the amount
    of $26,393.
(5) Mr. Turk retired on July 31, 1995.
(6) The amounts shown include distributions to Harold L. Turk from the
    Retirement Plan for the Employees of Dal-Tile Mexico of $370,277 and the
    Pension Plan of Materiales of $226,499. The amounts shown also include
    contributions of $1,165 made by the Mexican subsidiaries to workers'
    profit sharing for the benefit of Harold L. Turk.
(7) The amount shown includes payments to Harold L. Turk from August 1995
    through December 1995 for monthly consulting fees of $18,750, totaling
    $93,750.
 
                                      54
<PAGE>
 
 (8) The amount shown includes repayment of relocation expenses in fiscal 1995
     for Harold L. Turk in the amount of $10,000. It also includes a $15,000
     payment to Mr. Turk to allow him to purchase his company car, and a
     retirement bonus of $3,317.
 (9) Mr. Kulpa was appointed to his position as Vice President and Chief
     Operating Officer on July 2, 1994.
(10) The amounts shown include premiums paid for fiscal 1995 by the Company
     for split dollar life insurance in the amount of $6,676 for the benefit
     of Harold G. Turk.
 
 OPTION GRANTS
 
  There were no options or stock appreciation rights ("SARs") granted during
fiscal 1995 by the Company to any of the named executive officers of the
Company in the Summary Compensation Table above.
 
 OPTION EXERCISE TABLE
 
  The following table sets forth the number of shares covered by both
exercisable and unexercisable stock options as of December 31, 1995.
 
              AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
                     AND FISCAL YEAR-END OPTION/SAR VALUES
 
<TABLE>
<CAPTION>
                                                    NUMBER OF SECURITIES
                                                   UNDERLYING UNEXERCISED    VALUE OF UNEXERCISED IN
                                                   OPTIONS/SARS AT FISCAL   THE MONEY OPTIONS/SARS AT
                                                          YEAR-END             FISCAL YEAR-END (1)
                                                  ------------------------- -------------------------
                         SHARES ACQUIRED  VALUE
          NAME           ON EXERCISE (#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
          ----           --------------- -------- ----------- ------------- ----------- -------------
<S>                      <C>             <C>      <C>         <C>           <C>         <C>
Howard I. Bull..........         0           0                                  $            $
Harold L. Turk(2).......         0           0
Barry J. Kulpa..........         0           0
Harold G. Turk..........         0           0
Carlos E. Sala..........         0           0
William R. Hanks........         0           0
</TABLE>
- --------
(1) Values for "in-the-money" options represent the positive spread between
    the respective exercise prices of outstanding stock options and the value
    of the Common Stock as of December 31, 1995 as determined by the Company's
    management in accordance with an internal valuation.
(2) Harold L. Turk retired from the Company in July 1995.
 
DIRECTOR COMPENSATION
 
  Directors who are full-time employees of the Company receive no additional
compensation for serving on the Board of Directors or its committees and
directors who are employees of AEA Investors receive no compensation for
serving on the Board of Directors or its committees. Directors who are not
full-time employees of the Company or employees of AEA Investors receive an
annual fee of $5,000, except for the Chairman, who receives an annual fee of
$25,000, and $500 for each Board of Directors meeting attended, plus
reimbursement for traveling costs and other out-of-pocket expenses incurred in
attending such meetings. Directors who serve on one or more of the Audit
Committee, Compensation Committee or Executive Committee receive $500 for
attending a committee meeting which occurs on a date other than the date of a
meeting of the full Board of Directors.
 
 
                                      55
<PAGE>
 
EMPLOYMENT AGREEMENTS
 
  The Company has entered into employment agreements with Howard I. Bull,
Harold G. Turk and Carlos E. Sala. Dal-Tile Mexico entered into an employment
agreement with Harold L. Turk which expired on January 1, 1995. The agreement
with Mr. Bull, which will expire on April 15, 1997, provides for the payment
of an annual salary of not less than $400,000. The agreement with Harold G.
Turk, which expires on December 31, 1999, provides for the payment of an
annual base salary of at least $225,000. The agreement with Harold L. Turk
provided for the payment of annual total compensation, including base salary
and bonuses, of not less than $320,000. Mr. Sala's employment agreement
expires on February 5, 1998 and provides for payment of annual compensation,
including base salary and bonuses, of not less than $145,000. Each of the
employment contracts described herein contains provisions prohibiting the
employee from competing with the Company during the term of employment and, in
certain cases, for a period thereafter. In addition, the employment contract
with Carlos E. Sala provides that if his employment is terminated without
cause before the expiration of the contract, Mr. Sala will be paid, on a
semimonthly basis, all compensation owing under the contract for the remainder
of the contract term, provided he complies with all noncompetition
restrictions. These payments, however, will be offset by amounts earned by Mr.
Sala subsequent to the termination of employment without cause. The employment
contract with Mr. Bull provides that if his employment is terminated without
cause before the expiration of the contract, Mr. Bull will be paid, on the
date of termination and thereafter, all salary owed for the remainder of the
term, in accordance with the Company's usual payroll practices. The Company
entered into a consulting agreement with Harold L. Turk, which will expire on
July 31, 1998, which provides that Mr. Turk will be paid a monthly consulting
fee of $18,750 from August 1, 1995 through July 31, 1996. The monthly fee
decreases to $14,583 for the period August 1, 1996 through July 31, 1997, and
to $10,417 for the period August 1, 1997 through July 31, 1998.
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
  The following directors served on Dal-Tile's Compensation Committee during
the fiscal year ended December 31, 1995: Drew Lewis, E. Mandell de Windt,
Vincent A. Mai, Charles J. Pilliod, Jr., Henry F. Skelsey and Romulo
O'Farrill, Jr. Mr. O'Farrill ceased to be a director on December 29, 1995. See
"--Directors and Executive Officers". Charles J. Pilliod, Jr., Henry F.
Skelsey and Vincent A. Mai also served as officers of Dal-Tile and certain of
its subsidiaries during such fiscal year. Messrs. Mai and Skelsey are officers
of AEA Investors, a stockholder of Dal-Tile. AEA Investors received a
management fee and reimbursement for expenses totaling $991,000 during the
fiscal year ended December 31, 1995. See "Principal Stockholders" and "Certain
Transactions" for further information regarding AEA Investors.
 
                                      56
<PAGE>
 
                            PRINCIPAL STOCKHOLDERS
 
  The following table sets forth certain information as of May 1, 1996
regarding the beneficial ownership of Common Stock (a) immediately prior to
the Offerings, and (b) as adjusted to reflect the sale of the shares of Common
Stock in the Offerings, by (i) each person known to Dal-Tile to own
beneficially more than 5% of the outstanding shares of Common Stock, (ii) each
of Dal-Tile's directors, (iii) each of the executive officers named in the
table under "Management--Executive Compensation--Summary Compensation Table",
and (iv) all the Company's directors and executive officers as a group.
 
<TABLE>
<CAPTION>
                                                                 PERCENT OF
                                                             COMMON STOCK OWNED
                                                            --------------------
                                                 NUMBER OF  BEFORE THE AFTER THE
                                                 SHARES(1)  OFFERINGS  OFFERINGS
                                                 ---------  ---------- ---------
<S>                                              <C>        <C>        <C>
AEA Investors Inc..............................                   %          %
 65 East 55th Street
 New York, NY 10022
Armstrong Enterprises, Inc.(2).................
 Liberty and Charlotte Streets
 P.O. Box 3001
 Lancaster, PA 17604
The Prudential Insurance Company of America....
 Four Gateway Center
 Newark, NJ 07102
AVA Partners...................................
 1300 Mt. Kemble Avenue
 Morristown, NJ 07962
Charles J. Pilliod, Jr.........................        (3)
Howard I. Bull.................................        (4)
E. Mandell de Windt............................
Drew Lewis.....................................
George A. Lorch................................        (5)
Vincent A. Mai.................................        (6)
Frank A. Riddick III...........................        (7)
Robert J. Shannon..............................        (8)
Henry F. Skelsey...............................        (9)
John M. Goldsmith..............................
William R. Hanks...............................        (10)
Barry J. Kulpa.................................        (11)
Carlos E. Sala.................................        (12)
Harold G. Turk.................................        (13)
All directors and executive officers as a group
 (20 persons)..................................
</TABLE>
- --------
 * Less than 1%
 (1) For purposes of this table, a person or group of persons is deemed to
     have "beneficial ownership" of any shares as of a given date which such
     person has the right to acquire within 60 days after such date. For
     purposes of computing the percentage of outstanding shares held by each
     person or group of persons named above on a given date, any shares which
     such person or persons have the right to acquire within 60 days after
     such date is deemed to be outstanding, but is not deemed to be
     outstanding for the purpose of computing the percentage ownership of any
     other person.
 (2) AEI is a wholly owned subsidiary of AWI.
 (3) Includes      shares subject to options. Shares are held in nominee name,
     Hertrus and Company.
 (4) Includes      shares subject to options.
 (5) Excludes      shares indirectly owned by AWI, for which Mr. Lorch serves
     as an officer and director. Mr. Lorch disclaims beneficial ownership of
     such shares.
 (6) Excludes      shares owned by AEA Investors, for which Mr. Mai serves as
     an officer and director. Mr. Mai disclaims beneficial ownership of such
     shares.
 
                                      57
<PAGE>
 
 (7) Excludes      shares indirectly owned by AWI, for which Mr. Riddick
     serves as an officer. Mr. Riddick disclaims beneficial ownership of such
     shares.
 (8) Excludes      shares indirectly owned by AWI, for which Mr. Shannon
     serves as an officer. Mr. Shannon disclaims beneficial ownership of such
     shares.
 (9) Includes     shares held by Mr. Skelsey, as trustee for the benefit of
     his family; Mr. Skelsey disclaims beneficial ownership of such shares.
     Excludes     shares owned by AEA Investors, for which Mr. Skelsey serves
     as an officer; Mr. Skelsey disclaims beneficial ownership of such shares.
(10) Includes      shares subject to options.
(11) Includes      shares subject to options.
(12) Includes      shares subject to options.
(13) Includes      shares subject to options.
 
  Pursuant to the AEA/AWI Shareholders Agreement, each of AEA Investors and
AWI agreed to vote its shares of Common Stock (and AEA Investors agreed to
vote the shares of Common Stock owned by the Covered Shareholders (as defined
below)) to effectuate the provisions of the AEA/AWI Shareholders Agreement,
including for the election as directors of Dal-Tile of (i) six directors
designated by AEA Investors, (ii) three directors designated by AWI, and (iii)
the Chief Executive Officer of Dal-Tile. The rights and obligations of AEA
Investors and AWI so to designate directors are subject to change in the event
of certain circumstances, more particularly described in the AEA/AWI
Shareholders Agreement. The AEA/AWI Shareholders Agreement, among other
things, contains provisions (1) requiring the approval of a director
designated by AWI before the Company effects certain capital expenditures or
acquisition or disposition transactions, and (2) providing for registration
rights under certain circumstances under the Securities Act.
 
  In order to effectuate the provisions of the AEA/AWI Shareholders Agreement,
certain stockholders of Dal-Tile (the "Covered Shareholders") entered into an
agreement in which the Covered Shareholders agreed not to transfer shares of
Common Stock owned by them until the third anniversary of the closing of the
Offerings without the consent of AEA Investors and granted AEA Investors a
right to vote their shares of Common Stock at any meeting of the stockholders
of Dal-Tile or to give written consent in respect thereof, and it is expected
that the Covered Shareholders will instruct AEA Investors to take appropriate
actions to effect the foregoing.
 
                             CERTAIN TRANSACTIONS
 
  AEA Investors, which is a stockholder of Dal-Tile, currently provides
management, consulting and financial services to the Company for professional
service fees and is reimbursed for out-of-pocket expenses. In 1995, 1994 and
1993, payments of the management fee and reimbursement for expenses totaled
$991,000, $1,015,373 and $963,222, respectively. Such services include, but
are not necessarily limited to, advice and assistance concerning the strategy,
planning and financing of the Company, as needed from time to time. Upon
consummation of the Offerings, the management agreement will be terminated and
AEA Investors will be paid the Termination Fee of $4.0 million in connection
therewith. The Company receives the benefit of volume discounts for certain
office services and supplies made available to various companies associated
with AEA Investors pursuant to arrangements managed by a subsidiary of AEA
Investors. Messrs. Mai and Skelsey are officers and/or directors of Dal-Tile;
Mr. Mai is President and Chief Executive Officer of AEA Investors, and Mr.
Skelsey is a Vice President and Managing Director of AEA Investors.
 
  On December 29, 1995, AWI acquired 37% of the outstanding capital stock of
Dal-Tile in connection with the AO Acquisition. In connection with the AO
Acquisition, Dal-Tile entered into agreements with AWI relating to (i) the use
by the Company of certain trademarks owned by AWI, and (ii) certain transition
services (including computer services) to be supplied by AWI or its affiliates
to the Company. These agreements were negotiated in connection with the AO
Acquisition and have arms'-length terms and conditions. Transactions pursuant
to such
 
                                      58
<PAGE>
 
agreements are in the ordinary course of business. Messrs. Lorch, Riddick and
Shannon are directors of the Registrant; Mr. Lorch is a director and executive
officer of AWI, and Messrs. Riddick and Shannon are officers of AWI.
 
  Before the AO Acquisition, AO was a subsidiary of AWI. As a subsidiary of
AWI, AO purchased pyrophyllite from Newfoundland Minerals and installation
materials from an affiliate of AWI, and incurred expenses relating to
management information systems and engineering services provided by AWI or its
affiliates.
 
                         DESCRIPTION OF CAPITAL STOCK
 
COMMON STOCK CONVERSION
 
  Immediately prior to the consummation of the Offerings, (a) Dal-Tile will
amend and restate its currently existing certificate of incorporation to,
among other things, increase the number of authorized shares of capital stock
to     shares of Common Stock and     shares of Preferred Stock, $.01 par
value per share; and (b) the Common Stock Conversion will be effected (i.e.,
all existing classes of Dal-Tile's capital stock will be converted into a
total of     shares of Common Stock, on a   -for-1 basis). In addition, all
outstanding options to purchase Dal-Tile's existing capital stock will be
converted into    options to purchase Common Stock on a   -for-1 basis. The
Offerings will not be consummated unless certain conditions are satisfied,
including the consummation of the Common Stock Conversion. See "Certain
Transactions" and "Shares Eligible for Future Sale".
 
GENERAL
 
  The following brief description of Dal-Tile's capital stock does not purport
to be complete and is subject in all respects to applicable Delaware law and
to the provisions of the Restated Certificate of Incorporation and the
Restated Bylaws, copies of which have been filed as exhibits to the
Registration Statement on Form S-1 (together with all amendments, schedules
and exhibits thereto, the "Registration Statement") of which this Prospectus
is a part and to which exhibits reference is hereby made.
 
  The authorized capital stock of Dal-Tile will consist of     shares of
Common Stock, $.01 par value per share, and     shares of Preferred Stock, par
value $.01 per share. Immediately following consummation of the Offerings,
there will be     shares of Common Stock outstanding, no shares of Preferred
Stock outstanding and     shares of Common Stock will be issuable upon
exercise of outstanding options.
 
COMMON STOCK
 
  Holders of Common Stock are entitled to one vote per share on all matters to
be voted 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 the 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 therefor, after payment of dividends required to be paid on
outstanding Preferred Stock, if any, and subject to the terms of the
agreements governing Dal-Tile's long-term debt. See "Dividend Policy" and
"Description of Certain Indebtedness". In the event of the liquidation,
dissolution or winding up of Dal-Tile, 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.
 
                                      59
<PAGE>
 
  The Common Stock has no preemptive, conversion or redemption rights and is
not subject to further calls or assessments by Dal-Tile. Immediately upon
consummation of the Offerings, all the outstanding shares of Common Stock will
be validly issued, fully paid and nonassessable.
 
  Prior to the Offerings, there has been no public market for the Common
Stock. Application will be made to list the Common Stock on the New York Stock
Exchange under the symbol "  ".
 
  The Transfer Agent and Registrar for the Common Stock is    .
 
PREFERRED STOCK
 
  The Board of Directors is authorized without further stockholder action to
provide for the issuance from time to time of up to     shares of Preferred
Stock, in one or more classes or series, with such powers, designations,
preferences and relative, participating, optional or other special rights,
qualifications, limitations or restrictions as will be set forth in the
resolutions providing for the issue of such classes or series of Preferred
Stock adopted by the Board of Directors. The holders of Preferred Stock will
have no preemptive rights (unless otherwise provided in the applicable
certificate of designation) and will not be subject to future assessments by
Dal-Tile. Such Preferred Stock may have voting or other rights which could
adversely affect the rights of holders of the Common Stock. In addition, the
issuance of Preferred Stock, while providing flexibility in connection with
possible acquisitions and other corporate purposes, could, under certain
circumstances, make it more difficult for a third party to gain control of
Dal-Tile, discourage bids for the Common Stock at a premium, or otherwise
adversely affect the market price of the Common Stock.
 
POSSIBLE ANTITAKEOVER EFFECT OF CERTAIN CHARTER AND BYLAW PROVISIONS
 
  The DGCL and certain provisions of the Restated Certificate of Incorporation
and the Restated Bylaws could make the acquisition of Dal-Tile by means of a
tender offer, a proxy contest or otherwise more difficult.
 
 ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER NOMINATIONS AND STOCKHOLDER
PROPOSALS
 
  The Restated Bylaws establish an advance notice procedure for stockholders
to make nominations of candidates for election as directors or to bring other
business before an annual meeting of stockholders of Dal-Tile (the
"Stockholder Notice Procedure"). The Stockholder Notice Procedure provides
that only persons who are nominated by, or at the direction of, the Board of
Directors, or by a stockholder who has given timely written notice to the
Secretary of Dal-Tile prior to the meeting at which directors are to be
elected, will be eligible for election as directors of Dal-Tile. The
Stockholder Notice Procedure provides that at an annual meeting only such
business may be conducted as has been specified in the notice of the meeting
given by, or at the direction of, the Board of Directors (or any duly
authorized committee thereof) or brought before the meeting by, or at the
direction of, the Board of Directors (or any duly authorized committee
thereof) or by a stockholder who has given timely written notice to the
Secretary of Dal-Tile of such stockholder's intention to bring such business
before such meeting.
 
  Under the Stockholder Notice Procedure, a stockholder's notice of
nominations or business to be conducted at an annual meeting will be timely
only if it is received by Dal-Tile not less than 60 days nor more than 90 days
prior to the date of the annual meeting or, in the event that less than 70
days' notice or prior public disclosure of the date of the annual meeting is
given or made to stockholders, not later than the close of business on the
tenth day following the day on which such notice was mailed or such public
disclosure was made, whichever first occurs. Under the Stockholder Notice
Procedure, for notice of a stockholder nomination to be made at a special
meeting at which directors are to be elected to be timely, such notice must be
received by Dal-Tile not later than the close of business on the tenth day
following the day on which such notice of the date of the special meeting was
mailed or public disclosure of the date of the special meeting was made,
whichever first occurs.
 
  In addition, under the Stockholder Notice Procedure, a stockholder's notice
to Dal-Tile proposing to nominate a person for election as a director or
conduct certain business at an annual meeting must contain certain specified
information. If the Chairman of the Board of Directors presiding at a meeting
determines that a person was not nominated or other business was not brought
before the meeting in accordance with the Stockholder
 
                                      60
<PAGE>
 
Notice Procedure, such person will not be eligible for election as a director
or such business will not be conducted at such meeting, as the case may be.
 
 DIRECTOR'S LIABILITY
 
  The Restated Certificate of Incorporation provides that to the fullest
extent permitted by the DGCL as it currently exists, a director of Dal-Tile
shall not be liable to Dal-Tile or its stockholders for monetary damages for
breach of fiduciary duty as a director. Under current Delaware law, liability
of a director may not be limited (i) for any breach of the director's duty of
loyalty to Dal-Tile or its stockholders, (ii) for acts or omissions not in
good faith or that involve intentional misconduct or a knowing violation of
law, (iii) in respect of certain unlawful dividend payments or stock
redemptions or repurchases, and (iv) for any transaction from which the
director derives an improper personal benefit. The effect of this provision of
the Restated Certificate of Incorporation is to eliminate the rights of Dal-
Tile and its stockholders (through stockholders' derivative suits on behalf of
Dal-Tile) to recover monetary damages from a director for breach of the
fiduciary duty of care as a director (including breaches resulting from
negligent or grossly negligent behavior) except in the situations described in
clauses (i) through (iv) above. This provision does not limit or eliminate the
rights of Dal-Tile or any stockholder to seek non-monetary relief such as an
injunction or rescission in the event of a breach of a director's duty of
care. In addition, the Restated Certificate of Incorporation provides that
Dal-Tile shall indemnify its directors and executive officers to the fullest
extent permitted by Delaware law.
 
 SECTION 203 OF THE DGCL
 
  Dal-Tile is a Delaware corporation and is subject to Section 203 of the
DGCL. In general, Section 203 prevents an "interested stockholder" (defined as
a person who is the owner of 15% or more of a corporation's voting stock, or
who, as an affiliate or associate of a corporation, was the owner of 15% or
more of that corporation's voting stock within the prior three years) from
engaging in a "business combination" (as defined under the DGCL) with a
Delaware corporation for three years following the date such person became an
interested stockholder unless: (i) before such person became an interested
stockholder, the board of directors of the corporation approved the
transaction or the business combination in which the interested stockholder
became an interested stockholder; (ii) upon consummation of the transaction
that resulted in the interested stockholder becoming an interested
stockholder, the interested stockholder owned at least 85% of the voting stock
of the corporation outstanding at the time the transaction commenced
(excluding shares owned by persons who are both officers and directors of the
corporation and shares held by certain employee stock ownership plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer); or (iii) following the transaction in which such person
became an interested stockholder, the business combination is approved by the
board of directors of the corporation and authorized at a meeting of
stockholders by the affirmative vote of the holders of at least two-thirds of
the outstanding voting stock of the corporation not owned by the "interested
stockholder". A "business combination" generally includes mergers, stock or
asset sales and other transactions resulting in a financial benefit to the
"interested stockholders".
 
CERTAIN EFFECTS OF AUTHORIZED BUT UNISSUED STOCK
 
  Upon consummation of the Offerings, Dal-Tile's authorized but unissued
capital stock will consist of     shares of Common Stock (    shares, if the
U.S. Underwriters' over-allotment option is exercised in full) and     shares
of Preferred Stock. All the foregoing authorized but unissued shares of
capital stock will be available for future issuance without stockholder
approval. These additional shares may be utilized for a variety of corporate
purposes, including issuance pursuant to employee stock options and other
employee plans, director stock options and future public offerings to raise
additional capital or to facilitate corporate acquisitions.
 
  Dal-Tile does not presently have any current plans to issue additional
shares of Common Stock other than shares of Common Stock which may be issued
upon exercise of existing options or options which may be granted in the
future to Dal-Tile's directors or employees.
 
 
                                      61
<PAGE>
 
                      DESCRIPTION OF CERTAIN INDEBTEDNESS
 
NEW BANK CREDIT AGREEMENT
 
  In connection with the Refinancing, Dal-Tile Group expects to enter into the
New Bank Credit Agreement with a syndicate of banks and other institutional
lenders. It is expected that the New Bank Credit Agreement will provide for
loans up to $525 million, consisiting of the New Term Loan and the New
Revolving Credit Facility (the New Term Loan and loans under the New Revolving
Credit Facility, collectively, the "New Bank Loans"). The following summary is
subject to definitive loan documentation with respect to the New Bank Credit
Agreement.
 
  NEW TERM LOAN. The New Bank Credit Agreement will include a $275 million
term loan. The New Term Loan will be repayable in consecutive quarterly
installments commencing on December 31,    and ending on December 31,     , in
aggregate amounts for each of the following periods as follows (with the
installments within each year being equal):
 
                                        AGGREGATE
            YEAR                         AMOUNT
            ----                        ---------

 
The New Term Loan may be prepaid and commitments may be reduced by Dal-Tile
Group without premium or penalty in minimum amounts to be agreed upon.
Voluntary prepayments of the New Term Loan will be applied ratably to
subsequent scheduled repayments of the New Term Loan after giving effect to
all prior repayments. In addition, the New Bank Credit Agreement provides for
mandatory repayments, subject to certain exceptions, of the New Term Loan (and
after the New Term Loan has been repaid, commitment reductions under the New
Revolving Credit Facility) out of the net proceeds of the sale or disposition
of assets (other than certain sales in the ordinary course of business). Such
mandatory prepayments to the New Term Loan will be applied pro rata to the
remaining scheduled repayments of the New Term Loan.
 
  NEW REVOLVING CREDIT FACILITY. The New Revolving Credit Facility is a $250
million revolving credit facility. The New Revolving Credit Facility is
inclusive of a $  million letter of credit subfacility and a $  million swing
line loan subfacility, and will be available on a revolving basis until
December 31,   .
 
  USE OF PROCEEDS. Initial borrowings of the New Bank Loans will be used to
refinance indebtedness under the Existing Bank Credit Agreement, to refinance
and repurchase other existing indebtedness of the Company and to pay the
Termination Fee and other fees and expenses. Subsequent borrowings under the
New Revolving Credit Facility may be used for general corporate purposes of
the Company, including capital expenditures and the repayment and repurchase
of other existing indebtedness of the Company.
 
  INTEREST RATE. The New Bank Loans will bear interest at a rate equal to, at
the Company's option, (i) the ABR (as defined) in effect from time to time
plus the Applicable Margin for ABR Loans (as set forth below) (the "ABR
Loans"), or (ii) the Eurodollar Rate (as defined) for the respective interest
period plus the Applicable Margin (as set forth below) for Eurodollar Loans
(the "Eurodollar Loans"); provided that all swing line loans shall bear
interest based upon the ABR. The Applicable Margin will vary depending upon
the ratio of Consolidated Senior Debt to Consolidated EBITDA (as defined in
the New Bank Credit Agreement) and whether such loan is an ABR Loan or a
Eurodollar Loan, as set forth below:
 
     RATIO OF CONSOLIDATED TOTAL                    ABR   EURODOLLAR
     DEBT TO CONSOLIDATED EBITDA                   LOANS    LOANS   
     ---------------------------                   -----  ----------
                                                 
                                                 
 
 
                                      62
<PAGE>
 
"ABR" means the highest of (i) the rate of interest publicly announced by the
Administrative Agent under the New Bank Credit Agreement (the "Administrative
Agent") as its prime rate in effect at its principal office in New York City,
(ii) the secondary market rate for three-month certificates of deposit
(adjusted for statutory reserve requirements) plus 1% and (iii) the federal
funds effective rate from time to time plus 0.5%. "Eurodollar Rate" means the
rate (adjusted for statutory reserve requirements for eurocurrency
liabilities) at which eurodollar deposits for one, two, three or six months
(as selected by Dal-Tile Group) are offered to the Administrative Agent in the
interbank eurodollar market. Interest on ABR Loans will be payable quarterly
in arrears. Interest on Eurodollar Loans will be payable on the last day of
each relevant interest period and, in the case of any interest period longer
than three months, on each successive date three months after the first day of
such interest period.
 
  At any time when Dal-Tile Group is in default in the payment of any amount
due under the New Bank Credit Agreement, the principal of all loans shall bear
interest at  % above the rate otherwise applicable thereto. Overdue interest,
fees and other amounts shall bear interest at  % above the rate applicable
under the New Revolving Credit Facility for ABR Loans.
 
  Fees. Dal-Tile Group will be required to pay commitment fees on the average
daily unused portion of the New Revolving Credit Facility, payable quarterly
in arrears, at a rate per annum as set forth below:
 
<TABLE>
<CAPTION>
     RATIO OF CONSOLIDATED TOTAL   COMMITMENT
     DEBT TO CONSOLIDATED EBITDA      FEE
     ---------------------------   ----------
     <S>                           <C>
</TABLE>
 
Swing line loans shall, for purposes of the commitment fee calculations only,
not be deemed to be a utilization of the New Revolving Credit Facility.
 
  It is anticipated that letters of credit also will be issued under the New
Bank Credit Agreement and fees in connection with such letters of credit will
be repayable by Dal-Tile Group in an amount equal to the Applicable Margin
from time to time for Eurodollar Loans on the face amount of such letters of
credit plus a fronting fee for the account of the letter of credit issuers of
     on such outstanding amounts. Unreimbursed drawings on letters of credit
shall bear interest at the same rate as ABR Loans under the New Revolving
Credit Facility.
 
  As a consideration for the New Bank Loans, Dal-Tile Group will pay at
closing   % of the aggregate commitments under the New Bank Credit Agreement.
In addition, from the date on which a commitment letter is issued until
closing, Dal-Tile Group will pay a commitment fee at the rate of   % on the
aggregate commitments under the New Bank Credit Agreement. Dal-Tile Group also
will pay to the Administrative Agent an annual administrative fee equal to
$  .
 
  Guarantees. The New Bank Credit Agreement will be guaranteed by Dal-Tile and
each of Dal-Tile Group's material direct and indirect domestic subsidiaries.
 
  Conditions. The initial funding by the lenders under the New Bank Credit
Agreement (the "Lenders") will be subject to a number of conditions,
including, among other things, (a) the receipt by Dal-Tile Group or Dal-Tile
of net proceeds of at least $     million from the Offerings; (b) the
redemption, repurchase or prepayment by Dal-Tile Group of specified existing
indebtedness and accrued interest thereon (subject to certain exceptions); (c)
the absence of any material adverse effect on the (i) business, assets,
property, condition (financial or otherwise) or prospects of Dal-Tile Group
and its subsidiaries taken as a whole, or (ii) the validity or enforceability
of the New Bank Credit Agreement or the rights and remedies of the
Administrative Agent and the Lenders; and (d) other conditions customary for
transactions similar to those contemplated by the New Bank Credit Agreement.
 
                                      63
<PAGE>
 
  COVENANTS. The New Bank Credit Agreement will contain customary affirmative
and restrictive covenants, as well as financial covenants, under which the
Company must operate. Failure to comply with any of such covenants will permit
the Administrative Agent to accelerate, subject to the terms of the New Bank
Credit Agreement, the maturity of all amounts outstanding under the New Bank
Credit Agreement, and to terminate Dal-Tile Group's ability to borrow under
the New Revolving Credit Facility.
 
  EVENTS OF DEFAULT. The New Bank Credit Agreement will contain customary
events of default appropriate in the context of the proposed transaction,
including payment defaults, breach of representations and warranties, covenant
defaults, cross-events of default to certain other indebtedness, certain
events of bankruptcy and insolvency, ERISA events, judgment defaults, failure
of any guaranty supporting the New Bank Credit Agreement to be in full force
and effect and a "Change of Control" as defined therein.
 
EXISTING INDEBTEDNESS TO BE REFINANCED IN THE REFINANCING
 
  The Company intends to refinance the existing indebtedness of the Company
summarized below pursuant to the Refinancing. The summaries of such
indebtedness contained herein do not purport to be complete and are qualified
in their entirety by reference to the provisions of the various agreements and
indentures related thereto, copies of which have been filed as exhibits to the
Registration Statement of which this Prospectus is a part. Capitalized terms
used in this section and not otherwise defined shall have the meanings
ascribed thereto in the Zero Coupon Note Indenture, the Existing Bank Credit
Agreement or the Series Note Agreement, as applicable.
 
 THE ZERO COUPON NOTES
 
  On August 11, 1993, Dal-Tile issued the Zero Coupon Notes with proceeds of
$75,006,252, before fees and expenses, having a yield to maturity of 12% per
annum (computed on a semiannual bond equivalent basis), calculated from August
11, 1993. The Zero Coupon Notes defer interest payments until maturity on July
15, 1998, at which time principal and interest of $133,200,000 becomes due and
payable. The Zero Coupon Notes are not redeemable at the option of Dal-Tile,
except that if Dal-Tile issues shares of capital stock before July 16, 1996,
Dal-Tile, at its option, may use the net proceeds to redeem up to 33% of the
outstanding Zero Coupon Notes. The Redemption will be at 106% of the Accreted
Value. In the Redemption, Dal-Tile intends to use the $27,575,000 which AWI
contributed as part of the AO Acquisition, to redeem $34.0 million aggregate
principal amount at maturity of Zero Coupon Notes ($26.0 million aggregate
Accreted Value at March 31, 1996). See "Use of Proceeds" and "Capitalization".
Dal-Tile also is required to redeem the outstanding Zero Coupon Notes at 101%
of the Accreted Value if there shall occur a Change of Control. The Zero
Coupon Notes are secured by a pledge of all the outstanding capital stock of
Dal-Tile Group.
 
  AFFIRMATIVE AND NEGATIVE COVENANTS. The Zero Coupon Note Indenture contains
a number of covenants including, among others, covenants restricting Dal-Tile
and its subsidiaries with respect to the incurrence of indebtedness, the
creation of liens, entering into sales or leases, the declaration or payment
of dividends, the making of certain investments and loans, distributions by
and transfers to subsidiaries, payments of certain management fees, the
consummation of certain transactions such as sales of substantial assets,
mergers or consolidations or other transactions, or changes of control of Dal-
Tile. In addition, the Zero Coupon Note Indenture contains affirmative
covenants by Dal-Tile including, among others, preservation of corporate
existence, maintenance of insurance, payment of taxes and other claims, and
delivery of financial and other information.
 
  LIMITATION ON CONSOLIDATED DEBT. Dal-Tile and its Restricted Subsidiaries
may not (subject to certain exceptions) incur any Debt unless immediately
after giving effect to the incurrence of such Debt and the receipt and
application of the proceeds thereof, the Consolidated Cash Flow Ratio for the
preceding four full fiscal quarters determined on a pro forma basis as if such
Debt had been incurred and the proceeds thereof applied at the beginning of
such four fiscal quarters, would be greater than 2.00 to 1.
 
  RESTRICTED PAYMENTS. Subject to certain exceptions, the Zero Coupon Note
Indenture restricts the ability of Dal-Tile, among other things, (i) to
declare or pay any dividend, or make any distribution, in respect of its
 
                                      64
<PAGE>
 
Capital Stock or to the holders thereof, (ii) to (or permit any of its
Restricted Subsidiaries to) purchase, redeem, or otherwise retire or acquire
for value (a) any Capital Stock of Dal-Tile or (b) any securities convertible
or exchangeable into shares of Capital Stock of Dal-Tile or any options,
warrants or rights to purchase or acquire shares of Capital Stock of Dal-Tile
or securities convertible or exchangeable into shares of Capital Stock of Dal-
Tile, (iii) to make loans, guarantees, advances or capital contributions to,
or investments in the stock or securities of entities other than Restricted
Subsidiaries, and (iv) to redeem, defease (including, but not limited to,
legal or covenant defeasance), repurchase, retire or otherwise acquire or
retire for value prior to any scheduled maturity, repayment or sinking fund
payment Debt of Dal-Tile (other than the Zero Coupon Notes) which is pari
passu with or subordinate in right of payment to the Zero Coupon Notes (each
of clauses (i) through (iv) being a "Restricted Payment") unless: (1)
subsequent to the date of the Zero Coupon Note Indenture, Dal-Tile has
received net cash proceeds from the issuance and sale of shares of its Capital
Stock (other than Disqualified Stock) to any Person equal to or greater than
$50 million, and has made an offer to purchase outstanding Zero Coupon Notes
in an aggregate amount equal to not less than (i) 75% of the net cash proceeds
of such issuance and sale to any Person or Persons other than AEA Investors,
but not less than $37.5 million, minus (ii) the aggregate redemption price
paid in respect of Zero Coupon Notes redeemed prior to the date thereof, at
declining prices (ranging from 106% to 100% of the Accreted Value as of the
date of purchase); (2) upon giving effect to such Restricted Payment, no Event
of Default, or event that with the lapse of time or the giving of notice, or
both, would constitute an Event of Default, shall have occurred; and (3) upon
giving effect to such Restricted Payment, the aggregate of all Restricted
Payments made subsequent to the date of the Zero Coupon Note Indenture would
not exceed the sum of: (a) 50% of cumulative Consolidated Net Income (or,
where Consolidated Net Income shall be negative, minus 100% of such deficit)
for the period commencing on the date of the Zero Coupon Indenture and ending
on the last day of the last full fiscal quarter ending immediately preceding
the date of such Restricted Payment; plus (b) 100% of the aggregate net cash
proceeds from the issuance after the date of the Zero Coupon Note Indenture of
Capital Stock (other than Disqualified Stock) of Dal-Tile and options,
warrants or other rights on Capital Stock (other than Disqualified Stock) of
Dal-Tile, other than to a Subsidiary of Dal-Tile; minus (c) the amount of net
cash proceeds from the issuance and sale of Capital Stock used by Dal-Tile to
redeem Zero Coupon Notes or to purchase Zero Coupon Notes pursuant to clause
(1) above.
 
 THE EXISTING BANK CREDIT AGREEMENT
 
  Pursuant to the Existing Bank Credit Agreement with National Westminster
Bank, USA, as agent bank, Credit Suisse and NCNB Texas National Bank, N.A. as
co-agents, Dal-Tile Group has a $160 million revolving credit facility
available. The Existing Bank Credit Agreement terminates, and all borrowings
thereunder are due and payable, on the earlier of (i) January 9, 1998 and (ii)
the seventh day following a Change in Control. At March 31, 1996, there was an
aggregate principal amount of $128.3 million outstanding under the Existing
Bank Credit Agreement bearing interest at a weighted average rate of 7.9%.
 
  Under the Existing Bank Credit Agreement, borrowings may be made as Prime
Rate Loans or Eurodollar Loans. On and after January 9, 1994, Eurodollar Loans
and Prime Rate Loans must be repaid if the aggregate principal amount of all
such Loans outstanding exceeds the lesser of (i) the then Total Commitment and
(ii) a borrowing base amount based on eligible accounts receivable and
eligible inventory. The maximum amount available to Dal-Tile Group under the
inventory letter of credit facility is equal to the lesser of (i) $25 million
and (ii) the excess of (x) the Total Commitment over (y) the aggregate
outstanding principal amount of Prime Rate Loans and Eurodollar Loans. Prime
Rate Loans bear interest at rates per annum equal to the sum of the Prime Rate
and a margin varying from 0% to 1 1/4%, based on Dal-Tile Group's Ratio of
Total Liabilities to Consolidated Adjusted Net Worth. Eurodollar Loans
(available for one-, two-, three-, and six-month interest periods) bear
interest at rates per annum equal to the sum of the Eurodollar Base Rate and a
margin varying from 1% to 2 1/4%, based on Dal-Tile Group's ratio of total
liabilities to consolidated adjusted net worth.
 
  The Existing Bank Credit Agreement contains a number of covenants,
including, among others, covenants restricting Dal-Tile Group and its
subsidiaries with respect to the incurrence of indebtedness, the creation of
liens, entering into sale and leaseback transactions, entering into leases,
the declaration or payment of dividends,
 
                                      65
<PAGE>
 
the making of certain investments and loans, engaging in businesses unrelated
to the manufacture and distribution of tile and related building products
(unless such unrelated business contributes less than 20% of total
consolidated revenues of Dal-Tile Group and constitutes less than 20% of the
consolidated assets of Dal-Tile Group), transfers to affiliates, payments of
certain management fees, the consummation of certain transactions such as
sales of substantial assets, mergers or consolidations and other transactions.
In addition, the Existing Bank Credit Agreement contains affirmative covenants
by Dal-Tile Group and its subsidiaries, including, among others, compliance
with laws, preservation of corporate existence, maintenance of insurance,
payment of taxes and debt, maintenance of properties, environmental compliance
and delivery of financial and other information to the lenders under the
Existing Bank Credit Agreement. Dal-Tile Group also is required to comply with
certain financial tests and maintain certain financial ratios.
 
 THE SERIES A NOTES AND THE SERIES B NOTES
 
  The Series A Notes and the Series B Notes were issued pursuant to the Series
Note Agreement entered into between Dal-Tile Group and certain institutional
investors in connection with the AEA Acquisition. The Series A Notes mature on
January 9, 2000. Each Series A Note bears interest at the rate of 10.625% per
annum. Interest on the Series A Notes is payable semiannually on January 9 and
July 9. The Series B Notes mature on January 9, 2002. Each Series B Note bears
interest at the rate of 10.770% per annum payable semiannually on January 9
and July 9.
 
  The Series A Notes are subject to mandatory prepayment in the amount of $44
million on January 9 in each of the years 1996 through and including 1999. The
Series B Notes are subject to mandatory prepayment in the amount of $20
million on January 9 in each of the years 1998 through and including 2001. On
March 31, 1996, there were $176 million aggregate principal amount of
outstanding Series A Notes, and $100 million aggregate principal amount of
outstanding Series B Notes.
 
  Dal-Tile Group may, at its option, prepay the Series A Notes and the Series
B Notes, in whole or in part, at any time, by paying the holders thereof a
Make-Whole Premium together with interest accrued on the Series A Notes and
the Series B Notes to the date of prepayment. In addition, upon a Change of
Control, Dal-Tile Group shall prepay in full all of the Series A Notes and the
Series B Notes held by each holder who has accepted Dal-Tile Group's
prepayment offer by paying to each such holder a Make-Whole Premium with
respect to the unpaid principal amount of such Series A Notes and Series B
Notes together with interest accrued on the Notes to the date of prepayment.
 
  The covenants of the Series A Notes and the Series B Notes are substantially
equivalent to those under the Existing Bank Credit Agreement.
 
                        SHARES ELIGIBLE FOR FUTURE SALE
 
  There has been no public market for the Common Stock prior to the Offerings.
No prediction can be made as to the effect, if any, that market sales of
shares of Common Stock or the availability of shares of Common Stock for sale
will have on the market price prevailing from time to time. Nevertheless,
sales of substantial amounts of Common Stock of Dal-Tile in the public market
after the lapse of the restrictions described below could adversely affect
prevailing market prices and the ability of the Company to raise equity
capital in the future at a time and price which it deems appropriate.
 
  Upon completion of the Offerings Dal-Tile will have outstanding     shares
of Common Stock (or     shares, if the U.S. Underwriters exercise their over-
allotment option in full). All these shares of Common Stock will be freely
tradeable without restriction or limitation under the Securities Act, except
to the extent such shares are subject to the agreement with the U.S.
Underwriters described below, and except for any shares held by "affiliates",
as that term is defined under the Securities Act, of the Company. The shares
held by affiliates
 
                                      66
<PAGE>
 
may only be sold if they are registered under the Securities Act or unless an
exemption from registration, such as the exemption provided by Rule 144 under
the Securities Act ("Rule 144"), is available.
 
  In general, under Rule 144 as currently in effect, a stockholder (or
stockholders whose shares are aggregated) who has beneficially owned shares
constituting "restricted securities" (generally defined as securities acquired
from the Company or an affiliate of the Company in a non-public transaction)
for at least two years, is entitled to sell within any three-month period a
number of shares that does not exceed the greater of one percent of the
outstanding Common Stock or the average weekly trading volume in the Common
Stock during the four calendar weeks preceding the date on which notice of
such sale is filed pursuant to Rule 144. Sales under Rule 144 also are subject
to certain provisions regarding the manner of sale, notice requirements and
the availability of current public information about the Company. A
stockholder (or stockholders whose shares are aggregated) who is not an
affiliate of the Company for at least 90 days prior to a proposed transaction
and who has beneficially owned "restricted securities" for at least three
years is entitled to sell such shares under Rule 144 without regard to the
limitations described above.
 
  The Company and the Existing Stockholders owning substantially all the
outstanding Common Stock have agreed not to offer, sell, contract to sell, or
otherwise dispose of, any shares of Common Stock or any securities convertible
into, or exercisable or exchangeable for Common Stock, except in certain
circumstances, for a period of 180 days following the date of this Prospectus
without the prior consent of Smith Barney Inc. (the "Lockup"). Following the
Lockup, these shares will be eligible for sale in the public market subject to
the restrictions described above. See "Underwriting".
 
  In addition,     shares of Common Stock will be reserved for issuance
pursuant to the Company's stock option plans. These shares will be available
for sale in the public market from time to time upon registration or pursuant
to available exemptions from registration. See "Management--Executive
Compensation".
 
  To the extent that the Company's existing resources and future earnings are
insufficient to fund the Company's activities or to repay indebtedness
(including annual amortization payments under the New Term Loan), the Company
may need to raise additional funds through public or private financings. If
additional funds are raised through the issuance of equity securities, the
percentage ownership of the Company's stockholders at that time would be
diluted. Further, such equity securities may have rights, preferences or
privileges senior to those of the Common Stock. See "Description of Capital
Stock".
 
                                      67
<PAGE>
 
            CERTAIN U.S. TAX CONSEQUENCES TO NON-U.S. STOCKHOLDERS
 
  The following is a general discussion of certain Federal tax consequences of
the ownership and disposition of a share of Common Stock by beneficial owner
of such shares that is not a U.S. person for U.S. Federal income tax purposes
(a "non-U.S. holder"). For purposes of this discussion, a "U.S. person" means
a citizen or resident of the United States, a corporation or partnership
created or organized in the United States or under the laws of the United
States or of any State or political subdivision of the foregoing, or any
estate or trust whose income is includible in gross income for U.S. Federal
income tax purposes regardless of its source. The discussion does not address
all aspects of Federal income and estate taxation nor any aspects of state,
local, or foreign tax laws. The discussion does not consider any specific
facts or circumstances that may apply to particular non-U.S. holders
(including insurance companies, tax-exempt organizations, financial
institutions, broker dealers or certain U.S. expatriates). Furthermore, the
following discussion is based on current provisions of the U.S. Internal
Revenue Code of 1986, as amended (the "Code"), the regulations promulgated
thereunder and administrative and judicial interpretations as of the date
hereof, all of which are subject to change, possibly with retroactive effect.
Each prospective investor is urged to consult its own tax adviser with respect
to the U.S. Federal, state and local consequences of owning and disposing of a
share of Common Stock, as well as any tax consequences arising under the laws
of any other taxing jurisdiction.
 
U.S. INCOME AND ESTATE TAX CONSEQUENCES
 
  It is not currently contemplated that Dal-Tile will pay dividends on the
Common Stock in the foreseeable future. If Dal-Tile were to pay a dividend in
the future, such a dividend paid to a non-U.S. holder would be subject to U.S.
withholding tax at a 30% rate, or if applicable, a lower treaty rate, unless
the dividend is effectively connected with the conduct of a trade or business
in the United States by a non-U.S. holder (and, if certain tax treaties apply,
is attributable to a United States permanent establishment maintained by such
non-U.S. holder). A dividend that is effectively connected with the conduct of
a trade or business in the United States by the non-U.S. holder (and, if
certain tax treaties apply, is attributable to a United States permanent
establishment maintained by such non-U.S. holder) will be exempt from the
withholding tax described above and subject instead (i) to the U.S. Federal
income tax on net income that applies to U.S. persons and (ii) with respect to
corporate holders under certain circumstances, a 30% (or, if applicable, lower
treaty rate) branch profits tax that in general is imposed on its "effectively
connected earnings and profits" (within the meaning of the Code) for the
taxable year, as adjusted for certain items.
 
  Under current Treasury Regulations, dividends paid to an address in a
foreign country are presumed to be paid to a resident of that country (unless
the payor has knowledge to the contrary) for purposes of the withholding
discussed above and, under the current interpretation of the Treasury
Regulations, for purposes of determining the applicability of a tax treaty
rate. Under Proposed Treasury Regulations, not currently in effect, however, a
non-U.S. holder of Common Stock who wishes to claim the benefit of an
applicable treaty rate would be required to satisfy applicable certification
and other requirements. A non-U.S. holder that is eligible for a reduced rate
of U.S. withholding tax pursuant to an income tax treaty may obtain a refund
of any excess amounts withheld by filing an appropriate claim for refund with
the Internal Revenue Service (the "IRS").
 
  Under current law, a non-U.S. holder generally will not be subject to U.S.
Federal income tax on any gain recognized on a sale or other disposition of a
share of Common Stock unless (i) the gain is effectively connected with the
conduct of a trade or business within the United States of the non-U.S. holder
and, if certain tax treaties apply, is attributable to a United States
permanent establishment maintained by the non-U.S. holder, (ii) the gain is
not described in clause (i) above, the non-U.S. holder is an individual who
holds the share as a capital asset, is present in the United States for 183
days or more in the taxable year of the disposition and either (a) such
individual has a "tax home" (as defined for U.S. Federal income tax purposes)
in the United States or (b) the gain is attributable to an office or other
fixed place of business maintained in the United States by such individual, or
(iii) the Company is or has been a United States real property holding
corporation (a "USRPHC") for United States federal income tax purposes (which
the Company does not believe that it is or is likely to become) at any
 
                                      68
<PAGE>
 
time within the shorter of the five year period preceding such disposition or
such non-U.S. holder's holding period. If the Company were to become a USRPHC,
gains realized upon a disposition of Common Stock by a non-U.S. holder which
did not directly or indirectly own more than 5% of the Common Stock during the
shorter of the periods described above generally would not be subject to
United States federal income tax, provided that the Common Stock is "regularly
traded" on an established securities market. In case of a non-U.S. holder that
is described under clause (i) above, its gain will be subject to the U.S.
Federal income tax on net income that applies to U.S. persons and, in
addition, if such non-U.S. holder is a foreign corporation, it may be subject
to the branch profits tax as described in the preceding paragraph. An
individual non-U.S. holder that is described under clause (ii) above will be
subject to a flat 30% tax on the gain derived from the sale, which may be
offset by certain U.S. capital losses (notwithstanding the fact that he or she
is not considered a resident of the United States). Thus, individual non-U.S.
holders who have spent 183 days or more in the United States in the taxable
year in which they contemplate a sale of the Common Stock are urged to consult
their tax advisers as to the tax consequences of such sale.
 
  Shares of Common Stock owned at the time of his or her death by an
individual non-U.S. holder who is treated as a U.S. resident at such time for
U.S. Federal estate tax purposes will be includible in his or her gross estate
for U.S. Federal estate tax purposes unless an applicable estate tax treaty
provides otherwise.
 
BACK-UP WITHHOLDING AND INFORMATION REPORTING
 
 Dividends
 
  Except as provided below, Dal-Tile must report annually to the IRS and to
each non-U.S. holder the amount of dividends paid to and the tax withheld with
respect to such holder. These information reporting requirements apply
regardless of whether withholding was reduced or eliminated by an applicable
tax treaty. Copies of these information returns may also be available under
the provisions of a specific treaty or agreement with the tax authorities in
the country in which the non-U.S. holder resides. In general, backup
withholding at a rate of 31% and additional information reporting will apply
to dividends paid on shares of Common Stock to holders that are not "exempt
recipients" and that fail to provide in the manner required certain
identifying information (such as the holder's name, address and taxpayer
identification number ). Generally, individuals are not exempt recipients,
whereas corporations and certain other entities generally are exempt
recipients. However, dividends that are subject to U.S. withholding tax at the
30% statutory rate or at a reduced tax treaty rate are exempt from backup
withholding of U.S. Federal income tax and such additional information
reporting.
 
 Broker Sales
 
  If a non-U.S. holder sells shares of Common Stock through a U.S. office of a
U.S. or foreign broker, the broker is required to file an information return
and is required to withhold 31% of the sale proceeds unless the non-U.S.
holder is an exempt recipient or has provided the broker with the information
and statements, under penalties of perjury, necessary to establish an
exemption from backup withholding. If payment of the proceeds of the sale of a
share by a non-U.S. holder is made to or through the foreign office of a
broker, that broker will not be required to backup withhold or, except as
provided in the next sentence, to file information returns. In the case of
proceeds from a sale of a share by a non-U.S. holder paid to or through the
foreign office of a U.S. broker or a foreign office of a foreign broker that
is (i) a controlled foreign corporation for U.S. tax purposes or (ii) a person
50% or more of whose gross income for the three-year period ending with the
close of the taxable year preceding the year of payment (or for the part of
that period that the broker has been in existence) is effectively connected
with the conduct of a trade or business within the United States (a "Foreign
U.S. Connected Broker"), information reporting is required unless the broker
has documentary evidence in its files that the payee is not a U.S. person and
certain other conditions are met, or the payee otherwise establishes an
exemption. In addition, the Treasury Department has indicated that it is
studying the possible application of backup withholding in the case of such
foreign offices of U.S. and Foreign U.S. Connected Brokers.
 
 Refunds
 
  Any amounts withheld under the backup withholding rules from a payment to a
non-U.S. holder may be refunded or credited against the non-U.S. holder's U.S.
Federal income tax liability, provided that the required information is
furnished to the IRS.
 
 
                                      69
<PAGE>
 
                                 UNDERWRITING
 
  Upon the terms and subject to the conditions stated in the U.S. Underwriting
Agreement, each of the underwriters of the U.S. Offering named below (the
"U.S. Underwriters"), for whom Smith Barney Inc., Dillon, Read & Co. Inc.,
Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated are acting as the
representatives (the "Representatives"), has severally agreed to purchase, and
the Company has agreed to sell to each U.S. Underwriter, the number of shares
of Common Stock set forth opposite the name of such U.S. Underwriter below:
 
<TABLE>
<CAPTION>
                                                                          NUMBER
                                                                            OF
                               U.S. UNDERWRITERS                          SHARES
                               -----------------                          ------
      <S>                                                                 <C>
      Smith Barney Inc. .................................................
      Dillon, Read & Co. Inc. ...........................................
      Goldman, Sachs & Co. ..............................................
      Morgan Stanley & Co. Incorporated..................................
                                                                           ----
        Total............................................................
                                                                           ====
</TABLE>
 
  Under the terms and subject to the conditions contained in the International
Underwriting Agreement, each of the managers of the concurrent International
Offering named below (the "Managers"), for whom Smith Barney Inc., Dillon,
Read & Co. Inc., Goldman Sachs International and Morgan Stanley & Co.
International Limited, are acting as lead managers (the "Lead Managers"), has
severally agreed to purchase, and the Company has agreed to sell to each
Manager, the number of shares of Common Stock set forth opposite the name of
such Manager below:
 
<TABLE>
<CAPTION>
                                                                          NUMBER
                                                                            OF
                                   MANAGERS                               SHARES
                                   --------                               ------
      <S>                                                                 <C>
      Smith Barney Inc. .................................................
      Dillon, Read & Co. Inc. ...........................................
      Goldman Sachs International........................................
      Morgan Stanley & Co. International Limited.........................
                                                                           ----
        Total............................................................
                                                                           ====
</TABLE>
 
  Each of the U.S. Underwriting Agreement and the International Underwriting
Agreement provides that the obligations of the several U.S. Underwriters and
the several Managers to pay for and accept delivery of the shares of Common
Stock offered hereby are subject to the approval of certain legal matters by
counsel and to certain other conditions. The U.S. Underwriters and the
Managers are obligated to take and pay for all shares of Common Stock offered
hereby (other than those covered by the over-allotment option described below)
if any such shares are taken.
 
  The U.S. Underwriters and the Managers (collectively, the "Underwriters")
initially propose to offer part of the shares offered hereby directly to the
public at the public offering price set forth on the cover page of this
Prospectus and part of the shares offered hereby to certain dealers at a price
which represents a concession not in excess of $    per share under the public
offering price. The U.S. Underwriters and the Managers may allow, and such
dealers may reallow, a concession not in excess of $    per share to other
U.S. Underwriters or Managers, respectively, or to certain other dealers. The
Representatives and the Managers have advised the Company that the U.S.
Underwriters and the Managers do not intend to confirm any shares to accounts
over which they exercise discretionary authority. After the initial public
offering, the public offering price and such concessions may be changed by the
Underwriters.
 
  The Company has granted the U.S. Underwriters an option, exercisable at any
time and from time to time during a 30-day period from the date of this
Prospectus, to purchase up to an aggregate of      additional shares of Common
Stock at the public offering price set forth on the cover page hereof less
underwriting commissions. The U.S. Underwriters may exercise such option to
purchase additional shares solely for the purpose of covering
 
                                      70
<PAGE>
 
over-allotments, if any, incurred in connection with the sales of the shares
of Common Stock offered hereby. To the extent such option is exercised, each
U.S. Underwriter will be obligated, subject to certain conditions, to purchase
approximately the same percentage of such additional shares as the number of
shares set forth opposite each U.S. Underwriter's name in the preceding U.S.
Underwriters table bears to the total number of shares of Common Stock offered
by the U.S. Underwriters hereby.
 
  The Company and the U.S. Underwriters and the Managers have agreed to
indemnify each other against certain liabilities, including liabilities under
the Securities Act.
 
  The Company and the Existing Shareholders owing substantially all the
outstanding Common Stock have agreed that, for a period of 180 days from the
date of this Prospectus, they will not, without the prior written consent of
Smith Barney Inc., offer, sell, contract to sell, or otherwise dispose of, any
Common Stock or securities convertible into or exercisable or exchangeable for
Common Stock except in certain circumstances.
 
  The U.S. Underwriters and the Managers have entered into an Agreement
between U.S. Underwriters and Managers pursuant to which each U.S. Underwriter
has agreed that, as part of the distribution of the shares offered in the U.S.
Offering (i) it is not purchasing any such shares for the account of anyone
other than a U.S. or Canadian Person, and (ii) it has not offered or sold, and
will not offer, sell, resell or deliver, directly or indirectly, any of such
shares or distributed any prospectus relating to the U.S. Offering outside the
United States or Canada or to anyone other than a U.S. or Canadian Person. In
addition, each Manager has agreed that as part of the distribution of the
shares offered in the International Offering: (i) it is not purchasing any
such shares for the account of any U.S. or Canadian Person, and (ii) it has
not offered or sold, and will not offer, sell, resell or deliver, directly or
indirectly, any of such shares or distribute any prospectus relating to the
International Offering in the United States or Canada or to any U.S. or
Canadian Person. Each Manager has also agreed that it will offer to sell
shares only in compliance with all relevant requirements of any applicable
laws.
 
  The foregoing limitations do not apply to stabilization transactions or to
certain other transactions specified in the U.S. Underwriting Agreement, the
International Underwriting Agreement and the Agreement Between U.S.
Underwriters and Managers, including (i) certain purchases and sales between
the U.S. Underwriters and the Managers, (ii) certain offers, sales, resales,
deliveries or distributions to or through investment advisors or other persons
exercising investment discretion, (iii) purchases, offers or sales by a U.S.
Underwriter who is also acting as a Manager or by a Manager who is also acting
as a U.S. Underwriter, and (iv) other transactions specifically approved by
the Representatives and the Managers. As used herein, "U.S. or Canadian
Person" means any resident or national of the United States or Canada, any
corporation, partnership or other entity created or organized in or under the
laws of the United States or Canada or any estate or trust the income of which
is subject to U.S. or Canadian income taxation regardless of the source of its
income (other than the foreign branch of any U.S. or Canadian Person), and
includes any U.S. or Canadian branch of a person other than a U.S. or Canadian
Person.
 
  Any offer of shares in Canada will be made only pursuant to an exemption
from the requirement to file a prospectus in the relevant province of Canada
in which such offer is made.
 
  Each Manager has represented and agreed that (i) it has not offered or sold
and will not offer or sell in the United Kingdom, by means of any document,
any shares other than to persons whose ordinary business it is to buy or sell
shares or debentures, whether as principal or agent or in circumstances which
do not constitute an offer to the public within the meaning of the Public
Offering of Securities Regulation 1995, (ii) it has complied and will comply
with all applicable provisions of the Financial Services Act 1986 with respect
to anything done by it in relation to the shares in, from, or otherwise
involving, the United Kingdom, and (iii) it has only issued or passed on and
will only issue or pass on to any person in the United Kingdom any document
received by it in connection with the issue of the shares if that person is of
a kind described in Article 11(3) of the Financial Services Act 1986
(Investment Advertisements) (Exemptions) Order 1995 or is a person to whom the
document may otherwise lawfully be issued or passed on.
 
 
                                      71
<PAGE>
 
  No action has been or will be taken in any jurisdiction by the Company, the
U.S. Underwriters or the Managers that would permit any offering to the
general public of the Common Stock offered hereby in any jurisdiction other
than the United States.
 
  Purchasers of the Common Stock offered hereby may be required to pay stamp
taxes and other charges in accordance with the laws and practices of the
country of purchase in addition to the offering price set forth on the cover
page hereof.
 
  Pursuant to the Agreement Between U.S. Underwriters and Managers, sales may
be made between the U.S. Underwriters and the Managers of such number of
shares of Common Stock as may be mutually agreed. The price of any shares so
sold shall be the public offering price as then in effect for Common Stock
being sold by the U.S. Underwriters and the Managers, less all or any part of
the selling concession, unless otherwise determined by mutual agreement. To
the extent that there are sales between the U.S. Underwriters and the Managers
pursuant to the Agreement Between U.S. Underwriters and Managers, the number
of shares initially available for sale by the U.S. Underwriters and by the
Managers may be more or less than the number of shares appearing on the front
cover of this Prospectus.
 
  Prior to the Offerings, there has been no public market for Common Stock.
The initial public offering price of the shares was negotiated between the
Company and the Representatives. Among the factors considered in determining
such price were the history of and prospects for the Company's business and
the industry in which it competes, an assessment of the Company's management
and the present state of the Company's development, the past and present
revenues and earnings of the Company, the prospects for growth of the
Company's net sales and earnings, the current state of the economy in each of
the United States and Mexico, and the current level of economic activity in
the industry in which the Company competes and in related or comparable
industries, and currently prevailing conditions in the securities markets,
including current market valuations of publicly traded companies which the
Company and the Underwriters believe to be comparable to the Company.
 
  Application will be made to list the Common Stock on the New York Stock
Exchange under the symbol "   ". There can be no assurance that an active
trading market will develop for the Common Stock or that the Common Stock will
trade in the public market subsequent to the Offerings or at or above the
initial price to public.
 
                                 LEGAL MATTERS
 
  The validity of the Common Stock offered hereby will be passed upon for the
Company by Fried, Frank, Harris, Shriver & Jacobson (a partnership including
professional corporations), One New York Plaza, New York, New York. Certain
legal matters will be passed upon for the Underwriters by Cravath, Swaine &
Moore, New York, New York.
 
                                    EXPERTS
 
  The Consolidated Financial Statements and consolidated financial statement
schedule of Dal-Tile at December 31, 1994 and 1995, and for each of the three
years in the period ended December 31, 1995, appearing in this Prospectus and
the Registration Statement, have been audited by Ernst & Young LLP,
independent auditors, as set forth in their reports thereon appearing
elsewhere herein, and are included in reliance upon such reports given upon
the authority of such firm as experts in accounting and auditing.
 
  The consolidated financial statements of Ceramic Tile Operations of
Armstrong World Industries, Inc. and subsidiaries as of December 31, 1994 and
December 29, 1995 and for both of the years in the two-year period ended
December 31, 1994 and for the period ended December 29, 1995, appearing in
this Prospectus and the Registration Statement, have been audited by KPMG Peat
Marwick LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report
given upon the authority of said firm as experts in accounting and auditing.
 
                                      72
<PAGE>
 
                             AVAILABLE INFORMATION
 
  The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement under the Securities Act, with respect
to the Common Stock offered hereby. This Prospectus, which is part of the
Registration Statement, does not contain all of the information set forth in
the Registration Statement. For further information with respect to the
Company and the Common Stock offered hereby, reference is hereby made to the
Registration Statement. Statements contained in this Prospectus regarding the
contents of any contract, agreement or other document are not necessarily
complete. With respect to each such contract, agreement or document filed as
an exhibit to the Registration Statement, reference is made to the exhibit for
a more complete description of the matter involved, and each such statement
shall be deemed qualified in all respects by such reference.
 
  The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended, and, in accordance therewith, files reports
and other information with the Commission. The Registration Statement filed by
the Company with the Commission, as well as such reports and other information
filed by the Company with the Commission, may be inspected and copied at the
public reference facilities maintained by the Commission at 450 Fifth Street,
N.W., Room 1024, Washington, D.C. 20549, and should also be available for
inspection and copying at the regional offices of the Commission located in
the Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661 and 7 World Trade Center, 13th Floor, New York, New York 10048. Copies
of such material can also be obtained by mail from the Public Reference
Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at
prescribed rates. Copies of such material will be available for inspection at
the offices of the New York Stock Exchange, 20 Broad Street, New York, New
York 10005.
 
                                      73
<PAGE>
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
DAL-TILE INTERNATIONAL INC.
 
<TABLE>
<S>                                                                         <C>
Report of Ernst & Young LLP, Independent Auditors.........................   F-2
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1994 and 1995 and March 31,
 1996.....................................................................   F-3
Consolidated Statements of Operations for each of the three years in the
 period ended
 December 31, 1995, and each of the three month periods ended March 31,
 1995 and 1996............................................................   F-4
Consolidated Statements of Stockholders' Equity (Capital Deficiency) for
 each of the
 three years in the period ended December 31, 1995 and for the three month
 period ended
 March 31, 1996...........................................................   F-5
Consolidated Statements of Cash Flows for each of the three years in the
 period ended December 31, 1995, and each of the three month periods ended
 March 31, 1995 and 1996..................................................   F-6
Notes to Consolidated Financial Statements................................   F-7
 
CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
Report of KPMG Peat Marwick LLP, Independent Auditors.....................  F-21
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1994 and December 29,
 1995.....................................................................  F-22
Consolidated Statements of Operations for each of the years ended December
 31, 1993 and 1994 and the year ended December 29, 1995...................  F-23
Consolidated Statements of Cash Flows for each of the years ended December
 29, 1993 and 1994 and the year ended December 29, 1995...................  F-24
Notes to Consolidated Financial Statements................................  F-25
</TABLE>
 
                                      F-1
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors
Dal-Tile International Inc.
 
  We have audited the accompanying consolidated balance sheets of Dal-Tile
International Inc. (the Company) as of December 31, 1994 and 1995, and the
related consolidated statements of operations, stockholders' equity (capital
deficiency), and cash flows for each of the three years in the period ended
December 31, 1995. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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 December 31, 1994 and 1995, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1995, in conformity with
generally accepted accounting principles.
 
                                          Ernst & Young LLP
Dallas, Texas
March 15, 1996
 
                                      F-2
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                   DECEMBER 31      (UNAUDITED)
                                                ------------------   MARCH 31,
                                                  1994      1995       1996
                                                --------  --------  -----------
                                                       (IN THOUSANDS)
<S>                                             <C>       <C>       <C>
                    ASSETS
Current assets:
 Cash.......................................... $ 12,977  $ 72,965   $ 39,131
 Trade accounts receivable.....................   85,148   103,909    106,879
 Inventories...................................   80,467   118,811    121,876
 Prepaid expenses..............................    3,293     3,872      4,345
 Other current assets..........................    7,381     8,531      9,483
                                                --------  --------   --------
   Total current assets........................  189,266   308,088    281,714
Property, plant, and equipment, at cost:
 Land..........................................   12,776    19,444     19,444
 Leasehold improvements........................    7,298     8,567      8,741
 Buildings.....................................   56,748    63,065     63,125
 Machinery and equipment.......................   73,132   104,520    104,907
 Construction in process.......................   10,346    14,400     19,872
                                                --------  --------   --------
                                                 160,300   209,996    216,089
 Accumulated depreciation......................   37,557    42,073     46,227
                                                --------  --------   --------
                                                 122,743   167,923    169,862
Goodwill, net of amortization..................  166,781   162,016    160,825
Finance costs, net of amortization.............    8,461     6,432      6,307
Trade name and other assets....................    1,166    27,934     23,806
                                                --------  --------   --------
   Total assets................................ $488,417  $672,393   $642,514
                                                ========  ========   ========
 LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL
                  DEFICIENCY)
Current liabilities:
 Trade accounts payable........................ $ 19,162  $ 38,755   $ 19,798
 Accrued expenses..............................   14,640    27,983     27,492
 Accrued interest payable......................   17,088    17,398      7,928
 Current portion of long-term debt.............    3,349    47,047     47,047
 Income taxes payable..........................    3,257       --         --
 Deferred income taxes.........................    5,941     3,981      4,001
 Other current liabilities.....................   10,112    20,796     10,307
                                                --------  --------   --------
   Total current liabilities...................   73,549   155,960    116,573
Long-term debt.................................  489,404   480,769    476,487
Other long-term liabilities....................   22,635    25,023     38,022
Deferred income taxes..........................    6,652     1,002      1,068
Commitments and contingencies
Stockholders' equity (capital deficiency):
 Common stock..................................       25        41         41
 Additional paid-in capital....................  200,475   334,035    334,035
 Accumulated deficit........................... (268,144) (266,004)  (265,074)
 Currency translation adjustment...............  (36,179)  (58,433)   (58,638)
                                                --------  --------   --------
   Total stockholders' equity (capital
    deficiency)................................ (103,823)    9,639     10,364
                                                --------  --------   --------
   Total liabilities and stockholders' equity
    (capital deficiency)....................... $488,417  $672,393   $642,514
                                                ========  ========   ========
</TABLE>
 
                            See accompanying notes.
 
                                      F-3
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                              (UNAUDITED)
                                                          THREE MONTHS ENDED
                             YEAR ENDED DECEMBER 31            MARCH 31
                           -----------------------------  --------------------
                             1993       1994      1995      1995       1996
                           ---------  --------  --------  ---------  ---------
                              (IN THOUSANDS EXCEPT EARNINGS PER SHARE)
<S>                        <C>        <C>       <C>       <C>        <C>
Net sales................. $ 440,573  $506,309  $474,812  $ 119,353  $ 170,674
Cost of goods sold........   239,379   268,272   225,364     58,110     87,940
                           ---------  --------  --------  ---------  ---------
                             201,194   238,037   249,448     61,243     82,734
Operating expenses:
  Transportation..........    25,860    32,068    33,535      8,042      9,957
  Selling.................    68,412    75,566    76,758     19,367     24,418
  General and
   administrative.........    52,336    57,321    57,435     16,066     23,944
  Provision for merger
   integration charges....       --        --     22,430        --       9,000
  Provision for special
   charges................    53,233       --        --         --         --
  Amortization of
   goodwill...............    10,706     4,765     4,765      1,191      1,191
  Write-down of goodwill..   214,235       --        --         --         --
                           ---------  --------  --------  ---------  ---------
    Total expenses........   424,782   169,720   194,923     44,666     68,510
                           ---------  --------  --------  ---------  ---------
Operating income (loss)...  (223,588)   68,317    54,525     16,577     14,224
Interest expense..........    46,746    53,542    55,453     13,567     13,843
Interest income...........       517     1,403     1,250        488        584
Other (income) expense....     1,088    (1,341)   (2,994)    (1,600)      (531)
                           ---------  --------  --------  ---------  ---------
Income (loss) before
 income taxes.............  (270,905)   17,519     3,316      5,098      1,496
Income tax provision
 (benefit)................    (3,225)   10,614     1,176      4,272        566
                           ---------  --------  --------  ---------  ---------
Net income (loss)......... $(267,680) $  6,905  $  2,140  $     826  $     930
                           =========  ========  ========  =========  =========
Pro forma net income per
 share....................                                           $
                                                                     =========
Pro forma average shares
 of Common Stock..........
</TABLE>
 
 
                            See accompanying notes.
 
                                      F-4
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
     CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
 
<TABLE>
<CAPTION>
                                         COMMON STOCK                      ADDITIONAL              CURRENCY
                     -----------------------------------------------------  PAID-IN   ACCUMULATED TRANSLATION
                     CLASS A CLASS B CLASS C CLASS D CLASS E CLASS F TOTAL  CAPITAL     DEFICIT   ADJUSTMENT    TOTAL
                     ------- ------- ------- ------- ------- ------- ----- ---------- ----------- ----------- ---------
                                                               (IN THOUSANDS)
<S>                  <C>     <C>     <C>     <C>     <C>     <C>     <C>   <C>        <C>         <C>         <C>
Balance at December
 31, 1992..........   $ 10    $--      $ 3    $ 10     $ 1     $ 1   $ 25   $199,975   $  (7,369)  $  (3,116) $ 189,515
 Net loss..........    --      --      --      --      --      --     --         --     (267,680)        --    (267,680)
 Currency
  translation
  adjustment.......    --      --      --      --      --      --     --         --          --          716        716
                      ----    ----     ---    ----     ---     ---   ----   --------   ---------   ---------  ---------
Balance at December
 31, 1993..........     10     --        3      10       1       1     25    199,975    (275,049)     (2,400)   (77,449)
 Net income........    --      --      --      --      --      --     --         --        6,905         --       6,905
 Proceeds from sale
  of stock.........    --      --      --      --      --      --     --         500         --          --         500
 Currency
  translation
  adjustment.......    --      --      --      --      --      --     --         --          --      (33,779)   (33,779)
                      ----    ----     ---    ----     ---     ---   ----   --------   ---------   ---------  ---------
Balance at December
 31, 1994..........     10     --        3      10       1       1     25    200,475    (268,144)    (36,179)  (103,823)
 Net income........    --      --      --      --      --      --     --         --        2,140         --       2,140
 Stock issued in
  connection with
  the AO
  Acquisition......      6     --        2       6       1       1     16    133,560         --          --     133,576
 Currency
  translation
  adjustment.......    --      --      --      --      --      --     --         --          --      (22,254)   (22,254)
                      ----    ----     ---    ----     ---     ---   ----   --------   ---------   ---------  ---------
Balance at December
 31, 1995..........     16     --        5      16       2       2     41    334,035    (266,004)    (58,433)     9,639
 Net income
  (unaudited)......    --      --      --      --      --      --     --         --          930         --         930
 Currency
  translation
  adjustment
  (unaudited)......    --      --      --      --      --      --     --         --          --         (205)      (205)
                      ----    ----     ---    ----     ---     ---   ----   --------   ---------   ---------  ---------
Balance at March
 31, 1996
 (unaudited).......   $ 16    $--      $ 5    $ 16     $ 2     $ 2   $ 41   $334,035   $(265,074)  $ (58,638) $  10,364
                      ====    ====     ===    ====     ===     ===   ====   ========   =========   =========  =========
</TABLE>
 
                            See accompanying notes.
 
                                      F-5
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                             (UNAUDITED)
                                  YEAR ENDED             THREE MONTHS ENDED
                                  DECEMBER 31                  MARCH 31
                          -----------------------------  ---------------------
                            1993       1994      1995      1995        1996
                          ---------  --------  --------  ---------  ----------
                                           (IN THOUSANDS)
<S>                       <C>        <C>       <C>       <C>        <C>
OPERATING ACTIVITIES
Net income (loss).......  $(267,680) $  6,905  $  2,140  $     826  $      930
Adjustments to reconcile
 net income (loss) to
 net cash provided by
 (used in) operating
 activities:
 Depreciation and
  amortization..........     22,019    17,020    17,164      4,302       5,390
 Write-down of
  goodwill..............    214,235       --        --         --          --
 Merger integration
  reserve...............        --        --     22,430        --          --
 Special charge
  reserve...............     51,293       --        --         --          --
 Foreign exchange
  transaction (gain)
  loss..................       (321)   (6,564)   (6,067)    (1,576)        363
 Zero Coupon Notes
  interest expense......      3,473     9,700    10,899      2,576       2,919
 Deferred income tax
  provision (benefit)...     (6,727)      763    (3,088)       680          86
 Changes in operating
  assets and
  liabilities, net of
  assets/liabilities of
  business acquired:
   Trade accounts
    receivable..........    (11,808)  (13,726)    8,581      2,997      (2,905)
   Inventories..........    (16,911)    1,911    (3,580)    (2,280)     (3,049)
   Other assets.........       (891)    1,695    (5,754)      (584)     (1,521)
   Trade accounts
    payable and accrued
    expenses............     (2,899)   14,890    12,371     (1,903)    (16,270)
   Accrued interest
    payable.............        200       307       354     (8,685)     (9,472)
   Other liabilities....      9,824    (1,431)  (14,787)     9,647       2,561
                          ---------  --------  --------  ---------  ----------
Net cash provided by
 (used in) operating
 activities.............     (6,193)   31,470    40,663      6,000     (20,968)
INVESTING ACTIVITIES
Expenditures for
 property, plant, and
 equipment, net.........    (17,066)  (14,160)  (29,392)    (5,505)     (5,673)
FINANCING ACTIVITIES
Repayment of long-term
 debt...................    (86,392)  (36,934)  (22,538)      (746)    (44,300)
Borrowings under long-
 term debt..............     44,032    28,000    46,702     14,000      37,100
Proceeds from sale of
 stock..................        --        500    27,575        --          --
Proceeds from issuance
 of Zero Coupon Notes...     71,131       --        --         --          --
                          ---------  --------  --------  ---------  ----------
Net cash provided by
 (used in) financing
 activities.............     28,771    (8,434)   51,739     13,254      (7,200)
Effect of exchange rate
 changes on cash........        407    (4,694)   (3,022)    (2,353)          7
                          ---------  --------  --------  ---------  ----------
Net increase (decrease)
 in cash................      5,919     4,182    59,988     11,396     (33,834)
Cash at beginning of
 year...................      2,876     8,795    12,977     12,973      72,965
                          ---------  --------  --------  ---------  ----------
Cash at end of year.....  $   8,795  $ 12,977  $ 72,965  $  24,369  $   39,131
                          =========  ========  ========  =========  ==========
</TABLE>
 
                            See accompanying notes.
 
                                      F-6
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
 
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. The
Company, as a stand-alone holding company, has no operations and primarily has
as its assets, cash and the investment in the Group and as its liabilities,
the Senior Secured Zero Coupon Notes issued in 1993 (Note 4).
 
  The Group is a multinational manufacturing and distribution company
operating in the United States, Mexico, and Canada. The Group offers a full
range of 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 as a result of the 1995
acquisition.
 
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"). The AO Acquisition was accounted for under the purchase method
of accounting. As part of the AO Acquisition, AWI paid $27,575,000 cash to the
Company.
 
  In exchange for the stock and assets contributed as part of the AO
Acquisition, AWI received an aggregate of 590,238 shares of Class A Common
Stock of the Company, 5,873 shares of Class B Common Stock of the Company,
183,244 shares of Class C Common Stock of the Company, 587,302 shares of Class
D Common Stock of the Company, 73,413 shares of Class E Common Stock of the
Company, and 73,413 shares of Class F Common Stock of the Company,
representing, after giving effect to such issuance, 37% of the issued and
outstanding capital stock of the Company. The fair value of the capital stock
issued was approximately $133,575,000 including the $27,575,000 in cash. The
financial statements include the assets acquired and liabilities assumed and
exclude the results of operations for the year ended December 31, 1995, as the
acquisition occurred on December 29, 1995. The Company's operating results for
the three months ended March 31, 1996 reflect the results of operations of AO.
 
  AO manufactures and markets commercial and residential glazed and unglazed
tile for sale to contractors, distributors and home improvement centers in the
United States and Canada. The purchase price allocation is based on a
preliminary appraisal and is subject to change.
 
  The summarized unaudited pro forma results of operations for the two years
ended December 31, are as follows:
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31
                                                         -----------------------
                                                            1994        1995
                                                         ----------- -----------
     <S>                                                 <C>         <C>
     Net revenues.......................................    $735,991    $724,446
     Net income.........................................      18,879      42,614
</TABLE>
 
  The unaudited pro forma results do not necessarily represent results which
would have occurred if the AO Acquisition had taken place on the dates
indicated nor are they necessarily indicative of the results of future
operations. The pro forma results for 1995 reflect cost savings of $24,800,000
resulting from the consolidation of the two companies, but do not reflect
$22,430,000 of non-recurring merger integration charges recorded in 1995 in
connection with the AO Acquisition.
 
                                      F-7
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
BASIS OF PRESENTATION
 
  The consolidated financial statements do not give effect to (i) the
restatement of the Company's certificate of incorporation to increase the
number of authorized shares of capital stock, and (ii) the conversion of all
shares of all classes of the Company's currently outstanding capital stock
into      shares of a single class of common stock (the "common stock
conversion"). The common stock conversion will be effected immediately prior
to the consummation of the refinancing referred to in Note 17. Accordingly,
references to the common stock in the consolidated financial statements
reflect the outstanding classes of common stock and the number of outstanding
shares of each such class prior to the common stock conversion.
 
  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>
   The Group............................................. U.S. corporation
   Dal-Tile Corporation.................................. U.S. corporation
   American Olean Tile Company, Inc...................... U.S. corporation
   R&M Supplies, Inc. ("R&M")............................ U.S. corporation
   Dal-Minerals Company ("Dal-Minerals")................. U.S. corporation
   Dal-Tile of Mexico, S.A. de C.V. ("Dal-Tile Mexico"),
    formerly Ceramica Regiomontana, S.A. de C.V. ........ Mexican corporation
   Materiales Ceramicos, S.A. de C.V. ("Materiales")..... Mexican corporation
   Dal-Tile of Canada Inc. .............................. Canadian corporation
</TABLE>
 
  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.
 
CASH AND CASH EQUIVALENTS
 
  The Company considers all highly liquid investments 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--20
</TABLE>
 
GOODWILL
 
  Goodwill, which represents the excess cost over the fair value of net assets
acquired, is amortized on a straight-line basis over the expected period to be
benefited of 40 years. Accumulated amortization at December
 
                                      F-8
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
 
31, 1994 and 1995 and March 31, 1996, was $47,595,000, $52,360,000 and
$53,551,000, respectively. The carrying value of goodwill is reviewed if the
facts and circumstances suggest that it 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 (See Note 8).
 
FINANCE COSTS
 
  Finance costs incurred in connection with financing are being amortized over
the term of the related debt on a straight-line basis. Accumulated
amortization at December 31, 1994 and 1995 and March 31, 1996, was
approximately $6,885,000, $8,963,000 and $9,500,000, respectively.
 
PRO FORMA NET INCOME PER SHARE (UNAUDITED)
 
  Pro forma net income per share and average number of shares for the three
month period ended March 31, 1996, give effect to the stock split as if the
stock split had occurred on January 1, 1996.
 
ADVERTISING EXPENSES
 
  Advertising and promotion expenses are charged to income during the year in
which they are incurred. Advertising and promotion expenses incurred for the
years ended December 31, 1993, 1994, and 1995 and the three months ended March
31, 1995 and 1996 amounted to $3,631,000, $4,499,000, $4,668,000, $1,000,000
and $1,671,000, respectively.
 
RETIREMENT PLANS
 
  Dal-Tile Corporation maintains a defined contribution plan for eligible
employees. A participant may contribute up to 5% of his annual compensation to
the plan. Contributions by Dal-Tile Corporation to the plan are at the
discretion of its Board of Directors. The plan also allows employee
contributions under a 401(k) provision.
 
  Dal-Tile Mexico and Materiales maintain defined benefit plans for eligible
employees with funding policies based on local statutes.
 
FOREIGN CURRENCY TRANSLATION
 
  The Company's Mexican operations use the Mexican peso as their functional
currency. Assets and liabilities are translated from the functional currency
into the U.S. dollar using the period-end exchange rates. Income and expense
accounts are translated from the functional currency into the U.S. dollar
using the average exchange rate for the period. Translation gains or losses
are included as a component of stockholders' equity.
 
CONCENTRATIONS OF CREDIT RISK
 
  The Company is engaged in the manufacturing and distribution of glazed and
unglazed wall, floor, and mosaic tile in the United States and Mexico and the
distribution of 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 often 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. Credit losses have been
within management's expectation. Trade accounts receivable are net of an
allowance for losses from uncollectible accounts of $3,892,000, $9,389,000
(including $4,760,000 related to the AO Acquisition) and $8,364,000 (including
$2,352,000 related to the AO Acquisition) at December 31, 1994 and 1995 and
March 31, 1996, respectively.
 
                                      F-9
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
 
RECLASSIFICATIONS
 
  Certain prior year amounts have been reclassified to conform to the 1996
presentation.
 
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
  In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" (Statement 121), which requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying value.
Statement 121 also addresses the accounting for long-lived assets that are
expected to be disposed of. The Company has adopted Statement 121 and, based
on current circumstances, such adoption will not materially impact the
Company's annual financial results.
 
  In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-
Based Compensation" (Statement 123), which provides an alternative to APB
Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for
stock-based compensation issued to employees. Statement 123 allows for a fair
value based method of accounting for employee stock options and similar equity
instruments. However, for companies that continue to account for stock-based
compensation arrangements under APB Opinion No. 25, Statement 123 requires
disclosure of the pro forma effect on net income and net income per share of
its fair value based accounting for those arrangements. These disclosure
requirements are effective for fiscal years beginning after December 15, 1995,
or upon initial adoption of Statement 123, if earlier. The Company continues
to evaluate the provisions of Statement 123 and has not determined whether it
will adopt the recognition and measurement provisions of Statement 123, which
adoption the Company believes will not materially impact the Company's
financial results.
 
3. INVENTORIES
 
  Inventories consist of the following:
 
<TABLE>
<CAPTION>
                                                        DECEMBER 31
                                                      ---------------- MARCH 31,
                                                       1994     1995     1996
                                                      ------- -------- ---------
                                                            (IN THOUSANDS)
   <S>                                                <C>     <C>      <C>
   Finished products in U.S. ........................ $64,407 $ 95,355 $ 98,466
   Finished products in Mexico.......................   4,659    4,303    4,123
   Finished products in Canada.......................   1,715    3,362    3,300
   Goods-in-process..................................   1,231    3,567    2,998
   Raw materials.....................................   8,455   12,224   12,989
                                                      ------- -------- --------
   Total inventories................................. $80,467 $118,811 $121,876
                                                      ======= ======== ========
</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 $2,800,000 lower, $2,500,000 lower and $2,500,000 lower than
reported at December 31, 1994 and 1995 and March 31, 1996, respectively.
 
                                     F-10
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
 
4. LONG-TERM DEBT
 
  Long-term debt consists of the following:
 
<TABLE>
<CAPTION>
                                                      DECEMBER 31
                                                   ----------------- MARCH 31,
                                                     1994     1995     1996
                                                   -------- -------- ---------
                                                         (IN THOUSANDS)
   <S>                                             <C>      <C>      <C>
   Dal-Tile International Senior Secured Zero
    Coupon Notes, interest at 12%, due July 15,
    1998.........................................  $ 88,179 $ 99,078 $101,997
   Dal-Tile Group unsecured Series A notes,
    interest due semi-annually at 10.625%,
    principal due in annual installments of
    $44,000 commencing January 9, 1996 and
    through January 9, 2000......................   220,000  220,000  176,000
   Dal-Tile Group unsecured Series B notes,
    interest due semi-annually at 10.77%,
    principal due in annual installments of
    $20,000 commencing January 9, 1998 and
    through January 9, 2002......................   100,000  100,000  100,000
   Dal-Tile Group unsecured revolving line of
    credit, interest due monthly at LIBOR plus 2%
    or prime plus 1% (approximately 7.69% at
    December 31, 1995), principal due January 9,
    1998.........................................    69,697   91,197  128,297
   Dal-Tile Corporation Series 1987 and 1986
    Industrial Development Refunding and Revenue
    Bonds, interest due monthly at a variable
    rate not to exceed 15% (approximately 5.2% at
    December 31, 1995), bonds redeemable in
    variable annual installments through March 1,
    2004, secured by certain manufacturing
    facilities...................................     7,200    6,500    6,200
   Other.........................................     7,677   11,041   11,040
                                                   -------- -------- --------
                                                    492,753  527,816  523,534
   Less current portion..........................     3,349   47,047   47,047
                                                   -------- -------- --------
                                                   $489,404 $480,769 $476,487
                                                   ======== ======== ========
</TABLE>
 
  On August 11, 1993, the Company issued Senior Secured Zero Coupon Notes with
proceeds of $75,006,252, before fees and expenses, at a 12% annual interest
rate calculated semi-annually. The Zero Coupon Notes defer interest payments
until maturity on July 15, 1998 at which time principal and interest of
$133,200,000 become due. The Zero Coupon Notes are not redeemable at the
option of the Company, except that in the event the Company issues shares of
capital stock before July 16, 1996, the Company, at its option, may use the
net proceeds to redeem up to 33% of the outstanding Zero Coupon Notes. Such
redemption will be at 106% of the Accreted Value. The Company is also required
to redeem the outstanding Zero Coupon Notes at 101% of the Accreted Value if
there shall occur a Change of Control as defined in the Zero Coupon Note
Indenture. The Zero Coupon Notes are secured by a pledge of all the
outstanding shares of the Group. Under the terms of the Indenture relating to
the Zero Coupon Notes, the Company is restricted, among other things, from
incurring additional debt, paying dividends, and selling certain assets.
 
  The Group has a revolving line of credit agreement with a group of banks
which provides for borrowing up to $160,000,000. Amounts available for
borrowing under the revolving line of credit agreement are limited to
 
                                     F-11
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
4. LONG-TERM DEBT--(CONTINUED)
 
the lower of $160,000,000 or the borrowing base, as defined, which is
calculated based on levels of trade accounts receivable and inventories. As of
December 31, 1995 and March 31, 1996, the borrowing base calculation did not
restrict the availability under the revolving line of credit agreement of
$160,000,000. A commitment fee of 0.5% of the unused revolving line of credit
is payable monthly. Under the terms of the revolving line of credit, the Group
is required to maintain, among other things, certain minimum levels of net
worth, working capital, and quick ratio. The Group also has restrictions on
the payment of dividends and the making of intercompany loans to the Company
under the credit agreement and at December 31, 1995 and March 31, 1996, is
prohibited from making such payments.
 
  Under the terms of the Industrial Development Refunding and Revenue Bonds,
Dal-Tile Corporation is required to maintain certain minimum levels on net
worth, current ratio, and debt coverage.
 
  Aggregate maturities of long-term debt for the five years subsequent to
December 31, 1995, are:
 
<TABLE>
<CAPTION>
                                                                  (IN THOUSANDS)
                                                                  --------------
        <S>                                                       <C>
        1996.....................................................    $ 47,047
        1997.....................................................      46,823
        1998.....................................................     290,997
        1999.....................................................      66,451
        2000.....................................................      66,451
</TABLE>
 
  Total interest cost incurred for the years ended December 31, 1993, 1994,
and 1995 and the three months ended March 31, 1995 and 1996, amounted to
approximately $47,306,000, $54,208,000, $56,699,000, $13,234,000 and
$13,560,000, respectively, of which approximately $560,000, $666,000,
$1,246,000, $186,000 and $254,000, respectively, was capitalized to property,
plant, and equipment. Total interest paid, net of interest received, was
$42,093,000, $42,446,000, $43,460,000, $19,678,000 and $20,442,000 for the
years ended December 31, 1993, 1994, and 1995 and the three months ended March
31, 1995 and 1996, respectively.
 
                                     F-12
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
 
5. CAPITAL STRUCTURE
 
  Common stock consists of the following:
<TABLE>
<CAPTION>
                                                    DECEMBER 31
                                                    ------------  MARCH 31,
                                                    1994   1995     1996
                                                    -----  -----  ---------
                                                       (IN THOUSANDS)
<S>                                                 <C>    <C>    <C>       
Common stock, $.01 par value:
  Class A--authorized shares--1,290,714, issued and
   outstanding shares--1,005,000 at December 31,
   1994, authorized shares--2,830,952, issued and
   outstanding shares--1,595,238 at December 31,
   1995 and March 31, 1996.........................   $10    $16     $16
  Class B--authorized, issued and outstanding
   shares--10,000 at December 31, 1994, authorized
   shares--23,873, issued and outstanding shares--
   15,873 at December 31, 1995 and March 31, 1996..   --     --      --
  Class C--authorized, issued and outstanding
   shares--312,010 at December 31, 1994, authorized
   shares--745,254, issued and outstanding shares--
   495,254 at December 31, 1995 and March 31,
   1996............................................     3      5       5
  Class D--authorized, issued and outstanding
   shares--1,000,000 at December 31, 1994, autho-
   rized shares--2,387,302, issued and outstanding
   shares--1,587,302 at December 31, 1995 and March
   31, 1996........................................    10     16      16
  Class E--authorized, issued and outstanding
   shares--125,000 at December 31, 1994, authorized
   shares--298,413, issued and outstanding shares--
   198,413 at December 31, 1995 and March 31,
   1996............................................     1      2       2
  Class F--authorized, issued and outstanding
   shares--125,000 at December 31, 1994, authorized
   shares--298,413, issued and outstanding shares--
   198,413 at December 31, 1995 and March 31,
   1996............................................     1      2       2
                                                    -----  -----     ---
                                                      $25    $41     $41
                                                    =====  =====     ===    ===
</TABLE>
 
  The Company's authorized capital consists of six classes of common stock
with various rights and privileges. Class B Common Stock retains sole voting
privileges among all classes. All classes of common stock share ratably in
dividends. At December 31, 1995 and March 31, 1996, the Company has authorized
1,000,000 shares of preferred stock.
 
  Class A and Class D Common Stock have primary liquidation preferences equal
to the amount of the respective original investment, $100 per share. Class B,
Class C, Class E, and Class F Common Stock would participate in liquidation
proceeds only after the holders of Class A and Class D shares have recovered
their primary preference. Thereafter, Class B, Class C, and Class E have
preferences equal to $100 per share. Class F Common Stock is not entitled to
participate in liquidation proceeds unless the holders of Class D Common Stock
have recovered a minimum of 20% rate of return, compounded annually, on the
shares of Class D and Class E Common Stock that the Class D Common
shareholders own. Once Class F Common Stock has recovered its $100 per share
preference, all classes share ratably in any remaining liquidation proceeds.
 
6. PROVISION FOR MERGER INTEGRATION CHARGES
 
  In the fourth quarter of 1995, the Company recorded a pre-tax charge of
$22,430,000 for the revaluation of certain assets in connection with the AO
Acquisition (Note 1). In connection with the AO Acquisition and the Company's
merger integration plan, the Company will close certain manufacturing
facilities, as well as duplicative sale service centers, and will discontinue
the use of certain equipment. The noncash (approximately $20,200,000) write-
down of certain equipment represents the net book value of the less efficient
and duplicate equipment not needed in the combined Company. The cash portion
of the merger integration charge is
 
                                     F-13
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
6. PROVISION FOR MERGER INTEGRATION CHARGES--(CONTINUED)
 
approximately $2,200,000 which primarily consists of leasehold commitments on
equipment.
 
7. PROVISION FOR MERGER INTEGRATION CHARGES--FIRST QUARTER OF 1996 (UNAUDITED)
 
  In the first quarter of 1996, the Company recorded a pre-tax merger
integration charge of $9,000,000 for the closings of duplicative sales
centers, duplicative distribution centers, manufacturing facility closings and
severance costs associated with the elimination of overlapping positions. The
majority of the charge is related to lease commitments extending beyond 1996.
 
8. PROVISION FOR SPECIAL CHARGES
 
  During the fourth quarter of 1993, following a review of its operations, the
Company established provisions for a distribution enhancement program,
revaluation of certain assets, and severance costs for retiring employees. As
a result, the Company recorded a $53,233,000 special charge in the fourth
quarter which consisted of:
 
<TABLE>
   <S>                                                              <C>
   Distribution enhancement program................................ $23,350,000
   Asset revaluation...............................................  25,155,000
   Severance costs.................................................   4,728,000
                                                                    -----------
                                                                    $53,233,000
                                                                    ===========
</TABLE>
 
  The primary components of the distribution enhancement program were
$3,800,000 for facility consolidations, $6,406,000 for costs associated with
inventory relocation, $5,795,000 for lease obligations related to excess
facilities, and $7,349,000 for costs associated with the fourth quarter 1993
study and implementation of this program.
 
  In connection with the review, inventories and property, plant, and
equipment were written down $25,155,000 in the fourth quarter of 1993. This
write-down consists of a $17,000,000 reserve for inventories which under the
distribution enhancement program were not cost beneficial to relocate. The
remainder of the $25,155,000 charge consists of write-downs of $8,155,000 for
manufacturing equipment which was replaced with more efficient technology.
 
9. GOODWILL
 
  During the fourth quarter of 1993, management reviewed (as described in Note
8) its five operating subsidiaries. In connection with this review, the
Company assessed the carrying amounts of goodwill at each of the Company's
business units using the methodology described in Note 2 and as a result,
recorded a $214,235,000 write-down of goodwill.
 
  The Mexican business units (Dal-Tile Mexico and Materiales) did not achieve
expected operating results due primarily to large increases in capacity added
by other Mexican tile manufacturers in anticipation of strong growth in
Mexico. An oversupply of production capacity throughout 1993 resulted in
pricing pressures and a reduction of the Company's market share in Mexico.
Exports to the U.S. market did not grow as expected due to downturns in the
construction industry and continued recessionary conditions in California.
Additionally, the Mexican economy retreated during 1993.
 
                                     F-14
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
9. GOODWILL--(CONTINUED)
 
  Dal-Minerals owns the mineral rights to significant reserves of talcose rock
(talc). It was expected that the Company's usage of talc would significantly
increase and that alternative uses of talc could be identified and
economically exploited. The Company's uses of talc was not increasing
significantly and the Company was unable to satisfactorily develop alternative
markets for talc.
 
  R&M, as a distributor of refractories, projected their cash flows to
significantly decline as more efficient technology replaced the use of
refractories.
 
  Management believed this assessment in 1993 indicated that goodwill was
impaired at the business units referred to above. As a result, the fair value
of these business units was estimated using independent firms and cash flow
projections and compared to the carrying value of those assets. Accordingly,
in 1993, the Company wrote-off the related unamortized goodwill balances as
shown below:
 
<TABLE>
   <S>                                                             <C>
   Dal-Tile Mexico and Materiales................................. $ 97,658,000
   Dal-Minerals...................................................   87,073,000
   R&M............................................................   29,504,000
                                                                   ------------
                                                                   $214,235,000
                                                                   ============
</TABLE>
 
10. INCOME TAXES
 
  Income (loss) before income taxes relating to operations in the United
States and Mexico is as follows:
 
<TABLE>
<CAPTION>
                                                      1993      1994     1995
                                                    ---------  -------  -------
                                                         (IN THOUSANDS)
   <S>                                              <C>        <C>      <C>
   United States................................... $(179,309) $  (645) $(4,100)
   Mexico..........................................   (91,848)  18,261    7,754
   Other...........................................       252      (97)    (338)
                                                    ---------  -------  -------
                                                    $(270,905) $17,519  $ 3,316
                                                    =========  =======  =======
</TABLE>
 
  The components of the provision for income taxes include the following for:
 
<TABLE>
<CAPTION>
                                                        1993     1994    1995
                                                       -------  ------- -------
                                                           (IN THOUSANDS)
   <S>                                                 <C>      <C>     <C>
   U.S. federal--current.............................. $   --   $   --  $   --
   U.S. state--current................................   1,223    2,474   2,179
   U.S.--deferred.....................................  (7,400)     --      --
                                                       -------  ------- -------
                                                        (6,177)   2,474   2,179
   Mexico--current....................................   3,270    6,615   1,471
   Mexico--deferred...................................    (318)   1,525  (2,474)
                                                       -------  ------- -------
                                                         2,952    8,140  (1,003)
                                                       -------  ------- -------
     Total............................................ $(3,225) $10,614 $ 1,176
                                                       =======  ======= =======
</TABLE>
 
 
                                     F-15
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
10. INCOME TAXES--(CONTINUED)
 
  Principal reconciling items from income tax computed at the U.S. statutory
rate of 35% in 1995, 35% in 1994, and 35% in 1993 are as follows:
 
<TABLE>
<CAPTION>
                                                     1993     1994     1995
                                                   --------  -------  -------
                                                        (IN THOUSANDS)
   <S>                                             <C>       <C>      <C>
   Provision (benefit) at statutory rate.......... $(94,818) $ 6,132  $ 1,161
   Amortization of goodwill.......................    3,749    1,668    1,668
   Write-down of goodwill.........................   74,982      --       --
   State income tax...............................   (1,444)   1,676    1,416
   Loss not benefited (utilized)..................   14,736     (672)   1,436
   Other..........................................      (74)   1,462     (399)
   Difference between U.S. and Mexico statutory
    rate..........................................     (356)     348   (4,106)
                                                   --------  -------  -------
                                                   $ (3,225) $10,614  $ 1,176
                                                   ========  =======  =======
</TABLE>
 
  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>
                                                             1994      1995
                                                           --------  --------
                                                            (IN THOUSANDS)
   <S>                                                     <C>       <C>
   Deferred tax liabilities:
     Book basis of PP&E over tax.......................... $ 20,150  $ 10,847
     Book basis of inventories over tax...................    4,750     3,981
     Book basis of other assets over tax..................    1,784     1,756
     Other, net...........................................    2,551         8
                                                           --------  --------
       Total deferred tax liabilities.....................   29,235    16,592
   Deferred tax assets:
     Reserve for merger integration charges and special
      charges.............................................   17,194    10,818
     Net operating loss carryforwards.....................    9,355     5,425
     Expenses not yet deductible for tax..................    4,157     5,500
                                                           --------  --------
   Total deferred tax assets..............................   30,706    21,743
   Valuation allowance for deferred tax assets............  (14,064)  (10,134)
                                                           --------  --------
   Net deferred tax assets................................   16,642    11,609
                                                           --------  --------
   Net deferred tax liabilities........................... $ 12,593  $  4,983
                                                           ========  ========
</TABLE>
 
  The Company has a U.S. loss carryforward for regular tax purposes of
approximately $22,334,000, which expires in 2008-2010.
 
  Total income tax payments, net of refunds received, during the years 1993,
1994, and 1995 were $3,517,000, $5,842,000 and $6,145,000, respectively.
 
  No U.S. taxes have been provided on the undistributed earnings of foreign
subsidiaries since the Group expects these earnings to be indefinitely
reinvested. The undistributed earnings aggregate approximately $36,000,000 at
December 31, 1995. Since the determination of the amount of unrecognized
deferred tax liability and of the amount of withholding taxes that would be
payable upon remittance of these earnings is not practicable, these amounts
have not been determined.
 
                                     F-16
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
10. INCOME TAXES--(CONTINUED)
 
  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 1993, 1994, or 1995 and, for financial statement presentation purposes,
have been classified as components of income tax expense. Total tax provision
amounts accrued by Dal-Tile Mexico and Materiales for this obligation amounted
to approximately $1,200,000, $2,200,000, $1,500,000, $1,085,000 and $141,000
for 1993, 1994, and 1995 and the three months ended March 31, 1995 and 1996,
respectively.
 
11. RELATED PARTY TRANSACTIONS
 
  AEA Investors Inc., a stockholder of the Company, provides management,
consulting, and financial services to the Company for fees and expenses. The
Company has incurred fees and expenses for such services of $963,000,
$1,015,000, $991,000, $228,000 and $230,000 for the three years ended December
31, 1993, 1994, 1995 and for the three months ended March 31, 1995 and 1996,
respectively.
 
12. STOCK OPTION PLAN
 
  The Company has a stock option plan (the Plan) that provides for the
granting of options for up to 435,714 shares of its Class A Common Stock to
key employees of Dal-Tile Corporation and its subsidiaries and affiliates.
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 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:
 
<TABLE>
<CAPTION>
                                                        NUMBER OF TOTAL OPTION
                                                         SHARES      PRICE
                                                        --------- ------------
   <S>                                                  <C>       <C>
   Outstanding at December 31, 1992....................  256,530  $25,653,000
     Granted...........................................   10,000    1,000,000
     Canceled..........................................  (41,357)  (4,135,700)
                                                         -------  -----------
   Outstanding at December 31, 1993....................  225,173   22,517,300
     Granted...........................................   50,000    5,000,000
     Canceled..........................................   (3,000)    (300,000)
                                                         -------  -----------
   Outstanding at December 31, 1994....................  272,173   27,217,300
     Granted...........................................    5,500      550,000
     Canceled..........................................  (43,858)  (4,385,800)
                                                         -------  -----------
   Outstanding at December 31, 1995 (191,751 shares
    exercisable).......................................  233,815   23,381,500
     Granted...........................................  156,055   17,166,050
     Canceled..........................................  (10,350)  (1,035,000)
                                                         -------  -----------
   Outstanding at March 31, 1996 (224,410 shares
    exercisable).......................................  379,520  $39,512,550
                                                         =======  ===========
</TABLE>
 
  The Company has reserved 435,714 shares of Class A Common Stock for options,
56,194 of which are ungranted and are for future issuance under the Plan.
 
                                     F-17
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
 
13. COMMITMENTS AND CONTINGENCIES
 
  Dal-Tile Corporation leases substantially all of its sales service centers
and various warehouse, manufacturing, and transportation equipment under terms
of noncancelable operating leases. The minimum aggregate annual lease payments
subsequent to December 31, 1995, are as follows (in thousands):
 
<TABLE>
     <S>                                                                 <C>
     1996............................................................... $17,213
     1997...............................................................  13,739
     1998...............................................................  10,598
     1999...............................................................   7,918
     2000...............................................................   4,609
     Thereafter.........................................................   5,100
                                                                         -------
                                                                         $59,177
                                                                         =======
</TABLE>
 
  Rental expense amounted to approximately $17,076,000, $14,603,000,
$16,427,000, $3,219,000 and $3,677,000 for the years ended December 31, 1993,
1994 and 1995 and the three months ended March 31, 1995 and 1996,
respectively.
 
  The Company is subject to federal, state, and local 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 judicial and administrative proceedings
relating to environmental matters. The Company, in the past, has disposed of
substances which are now characterized as hazardous, and currently is engaged
in the cleanup of hazardous substances at certain sites. Because remedial
investigations and cleanup activities have not been completed, the Company
does not currently have information sufficient to determine with certainty the
costs of remediation. The Company has provided reserves which management
believes are adequate to cover any potential liabilities the Company may incur
with respect to such remedial investigations and cleanup activities.
 
  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 position.
 
14. GEOGRAPHIC AREA OPERATIONS
 
  The Company currently conducts its business in one industry segment,
engaging in the manufacturing and distribution of wall, floor, and mosaic
tile. The Company operates manufacturing facilities in the U.S. and Mexico and
in 1993, 1994 and 1995 distributed products through wholly-owned sales service
centers in the U.S. and Canada and nonaffiliated distributors in 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.
 
                                     F-18
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
14. GEOGRAPHIC AREA OPERATIONS--(CONTINUED)
 
  Financial information by geographical area is summarized below:
 
<TABLE>
<CAPTION>
                                           YEAR ENDED DECEMBER 31,
                                         -----------------------------  --- ---
                                           1993       1994      1995
                                         ---------  --------  --------
                                               (IN THOUSANDS)
<S>                                      <C>        <C>       <C>       <C> <C>
Consolidated revenue:
 Unaffiliated customers:
  United States......................... $ 389,887  $452,903  $446,323
  Mexico................................    46,529    48,594    23,012
  Other.................................     4,157     4,812     5,477
                                         ---------  --------  --------
   Total consolidated revenues from
    unaffiliated customers..............   440,573   506,309   474,812
 Intercompany revenue:
  United States.........................     1,807     3,041     3,174
  Mexico................................    50,360    55,245    43,109
  Eliminations..........................   (52,167)  (58,286)  (46,283)
                                         ---------  --------  --------
   Total consolidated revenue........... $ 440,573  $506,309  $474,812
                                         =========  ========  ========
Consolidated operating income (loss):
  United States......................... $(131,775) $ 52,507  $ 48,874
  Mexico................................   (91,676)   16,283     6,120
  Eliminations/other....................      (137)     (473)     (469)
                                         ---------  --------  --------
   Total consolidated operating income
    (loss).............................. $(223,588) $ 68,317  $ 54,525
                                         =========  ========  ========
 Consolidated identifiable assets:
  United States......................... $ 408,178  $412,292  $618,328
  Mexico................................    99,900    65,955    38,585
  Eliminations/other....................     4,752    10,170    15,480
                                         ---------  --------  --------
   Total consolidated identifiable
    assets.............................. $ 512,830  $488,417  $672,393
                                         =========  ========  ========
</TABLE>
 
15. 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.
 
                                     F-19
<PAGE>
 
                          DAL-TILE INTERNATIONAL INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 (INFORMATION PERTAINING TO THE THREE MONTHS ENDED MARCH 31, 1995 AND 1996 IS
                                  UNAUDITED)
 
16. CONDENSED UNCONSOLIDATED FINANCIAL STATEMENTS
 
  Provided below are the condensed unconsolidated financial statements of the
Company.
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED
                                                          DECEMBER 31,
                                                       -------------------
                                                         1994       1995
                                                       ---------  --------
                                                         (IN THOUSANDS)
   <S>                                                 <C>        <C>      <C>
   Condensed balance sheets:
     Cash............................................. $   3,483  $ 30,371
     Finance costs and other assets...................     2,883     3,027
     Investment in the Group, net of accumulated
      losses..........................................       --     79,343
                                                       ---------  --------
                                                       $   6,366  $112,741
                                                       =========  ========
     Senior Secured Zero Coupon Notes................. $  88,179  $ 99,078
     Other liabilities................................     4,480     4,024
     Accumulated losses, net of investment in the
      Group...........................................    17,530       --
     Stockholder's equity.............................  (103,823)    9,639
                                                       ---------  --------
                                                       $   6,366  $112,741
                                                       =========  ========
</TABLE>
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31
                                                   ---------------------------
                                                     1993      1994     1995
                                                   ---------  -------  -------
                                                        (IN THOUSANDS)
   <S>                                             <C>        <C>      <C>
   Condensed statements of income (loss):
     Equity in net income (loss) of the Group....  $(263,843) $17,855  $14,125
     Other expense...............................        196      566      450
     Interest income.............................        125       98      142
     Interest expense............................      3,766   10,482   11,677
                                                   ---------  -------  -------
     Net income (loss)...........................  $(267,680) $ 6,905  $ 2,140
                                                   =========  =======  =======
   Condensed statements of cash flows:
     Cash flow provided by operating activities..  $   4,185  $  (327) $  (687)
     Investing activities:
       Investment in the Group...................    (72,006)     --       --
     Financing activities:
       Proceeds from sale of stock...............        --       500   27,575
       Proceeds from issuance of Senior Secured
        Zero Coupon Notes........................     71,131      --       --
                                                   ---------  -------  -------
     Net increase in cash........................      3,310      173   26,888
     Cash at beginning of period.................        --     3,310    3,483
                                                   ---------  -------  -------
     Cash at end of period.......................  $   3,310  $ 3,483  $30,371
                                                   =========  =======  =======
</TABLE>
 
17. REFINANCING (UNAUDITED)
 
  The Company has filed a Registration Statement on Form S-1 with the
Securities and Exchange Commission for initial public offerings of equity
securities and contemplates entering into a new bank credit agreement, both of
which are designed to repay substantially all the Company's debt.
 
                                     F-20
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT
 
The Board of Directors
Armstrong World Industries, Inc.:
 
  We have audited the accompanying consolidated balance sheets of Ceramic Tile
Operations of Armstrong World Industries, Inc. and subsidiaries as of December
31, 1994 and December 29, 1995, and the related consolidated statements of
operations and cash flows for both of the years in the two-year period ended
December 31, 1994 and for the period ended December 29, 1995. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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 financial position of Ceramic
Tile Operations of Armstrong World Industries, Inc. and subsidiaries as of
December 31, 1994, and December 29, 1995, and the results of their operations
and their cash flows for both of the years in the two-year period ended
December 31, 1994 and for the period ended December 29, 1995, in conformity
with generally accepted accounting principles.
 
KPMG Peat Marwick LLP
February 2, 1996
Philadelphia, Pennsylvania
 
                                     F-21
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
                                 BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                          AS OF DECEMBER 31, AS OF DECEMBER 29,
                                                 1994               1995
                                          ------------------ ------------------
                                                     (IN THOUSANDS)
<S>                                       <C>                <C>
                 ASSETS
Current assets:
 Accounts receivable (less allowance for
  discounts and losses:
  1994--$3,375: 1995--$4,010)............      $ 30,087           $ 30,696
 Inventories.............................        64,442             72,411
 Income tax benefits.....................        18,981             22,660
 Other current assets....................         2,284              1,805
                                               --------           --------
    Total current assets.................       115,794            127,572
 Property, plant and equipment (less
  accumulated depreciation: 1994--
  $63,882: 1995--$71,541)................       159,920            151,580
 Investment in Recubrimientos
  Interceramic, S.A. de C.V. ............        14,279             12,268
 Other noncurrent assets.................        21,612             19,783
                                               --------           --------
    Total assets.........................      $311,605           $311,203
                                               ========           ========
         LIABILITIES AND EQUITY
Current liabilities:
 Current installments of long-term debt..      $    151           $    --
 Current amounts due to affiliates.......         3,697              7,611
 Accounts payable and accrued expenses...        18,814             18,360
                                               --------           --------
    Total current liabilities............        22,662             25,971
Long-term debt...........................         1,000              1,000
Deferred income taxes....................        19,797             23,195
Long-term advances due to affiliates.....        47,149             71,206
Other long-term liabilities..............         5,153              5,317
                                               --------           --------
    Total noncurrent liabilities.........        73,099            100,718
Equity:
 Common stocks...........................           329                101
 Capital in excess of par values.........       333,377            303,604
 Accumulated deficit.....................      (118,044)          (119,053)
 Foreign currency translation............           182               (138)
                                               --------           --------
    Total equity.........................       215,844            184,514
                                               --------           --------
      Total liabilities and equity.......      $311,605           $311,203
                                               ========           ========
</TABLE>
 
      The accompanying footnotes are an integral part of these statements.
 
                                      F-22
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
                            STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                           YEARS ENDED DECEMBER 31,    PERIOD ENDED DECEMBER 29,
                           --------------------------  -------------------------
                               1993          1994                1995
                           ------------  ------------  -------------------------
                                             (IN THOUSANDS)
<S>                        <C>           <C>           <C>
Net sales................  $    210,668  $    220,250          $240,049
Cost of goods sold.......       168,887       159,427           171,377
                           ------------  ------------          --------
Gross profit.............        41,781        60,823            68,672
  Selling, general, and
   administrative ex-
   penses................        67,134        59,705            61,615
  (Income)/loss from
   Recubrimientos
   Interceramic, S.A. de
   C.V. .................          (369)          783             1,630
  Restructuring
   charge/(credit).......        19,279          (350)             (733)
                           ------------  ------------          --------
Operating income/(loss)..       (44,263)          685             6,160
Interest income..........           (13)         (219)           (1,292)
Interest expense.........         2,231         4,268             7,951
                           ------------  ------------          --------
Loss before income tax
 (benefit) ..............       (46,481)       (3,364)             (499)
Income tax (benefit).....       (16,227)         (799)              509
                           ------------  ------------          --------
    Net loss.............  $    (30,254) $     (2,565)         $ (1,008)
                           ============  ============          ========
</TABLE>
 
 
 
      The accompanying footnotes are an integral part of these statements.
 
                                      F-23
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
                            STATEMENTS OF CASH FLOWS
 
 
<TABLE>
<CAPTION>
                                                                    PERIOD
                                                                     ENDED
                                                 YEARS ENDED       DECEMBER
                                                 DECEMBER 31,         29,
                                               -----------------  ---------
                                                 1993     1994     1995
                                               --------  -------  -------
                                                    (IN THOUSANDS)
<S>                                            <C>       <C>      <C>      
Cash flows from operating activities:
 Net loss..................................... $(30,254) $(2,565) $(1,008)
 Adjustments to net loss:
  Depreciation and amortization...............   14,945   14,074   13,816
  Deferred income taxes.......................   (8,832)   9,848    3,398
  Restructuring charge/(credit)...............   19,279     (350)    (733)
  Restructuring payments......................   (5,491)  (2,464)  (1,523)
  Loss on sales of assets.....................    1,432      224      229
 Changes in operating assets and liabilities,
  net of restructuring:
  (Increase)/decrease in receivables..........   (1,186)   1,509     (609)
  (Increase)/decrease in inventories..........    5,126   (8,605)  (7,969)
  (Increase)/decrease in income tax benefits..    7,572    5,574   (3,679)
  (Increase)/decrease in other current as-
   sets.......................................     (403)  (1,356)     479
  (Increase)/decrease in investment in
   Recubrimientos Interceramic,
   S.A. de C.V. ..............................     (369)     491    1,411
  (Increase)/decrease in other noncurrent as-
   sets.......................................   (4,899)    (800)     270
  Increase/(decrease) in accounts payable and
   accrued expenses...........................    6,179   (5,898)   1,069
  Increase in other long-term liabilities.....    1,913    1,223      164
  Other, net..................................   (1,272)   1,049     (421)
                                               --------  -------  -------
Net cash provided by operating activities.....    3,740   11,954    4,893
Cash flows from investing activities:
 Purchases of property, plant and equipment...  (19,734) (20,393)  (9,572)
 Proceeds from sales of assets................      670       55    6,859
                                               --------  -------  -------
Net cash used for investing activities........  (19,064) (20,338)  (2,713)
Cash flows from financing activities:
 Increase/(decrease) in current installments
  of long-term debt...........................       --       58     (151)
 Increase/(decrease) in current amounts due to
  affiliates..................................   (3,942)   5,332    3,914
 Reduction of long-term debt..................      (93)    (178)      --
 Dividends paid                                      --       --  (30,000)
 Increase in long-term amounts due to aff-
  iliates.....................................   19,359    3,172   24,057
                                               --------  -------  -------
Net cash provided by/(used for) financing ac-
 tivities.....................................   15,324    8,384   (2,180)
                                               --------  -------  -------
Net change in cash............................      --       --       --
                                               ========  =======  =======
</TABLE>
 
 
 
      The accompanying footnotes are an integral part of these statements.
 
                                      F-24
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                     1995
                            (AMOUNTS IN THOUSANDS)

  Ceramic Tile Operations of Armstrong World Industries, Inc. (CTO, or the
Company) manufactures and markets commercial and residential ceramic tile for
sale to contractors, distributors, and home improvement centers in the United
States and Canada.
 
  On December 29, 1995, Armstrong World Industries, Inc. (AWI) completed the
combination of CTO with Dal-Tile International, Inc. In exchange for a 37%
ownership in the new combination, AWI donated substantially all of its equity
in CTO and contributed $27,575 in cash. AWI retained certain assets and
liabilities primarily related to employee benefits. AWI recorded a loss of
$116,800 from the formation of this combination. These transactions are not
reflected in these statements.
 
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
CONSOLIDATION
 
  The accompanying consolidated financial statements include:
 
    a. the accounts of American Olean Tile Company, Inc. (AOT), a wholly
  owned subsidiary of AWI, through December 29, 1995. AOT manufactures and
  markets commercial and residential ceramic tile for sale to contractors,
  distributors, and AWI.
 
    b. allocations and specifically identifiable transactions and balances of
  AWI, the parent company. AWI manufactures and markets a variety of indoor
  furnishings. AWI also markets and distributes ceramic tile to home
  improvement centers.
 
    c. specifically identifiable transactions and balances of Armstrong World
  Industries Canada Ltd. (AWICL), an affiliated foreign subsidiary. The
  Newfoundland division of AWICL mines pyrophyllite, a mineral used in the
  manufacture of ceramic tile, for exclusive sale to AOT.
 
    d. specifically identifiable transactions and balances of Armstrong Cork
  Finance Corporation (ACFC), an affiliated domestic subsidiary. Assets in
  ACFC consist of its 49.99% investment in the equity of Recubrimientos
  Interceramic, S. A. de C. V. (RISA), Chihuahua, Mexico, and related
  goodwill and intangible assets. RISA produces residential ceramic tiles for
  sale to AOT and other unaffiliated customers.
 
  All significant intra-operations transactions have been eliminated from the
consolidated statements.
 
  These statements are prepared in accordance with generally accepted
accounting principles and include management estimates and judgments, where
appropriate. Actual results may differ from these estimates.
 
ALLOCATIONS FROM AWI AND AFFILIATED SUBSIDIARIES
 
  The method of allocating expenses to CTO from the accounts of AWI involved
the use of proportional cost allocation based on AWI departmental effort
analysis and actual participation in benefit programs by AOT employees.
Allocations of expenses to CTO from affiliated subsidiaries were based upon
transactions specifically identified within the accounting records of these
subsidiaries. Management asserts that the methodology used was reasonable.
 
CASH AND EQUIVALENTS
 
  Cash positions are not reflected on the balance sheets of CTO, since these
accounts were in overdraft positions that have been classified as current
liabilities.
 
ACCOUNTS RECEIVABLE
 
  Accounts receivable include trade receivables which are recorded in gross
billed amounts as of the date of shipment. Provisions have been made for
estimated applicable discounts and losses.
 
 
                                     F-25
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                     1995
                            (AMOUNTS IN THOUSANDS)

NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
 
INVENTORIES
 
  In excess of 90% of the December 31, 1994 and December 29, 1995 inventories
were valued using the FIFO method, with the remaining inventories valued at
the lower of average cost or market.
 
CURRENT AMOUNTS DUE TO/FROM AFFILIATES
 
  Current amounts due to/from affiliates represent the net amounts payable or
receivable from affiliated companies.
 
INCOME TAXES
 
  Current and deferred income taxes payable, deferred tax assets, and tax
expense of CTO are the amounts originally recorded on the accounting records
of AOT plus the tax effects calculated at statutory rates for allocated
amounts from the accounts of AWI and affiliated subsidiaries. The tax benefits
are primarily the result of AWI's allocation to AOT of AOT's proportional
share of AWI's consolidated tax benefit or liability. On the accounts of AWI
and affiliated subsidiaries, amounts payable or receivable at December 31,
1994 and December 29, 1995 represent the accumulation of tax expense or
benefit associated with allocated amounts from all prior years. The Company
follows Statement of Financial Accounting Standards Number 109, Accounting for
Income Taxes, under which deferred tax assets and liabilities are recognized
using enacted tax rates for the expected future tax consequences of events
that have been recognized in the financial statements or tax returns.
 
PROPERTY, PLANT AND EQUIPMENT
 
  Property, plant and equipment values are stated at acquisition cost with
accumulated depreciation and amortization deducted to arrive at net book
value. Depreciation charges for financial reporting are determined on the
straight-line method over estimated useful lives. The principal lives used in
determining depreciation rates of various assets are buildings, 20-45 years,
and machinery and equipment, 4-20 years.
 
OTHER NONCURRENT ASSETS
 
  Noncurrent assets are carried at cost or less. Goodwill and other nontax-
deductible intangible assets are stated on the basis of cost and are amortized
over a forty-year period. The Company assesses the recoverability of these
intangible assets by determining whether the goodwill balance over its
remaining life can be recovered through projected undiscounted future cash
flows. Other intangible assets primarily include tax-deductible acquired
intangibles and computer software. Tax-deductible intangibles are stated on
the basis of cost and are being amortized over periods ranging from four to
forty years. On an ongoing basis, management reviews the valuation and
amortization of tax-deductible intangible assets. Computer software is
amortized over periods ranging from three to five years.
 
ENVIRONMENTAL COSTS
 
  Recurring costs associated with emission abatement and the management and
disposal of waste materials in ongoing operations are expensed on a current
basis. Costs are also accrued when associated with the required environmental
remediation when it becomes probable that a liability has been incurred and
its proportionate share
 
                                     F-26
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                     1995
                            (AMOUNTS IN THOUSANDS)

NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
 
of the amount can be reasonably estimated. CTO environmental reserves were
$1,333 at December 31, 1994 and $346 at December 29, 1995.
 
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
 
  Accounts payable represents amounts billed to AOT by trade suppliers.
Accrued expenses primarily include employment costs, restructuring accruals,
and other accrued expenses such as current insurance costs, interest payable
to unaffiliated companies, and sundry payables.
 
NOTE 2--ADVERTISING
 
  Advertising costs were $6,927 in 1993, $6,169 in 1994 and $5,286 in 1995.
 
NOTE 3--INCOME TAXES
 
<TABLE>
<CAPTION>
DETAILS OF TAXES                                      1993     1994     1995
- ----------------                                    --------  -------  -------
<S>                                                 <C>       <C>      <C>
Earnings (loss) before income taxes (benefit):
 Domestic.......................................... $(46,766) $(2,573) $ 1,147
 Foreign...........................................      128     (713)  (1,646)
 Eliminations......................................      157      (78)     --
                                                    --------  -------  -------
    Total.......................................... $(46,481) $(3,364) $  (499)
                                                    ========  =======  =======
Income taxes benefit:
 Payable:
  Federal.......................................... $(16,815) $(5,407) $(3,830)
  Foreign..........................................      (82)      25       (6)
                                                    --------  -------  -------
                                                     (16,897)  (5,382)  (3,836)
 Deferred:
  Federal..........................................      670    4,583    4,345
                                                    --------  -------  -------
    Total income taxes (benefit)................... $(16,227) $  (799) $   509
                                                    ========  =======  =======
<CAPTION>
RECONCILIATION TO U.S. STATUTORY TAX RATE             1993     1994     1995
- -----------------------------------------           --------  -------  -------
<S>                                                 <C>       <C>      <C>
Tax (benefit) at statutory rate.................... $(16,268) $(1,177) $  (175)
(Benefit) loss on foreign-source income............     (285)     279      571
Meals and entertainment............................       50      110      113
Other items........................................      276      (11)      --
                                                    --------  -------  -------
Tax expense (benefit) at effective rates........... $(16,227) $  (799) $   509
                                                    ========  =======  =======
</TABLE>
 
 
                                     F-27
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                     1995
                            (AMOUNTS IN THOUSANDS)

NOTE 3--INCOME TAXES--(CONTINUED)
 
  Income tax benefits were $18,891 in 1994 and $22,660 in 1995. Of these
amounts, deferred tax benefits were $7,756 in 1994 and $ 6,810 in 1995. The
tax effects of principal temporary differences between the carrying amounts of
assets and liabilities and their tax bases are summarized in the following
table:
 
<TABLE>
<CAPTION>
                                                              1994      1995
                                                            --------  --------
<S>                                                         <C>       <C>
Restructuring benefits..................................... $(12,978) $ (7,203)
Inventory valuation........................................     (969)   (1,343)
Bad debt/billing adjustments...............................     (975)   (1,175)
Fixed asset writedown......................................     (700)     (239)
Employment costs*..........................................     (908)   (2,080)
Other*.....................................................     (410)     (349)
                                                            --------  --------
    Net deferred assets.................................... $(16,940) $(12,389)
                                                            ========  ========
Accumulated depreciation................................... $ 23,283  $ 24,581
Trademarks.................................................    3,992     3,241
Goodwill...................................................    1,102       --
Other......................................................      604       952
                                                            --------  --------
    Total deferred income tax liabilities.................. $ 28,981  $ 28,774
                                                            --------  --------
    Net deferred income tax liabilities.................... $ 12,041  $ 16,385
                                                            --------  --------
Less net income tax (benefits)--current deferred...........   (7,756)   (6,810)
                                                            --------  --------
    Deferred income taxes--long-term....................... $ 19,797  $ 23,195
                                                            ========  ========
</TABLE>
- --------
*Certain items in 1994 have been reclassified compared to previously published
reports.
 
NOTE 4--INVENTORIES
 
<TABLE>
<CAPTION>
                                                                1994     1995
                                                              -------- --------
<S>                                                           <C>      <C>
Finished goods............................................... $ 52,339 $ 65,184
Goods in process.............................................    2,564    2,353
Raw materials and supplies...................................    9,539    4,874
                                                              -------- --------
  Total...................................................... $ 64,442 $ 72,411
                                                              ======== ========
 
NOTE 5--PROPERTY, PLANT, AND EQUIPMENT
 
<CAPTION>
                                                                1994     1995
                                                              -------- --------
<S>                                                           <C>      <C>
Land......................................................... $  8,740 $  6,509
Buildings....................................................   62,121   56,614
Machinery and equipment......................................  142,840  153,203
Construction in progress.....................................   10,101    6,795
                                                               223,802  223,121
Less accumulated depreciation................................   63,882   71,541
                                                              -------- --------
  Net........................................................ $159,920 $151,580
                                                              ======== ========
</TABLE>
 
                                     F-28
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                     1995
                            (AMOUNTS IN THOUSANDS)
 
NOTE 5--PROPERTY, PLANT, AND EQUIPMENT--(CONTINUED)
 
  The $681 increase in gross book value to $223,121 at the end of 1995
included $9,572 for capital additions and a $10,253 reduction from sales and
the retirement of fully depreciated assets. Depreciation expense amounted to
$12,081, $11,922, and $12,038 in the years ended December 31, 1993 and 1994,
and the period ended December 29, 1995, respectively.
 
NOTE 6--INVESTMENT IN RECUBRIMIENTOS INTERCERAMIC S.A. DE C.V.
 
  The investment in RISA is recorded by ACFC under the equity method of
accounting for investments in unconsolidated affiliates. The investment also
includes goodwill (amortized over forty years) and capitalized start-up costs
(amortized over five years) related to the purchase of CTO's interest in RISA.
Details of the investment in RISA are as follows:
 
<TABLE>
<CAPTION>
                                                                1994     1995
                                                               -------  -------
<S>                                                            <C>      <C>
Balance at beginning of year.................................  $14,770  $14,279
Loss after tax...............................................     (519)  (1,411)
Amortization of goodwill and other intangibles...............     (264)    (219)
Foreign currency revaluation.................................      292     (381)
                                                               -------  -------
  Balance at end of year.....................................  $14,279  $12,268
                                                               =======  =======
 
NOTE 7--OTHER NONCURRENT ASSETS
 
<CAPTION>
                                                                1994     1995
                                                               -------  -------
<S>                                                            <C>      <C>
Goodwill and other nontax-deductible intangible assets (net
 of accumulated amortization of 1994--$2,193; 1995--$2,552)..  $12,426  $12,219
Tax-deductible intangible assets (excluding computer
 software) (net of accumulated amortization of 1994--$2,104;
 1995--$3,026)...............................................    6,010    5,088
Computer software (net of accumulated amortization of 1994--
 $1,267; 1995--$2,151).......................................    2,440    1,657
Other........................................................      736      819
                                                               -------  -------
  Total......................................................  $21,612  $19,783
                                                               =======  =======
</TABLE>
 
  Amortization of goodwill and other nontax-deductible intangibles charged
against earnings before income tax amounted to $359, $356, and $356 for the
years ended December 31, 1993 and 1994, and the period ended December 29,
1995, respectively. Amortization of tax-deductible intangibles charged against
earnings before income tax amounted to $1,714, $922, and $922 for the years
ended December 31, 1993 and 1994, and the period ended December 29, 1995,
respectively. Amortization of computer software charged against earnings
before income taxes (benefit) amounted to $527, $617, and $281 for the years
ended December 31, 1993 and 1994, and the period ended December 29, 1995,
respectively. Other noncurrent assets are allocations from the accounts of AWI
related to participation by AOT managers in deferred compensation and benefit
security plans.
 
                                     F-29
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                      1995
                             (AMOUNTS IN THOUSANDS)
 
NOTE 8--ACCOUNTS PAYABLE AND ACCRUED EXPENSES
 
<TABLE>
<CAPTION>
                                                                  1994    1995
                                                                 ------- -------
<S>                                                              <C>     <C>
Bank overdrafts................................................. $ 1,877 $ 1,842
Accounts payable................................................   4,137   4,928
Employment costs................................................   4,248   4,945
Restructuring costs.............................................   1,593     440
Other accrued expenses..........................................   6,959   6,205
                                                                 ------- -------
    Total....................................................... $18,814 $18,360
                                                                 ======= =======
</TABLE>
 
NOTE 9--RESTRUCTURING CHARGE/(CREDIT)
 
  Restructuring charge (credit) for CTO amounted to $19,279 in 1993, ($350) in
1994, and ($733) in 1995. The 1993 charges were primarily the result of write-
downs of the value of land, buildings, and equipment, as well as accruals made
for severance and special retirement incentives associated with the elimination
of employee positions.
 
<TABLE>
<CAPTION>
RESTRUCTURING CHARGE/(CREDIT)                              1993   1994   1995
- -----------------------------                             ------- -----  -----
<S>                                                       <C>     <C>    <C>
Property, plant, and equipment........................... $11,274   --   $(733)
Tax-deductible intangibles...............................   1,805   --     --
Early retirement incentives..............................   5,368  (350)   --
Severance pay............................................     832   --     --
                                                          ------- -----  -----
    Total charge/(credit) before tax..................... $19,279 $(350) $(733)
                                                          ======= =====  =====
</TABLE>
 
<TABLE>
<CAPTION>
RESTRUCTURING RESERVES                                         1994     1995
- ----------------------                                        -------  -------
<S>                                                           <C>      <C>
Balance at beginning of year:
  Restructuring costs........................................ $ 5,222  $ 1,593
  Reductions to inventories, property, plant and equipment,
   goodwill, and
   tax-deductible intangibles................................  24,617   14,665
                                                              -------  -------
    Total....................................................  29,839   16,258
                                                              =======  =======
Charges/(credit).............................................    (350)    (733)
Severance payments...........................................  (2,464)    (325)
Plant shutdown payments......................................     --    (1,198)
Retirement of assets......................................... (10,767) (11,440)
Balance at end of year:
  Restructuring costs........................................   1,593      440
  Reductions to inventories, property, plant and equipment,
   goodwill, and tax-deductible intangibles..................  14,665    2,122
                                                              -------  -------
    Total.................................................... $16,258  $ 2,562
                                                              =======  =======
</TABLE>
 
                                      F-30
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                     1995
                            (AMOUNTS IN THOUSANDS)
 
NOTE 10--PENSION COSTS
 
  AOT has a defined-benefit pension plan covering all production and
maintenance employees at each of its six plant locations. Benefits paid from
the plan are based on the employee's compensation and years of service.
Generally, the Company's practice is to fund the actuarially determined
current service costs and the amounts necessary to amortize prior service
obligations over periods ranging up to 30 years, but not in excess of the full
funding limitation. Funding requirements are determined independently of
expense, using an expected long-term rate of return on assets of 8.67%. The
plan is subject to the full funding limitation in 1993, 1994 and 1995. AOT
made contributions of $658 in 1993. Effective March 31, 1994, the plan was
merged into the Retirement Income Plan of AWI and the plan's pension assets
and related obligations are included with those of the AWI retirement plan at
December 31, 1994 and December 29, 1995. Consequently, no contributions were
made in 1994 and 1995.
 
<TABLE>
<CAPTION>
NET COST FOR PENSION PLAN                            1993      1994     1995
- -------------------------                          --------  --------  -------
<S>                                                <C>       <C>       <C>
Actual (return) loss on plan assets............... $ (3,221) $  2,609  $(9,837)
Less amount deferred..............................      801    (5,097)   7,319
                                                   --------  --------  -------
Expected return on plan assets....................   (2,420)   (2,488)  (2,518)
Net amortization and other........................      305      (318)    (223)
Service cost--benefits earned during the year.....      900     1,030      801
Interest cost on the projected benefit obliga-
 tion.............................................    2,555     2,702    2,617
                                                   --------  --------  -------
  Net pension cost................................ $  1,340  $    926  $   677
                                                   ========  ========  =======
</TABLE>
 
<TABLE>
<CAPTION>
FUNDED STATUS OF PENSION PLAN                                1994*      1995
- -----------------------------                               --------  --------
<S>                                                         <C>       <C>
Actuarial present value of benefit obligations:
  Vested benefit obligation................................ $(31,455) $(32,184)
  Accumulated benefit obligation........................... $(33,498) $(34,273)
  Projected benefit obligation for services rendered to
   date.................................................... $(33,858) $(34,641)
Plan assets at fair value.................................. $ 29,929  $ 30,147
                                                            --------  --------
Projected benefit obligation in excess of plan assets...... $ (3,929) $ (4,494)
Unrecognized prior service cost............................    4,549     4,244
Unrecognized net loss--experience differed from assump-
 tions.....................................................   (2,587)   (2,394)
                                                            --------  --------
  Accrued pension cost..................................... $ (1,967) $ (2,644)
                                                            ========  ========
</TABLE>
- --------
* The 1994 funded status data have been adjusted to accurately reflect the
merger of the American Olean plan with the Armstrong plan.
 
  Rates used to determine the actuarial present value of the pension benefit
obligations at the end of 1994 and 1995 were:
 
  a. the discount rate or the assumed rate at which the pension benefits
     could be effectively settled of 8.00% in 1994 and 7.00% in 1995, and
 
  b. the compensation rate or the long-term rate at which compensation is
     expected to increase as a result of inflation, promotions, seniority,
     and other factors of 4.75% for 1994 and 1995.
 
  The expected long-term rate of return on assets was 8.50% for 1994 and 8.75%
for 1995.
 
  The plan assets at December 29, 1995 are based on measurements from October
31, 1995 to December 29, 1995. Stated at fair value, they are primarily listed
stocks, bonds, and investments with a major insurance company.
 
                                     F-31
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                      1995
                             (AMOUNTS IN THOUSANDS)
 
NOTE 11--DEBT
 
<TABLE>
<CAPTION>
                                                                   1994   1995
                                                                  ------ ------
<S>                                                               <C>    <C>
Long-term debt:
  7% Industrial development bond due 2004........................ $1,000 $1,000
  17.3% Capitalized truck fleet lease due 1995...................    151    --
                                                                  ------ ------
    Total long-term debt.........................................  1,151  1,000
  Less current installments......................................    151    --
                                                                  ------ ------
    Net long-term debt........................................... $1,000 $1,000
                                                                  ====== ======
</TABLE>
 
NOTE 12--SCHEDULE OF EQUITY
 
<TABLE>
<CAPTION>
                                                1993       1994       1995
                                              ---------  ---------  ---------
<S>                                           <C>        <C>        <C>
COMMON STOCKS
American Olean Tile Company, Inc.
 $100 par value, authorized and issued 2,285
 shares...................................... $     229  $     229  $     229
Armstrong World Industries Canada, Ltd.
 (Newfoundland)..............................       100        100        100
                                              ---------  ---------  ---------
    Balance at beginning of year............. $     329  $     329  $     329
                                              =========  =========  =========
Decrease due to reincorporation of American
 Olean Tile Company, Inc.*...................                            (228)
                                              ---------  ---------  ---------
American Olean Tile Company, Inc.
 $1 per value, authorized and issued 1,000
 shares......................................                       $       1
 $100 par value, authorized and issued 2,285
  shares..................................... $     229  $     229
Armstrong World Industries Canada, Ltd.
 (Newfoundland)..............................       100        100        100
                                              ---------  ---------  ---------
    Balance at end of year................... $     329  $     329  $     101
                                              =========  =========  =========
CAPITAL IN EXCESS OF PAR VALUES
Balance at beginning of year................. $ 333,377  $ 333,377  $ 333,377
Increase due to reincorporation*.............                             227
Less dividend (see note 15)..................                         (30,000)
                                              ---------  ---------  ---------
    Balance at end of year................... $ 333,377  $ 333,377  $ 303,604
                                              =========  =========  =========
ACCUMULATED DEFICIT
Balance at beginning of year.................  ($85,224) ($115,479) ($118,044)
Net loss.....................................   (30,254)    (2,565)    (1,008)
                                              ---------  ---------  ---------
    Balance at end of year................... ($115,479) ($118,044) ($119,053)
                                              =========  =========  =========
FOREIGN CURRENCY TRANSLATION
Balance at beginning of year................. $     579  $     418  $     182
Translation adjustments:
 Armstrong World Industries, Canada, Ltd.
  (Newfoundland).............................      (161)      (528)        61
 Recubrimientos Interceramic, S. A. de
  C.V. ......................................       --         292       (381)
                                              ---------  ---------  ---------
    Balance at end of year................... $     418  $     182  $    (138)
                                              ---------  ---------  ---------
    Total equity............................. $ 218,645  $ 215,844  $ 184,514
                                              =========  =========  =========
</TABLE>
- --------
* In January 1995, AOT, previously incorporated in New York, was reincorporated
in Pennsylvania.
 
                                      F-32
<PAGE>
 
          CERAMIC TILE OPERATIONS OF ARMSTRONG WORLD INDUSTRIES, INC.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND THE PERIOD ENDED DECEMBER 29,
                                     1995
                            (AMOUNTS IN THOUSANDS)
 
NOTE 13--LEASED PROPERTY UNDER OPERATING LEASES
 
  Rental expenses were $4,527, $4,440, and $4,620 for 1993 and 1994 and the
period ended December 29, 1995, respectively, for all operating leases except
those with terms of a month or less that were not renewed. Operating leases
principally involve the rental of facilities for sales service centers. As of
December 29, 1995 future minimum rental payments under operating leases that
have initial non-cancelable lease terms in excess of one year were:
 
<TABLE>
      <S>                                                                <C>
      1996.............................................................. $ 5,478
      1997..............................................................   4,261
      1998..............................................................   1,894
      1999..............................................................   1,530
      2000..............................................................   1,016
      Later years.......................................................   1,568
                                                                         -------
        Total........................................................... $15,747
                                                                         =======
</TABLE>
 
NOTE 14--CREDIT RISK
 
  Financial instruments which potentially subject the Company to significant
concentrations of credit risk primarily consist of accounts receivable.
Concentrations of credit risk with respect to accounts receivable are limited
due to the large number of entities comprising CTO's customer base and their
dispersion across differential geographical areas. As of December 29, 1995,
CTO had no significant concentrations of credit risk.
 
  Included in the gross accounts receivable is an amount of $620 due from
Color Tile, Inc. on which a reserve of $596 has been established. On January
24, 1996, Color Tile filed for protection under Chapter 11 of the United
States Bankruptcy Code. The Company anticipates recovering none of the January
24 net outstanding amount of $596.
 
NOTE 15--RELATED PARTY TRANSACTIONS
 
  CTO sold ceramic tile products to AWI for resale primarily to home
improvement centers in the United States. In 1993, 1994 and 1995, sales were
$13,522, $20,747 and $28,914, respectively.
 
  CTO incurred interest expense on demand notes from affiliated companies in
the amounts of $2,110, $4,134, and $7,856 in the years 1993, 1994, and 1995,
respectively. CTO also accrued interest income on demand notes to affiliated
companies in the amounts of $214 and $1,285 in the years 1994 and 1995,
respectively. Interest expense on loans from affiliated companies is computed
at prime plus 1%.
 
  In January, 1995, CTO declared and paid a dividend of $30,000 to its parent
corporation, Armstrong Enterprises, Inc. (AEI), a wholly owned subsidiary of
AWI. This dividend was returned to CTO in the form of a demand note payable to
AEI.
 
                                     F-33
<PAGE>
 
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
 
 NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER CONTAINED HEREIN, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER OF ANY
SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, THOSE TO WHICH IT RELATES IN ANY STATE TO ANY
PERSON TO WHOM IT IS NOT LAWFUL TO MAKE SUCH OFFER IN SUCH STATE. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY OR THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO ITS DATE.
 
                                 ------------
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
<S>                                                                         <C>
Prospectus Summary........................................................    3
Risk Factors..............................................................   10
Use of Proceeds...........................................................   15
Refinancing...............................................................   16
Dividend Policy...........................................................   18
Capitalization............................................................   19
Dilution..................................................................   20
Unaudited Pro Forma Consolidated
 Financial Information....................................................   21
Selected Consolidated Financial Data......................................   27
Management's Discussion and Analysis of Financial Condition and Results of
 Operations...............................................................   28
Ceramic Tile Industry.....................................................   38
Business..................................................................   40
Management................................................................   51
Principal Stockholders....................................................   57
Certain Transactions......................................................   58
Description of Capital Stock..............................................   59
Description of Certain Indebtedness.......................................   62
Shares Eligible for Future Sale...........................................   66
Certain U.S. Tax Consequences for Non-U.S. Stockholders...................   68
Underwriting..............................................................   70
Legal Matters.............................................................   72
Experts...................................................................   72
Available Information.....................................................   73
Index to Consolidated Financial Statements................................  F-1
</TABLE>
 
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
 
                                       SHARES
 
                          DAL-TILE INTERNATIONAL INC.
 
                                 COMMON STOCK
 
                                    [LOGO]
 
                                   --------
 
                                  PROSPECTUS
 
                                       , 1996
 
                                   --------
 
                               SMITH BARNEY INC.
                            DILLON, READ & CO. INC.
                             GOLDMAN, SACHS & CO.
                             MORGAN STANLEY & CO.
                                 INCORPORATED
 
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A         +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE   +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY  +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT        +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR   +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE      +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE    +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF  +
+ANY SUCH STATE.                                                               +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

 
                   [INTERNATIONAL PROSPECTUS ALTERNATE PAGE]
 
                   SUBJECT TO COMPLETION, DATED JUNE 3, 1996
PROSPECTUS
 
                                       SHARES                          [LOGO]
                          DAL-TILE INTERNATIONAL INC.
                                  COMMON STOCK
 
                                   --------
 
  All of the shares of Common Stock, $.01 par value per share (the "Common
Stock"), offered hereby are being sold by Dal-Tile International Inc. Of the
   shares of Common Stock offered hereby, a total of    shares are being
offered hereby in an international offering outside the United States and
Canada (the "International Offering") by the Managers (as defined) and a total
of     shares are being offered by the U.S. Underwriters (as defined) in a
concurrent offering in the United States and Canada (the "U.S. Offering" and,
together with the International Offering, the "Offerings").
 
  Prior to the Offerings, there has been no public market for the Common Stock
of the Company. It is currently estimated that the initial public offering
price will be between $    and $    per share. See "Underwriting" for
information relating to the factors considered in determining the initial
public offering price.
 
  Application will be made to have the Common Stock listed on the New York
Stock Exchange under the symbol "    ".
 
                                   --------
 
  SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
 
                                   --------
 
THESE SECURITIES  HAVE NOT BEEN APPROVED  OR DISAPPROVED BY  THE SECURITIES AND
EXCHANGE  COMMISSION OR ANY STATE SECURITIES COMMISSION NOR  HAS THE SECURITIES
 AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
    PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
     PROSPECTUS.  ANY   REPRESENTATION  TO  THE
      CONTRARY IS A CRIMINAL OFFENSE.
 
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                     UNDERWRITING
           PRICE TO DISCOUNTS AND  PROCEEDS TO
            PUBLIC  COMMISSIONS(1) COMPANY(2)
- ----------------------------------------------
<S>        <C>      <C>            <C>
Per Share    $           $             $
- ----------------------------------------------
Total(3)     $           $            $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
 (1) For information regarding indemnification of the Managers and the U.S.
     Underwriters, see "Underwriting".
 
 (2) Before deducting expenses estimated at approximately $    payable by the
     Company.
 
 (3) The Company has granted the U.S. Underwriters a 30-day option to purchase
     up to        additional shares of Common Stock solely to cover over-
     allotments, if any. See "Underwriting". If such option is exercised in
     full, the total Price to Public, Underwriting Discounts and Commissions,
     and Proceeds to Company will be $   , $   , and $   , respectively.
 
                                   --------
 
  The shares of Common Stock are being offered by the several Managers named
herein, subject to prior sale, when, as and if accepted by them and subject to
certain conditions. It is expected that certificates for the shares of Common
Stock offered hereby will be available for delivery on or about         , 1996,
at the offices of Smith Barney Inc., 333 West 34th Street, New York, New York
10001.
 
                                   --------
 
SMITH BARNEY INC.
           DILLON, READ & CO. INC.
                      GOLDMAN SACHS INTERNATIONAL
                                                            MORGAN STANLEY & CO.
                                          INTERNATIONAL
 
 
        , 1996
<PAGE>
 
                   [INTERNATIONAL PROSPECTUS ALTERNATE PAGE]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
 NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER CONTAINED HEREIN, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER OF ANY SECURITIES
OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF
AN OFFER TO BUY, THOSE TO WHICH IT RELATES IN ANY STATE TO ANY PERSON TO WHOM
IT IS NOT LAWFUL TO MAKE SUCH OFFER IN SUCH STATE. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
COMPANY OR THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
ITS DATE.
 
                                  -----------
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
<S>                                                                         <C>
Prospectus Summary........................................................    3
Risk Factors..............................................................   10
Use of Proceeds...........................................................   15
Refinancing...............................................................   16
Dividend Policy...........................................................   18
Capitalization............................................................   19
Dilution..................................................................   20
Unaudited Pro Forma Consolidated
 Financial Information....................................................   21
Selected Consolidated Financial Data......................................   27
Management's Discussion and Analysis of Financial Condition and Results of
 Operations...............................................................   28
Ceramic Tile Industry.....................................................   38
Business..................................................................   40
Management................................................................   51
Principal Stockholders....................................................   57
Certain Transactions......................................................   58
Description of Capital Stock..............................................   59
Description of Certain Indebtedness.......................................   62
Shares Eligible for Future Sale...........................................   66
Certain U.S. Tax Consequences for Non-U.S. Stockholders...................   68
Underwriting..............................................................   70
Legal Matters.............................................................   72
Experts...................................................................   72
Available Information.....................................................   73
Index to Consolidated Financial Statements................................  F-1
</TABLE>
 
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
 
                                       SHARES
 
                          DAL-TILE INTERNATIONAL INC.
 
                                  COMMON STOCK
 
                                     [LOGO]
 
                                    -------
 
                                   PROSPECTUS
 
                                       , 1996
 
                                    -------
 
                               SMITH BARNEY INC.
                            DILLON, READ & CO. INC.
                          GOLDMAN SACHS INTERNATIONAL
                              MORGAN STANLEY & CO.
                                 INTERNATIONAL
 
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
 
                                    PART II
 
                    INFORMATION NOT REQUIRED IN PROSPECTUS
 
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.*
 
  The following table sets forth the estimated expenses to be borne by the
Company, in connection with the issuance and distribution of the securities
being registered hereby, other than underwriting discounts and commissions.
 
<TABLE>
      <S>                                                               <C>
      SEC registration fee............................................. $51,552
      NASD filing fee..................................................  15,450
      Accounting fees and expenses**...................................
      Legal fees and expenses**........................................
      Blue Sky expenses and counsel fees**.............................
      Printing and engraving expenses**................................
      NYSE listing fee**...............................................
      Transfer Agent and Registrar's fees and expenses**...............
      Miscellaneous expenses**.........................................
                                                                        -------
        Total.......................................................... $
                                                                        =======
</TABLE>
     --------
     * Except for the SEC registration fee, the NASD filing fee and
       the NYSE listing fee, all the foregoing expenses have been
       estimated.
     ** To be completed by amendment.
 
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
 
  Article SEVENTH of the Restated Certificate of Incorporation of the Company
provides as follows:
 
  "To the fullest extent permitted by the Delaware General Corporation Law as
the same exists or may hereafter be amended, a Director of the Corporation
shall not be liable to the Corporation or its stockholders for monetary
damages for breach of fiduciary duty as a Director".
 
  Section 145 of the General Corporation Law of the State of Delaware provides
as follows:
 
  Under certain circumstances a corporation may indemnify any person who was
or is a party or is threatened to be made a party to any threatened, pending
or completed action, suit or proceeding, whether civil, criminal,
administrative or investigative, by reason of the fact that he is or was a
director, officer, employee or agent of the corporation or is or was serving
at its request in such capacity in another corporation or business
association, against expenses (including attorney's fees), judgments, fines
and amounts paid in settlement actually and reasonably incurred by him in
connection with such action, suit or proceeding if he acted in good faith and
in a manner he reasonably believed to be in or not opposed to the best
interests of the corporation and, with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful.
 
  In a derivative action, i.e., one by or in the right of the corporation,
indemnification may be made only for expenses actually and reasonably incurred
by a director, officer, employee or agent of the corporation, or a person who
is or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation or business association in connection
with the defense or settlement of an action or suit, if such person has acted
in good faith and in a manner that he or she reasonably believed to be in or
not opposed to the best interests of the corporation, except that no
indemnification shall be made if such person shall have been adjudged to be
liable to the corporation, unless and only to the extent that the court in
which the action or suit was brought shall determine upon application that the
defendant is fairly and reasonably entitled to indemnity for such expenses
despite such adjudication of liability.
 
 
                                     II-1
<PAGE>
 
  The Company has entered into agreements to provide indemnification for its
directors in addition to the indemnification provided for in the Restated
Bylaws of the Company. These agreements, among other things, indemnify the
directors, to the fullest extent provided by Delaware law, for certain
expenses (including attorney's fees), losses, claims, liabilities, judgments,
fines and settlement amounts incurred by such indemnitee in any action or
proceeding, including any action by or in the right of the Company, on account
of services as a director or officer of any affiliate of the Company, or as a
director or officer of any other company or enterprise that the indemnitee
provides services to at the request of the Company.
 
  The form of Underwriting Agreement filed as Exhibit 1.1 provides for the
indemnification of the Company, its controlling persons, its directors and
certain of its officers by the Underwriters against certain liabilities,
including liabilities under the Securities Act.
 
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
 
  The AO Acquisition occurred on December 29, 1995, and, in connection
therewith AWI received 37% of the Company's outstanding capital stock. As part
of the AO Acquisition, AWI paid the Company cash in the amount of $27.6
million.
 
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
 
  (a) EXHIBITS. The following is a list of exhibits filed as part of the
Registration Statement.
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.
 -------
 <C>     <S>
  * 1.1  Form of Underwriting Agreement.
    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.)
  * 3.1  Form of Restated Certificate of Incorporation of the Company.
  * 3.2  Form of Restated Bylaws of the Company.
  * 4.1  Specimen form of certificate for Common Stock.
  * 5.1  Opinion of Fried, Frank, Harris, Shriver & Jacobson, counsel to the
         Company, as to the legality of the securities being offered.
   10.1  Dal-Tile International Inc. 1990 Stock Option Plan, as amended. (Filed
         as Exhibit 10.1 to the Registrant's Registration Statement on Form S-
         1, Number 33-64140 and incorporated herein by reference.)
   10.2  Employment Agreement, dated June 1, 1990, between Ceramica
         Regiomontana, S.A. de C.V. and Howard L. Turk. (Filed as Exhibit
         10.2.1 to the Registrant's Registration Statement on Form S-1, Number
         33-64140 and incorporated herein by reference.)
   10.3  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, Number 33-64140
         and incorporated herein by reference.)
   10.4  Employment Agreement, dated February 5, 1990, between Dal-Tile
         Corporation and Carlos E. Sala. (Filed as Exhibit 10.2.4 to the
         Registrant's Registration Statement on Form S-1, Number 33-64140 and
         incorporated herein by reference.)
   10.5  Employment Agreement, dated April 15, 1994, between Dal-Tile
         Corporation and Howard I. Bull. (Filed as Exhibit 10.2.5 to the
         Registrant's Annual Report on Form 10-K for the year ended December
         31, 1994 and incorporated herein by reference.)
   10.6  Indenture dated as of August 11, 1993, between Dal-Tile International
         Inc. and Citibank, N.A., as trustee relating to the Zero Coupon Notes.
         (Filed as Exhibit 4.1 to the Registrant's Annual Report on Form 10-K
         for the year ended December 31, 1993 and incorporated herein by
         reference.)
</TABLE>
 
                                     II-2
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.
 -------
 <C>     <S>
   10.7  Pledge Agreement dated as of August 11, 1993, between Dal-Tile
         International, Inc. and Citibank, N.A., as Collateral Agent, relating
         to the Zero Coupon Notes. (Filed as Exhibit 4.2 to Dal-Tile
         International, Inc.'s Annual Report on Form 10-K for the year ended
         December 31, 1993 and incorporated herein by reference.)
   10.8  Bank Credit Agreement dated as of January 9, 1990, among Dal-Tile
         Group Inc., the Banks signatory thereto and National Westminster Bank
         USA, as agent. (Filed as Exhibit 10.3.1 to the Registrant's
         Registration Statement on Form S-1, Number 33-64140 and incorporated
         herein by reference.)
   10.9  Amendment to Bank Credit Agreement, dated April 17, 1991, among Dal-
         Tile Group Inc., National Westminster Bank USA, Credit Suisse and
         NationsBank (formerly NCNB Texas National Bank).
         (Filed as Exhibit 10.3.2 to the Registrant's Registration Statement on
         Form S-1, Number 33-64140 and incorporated herein by reference.)
  10.10  Amendment to Bank Credit Agreement, dated March 30, 1994, among Dal-
         Tile Group Inc., National Westminster Bank USA, Credit Suisse and
         NationsBank (formerly NCNB Texas National Bank).
         (Filed as Exhibit 10.3.3 to the Registrant's Annual Report on Form 10-
         K for the year ended December 31, 1993 and incorporated herein by
         reference.)
  10.11  10.625% Series A and 10.770% Series B Senior Note Purchase Agreement
         dated as of January 9, 1990, between Dal-Tile Group Inc. and the
         Purchasers named therein. (Filed as Exhibit 10.3.3 to the Registrant's
         Registration Statement on Form S-1, Number 33-64140 and incorporated
         herein by reference.)
  10.12  Amendment to 10.625% Series A and 10.770% Series B Note Purchase
         Agreement, dated March 24, 1994, between Dal-Tile Group Inc. and the
         Purchasers named therein. (Filed as Exhibit 10.3.5 to the Registrant's
         Annual Report on Form 10-K for the year ended December 31, 1993 and
         incorporated herein by reference.)
  10.13  Form of Indemnification Agreement between the Company and its
         directors. (Filed as Exhibit 10.4 to the Registrant's Registration
         Statement on Form S-1, Number 33-64140 and incorporated herein by
         reference.)
  10.14  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, Number 33-64140 and incorporated herein by
         reference.)
  10.15  Shareholders Agreement, dated December 29, 1995, among Dal-Tile
         International Inc., AEA Investors Inc., Armstrong World Industries,
         Inc., Armstrong Enterprises, Inc. and Armstrong Cork Finance
         Corporation. (Filed as Exhibit 10.6 to the Registrant's Annual Report
         on Form 10-K for the year ended December 31, 1995 and incorporated
         herein by reference.)
   21.1  List of subsidiaries of the Company.
  *23.1  Consent of Fried, Frank, Harris, Shriver & Jacobson (included in
         Exhibit 5.1).
   23.2  Consent of Ernst & Young LLP.
   23.3  Consent of KPMG Peat Marwick LLP.
   24.1  Powers of Attorney (included on pages II-5 and II-6 of the
         Registration Statement).
</TABLE>
- --------
* To be filed by amendment.
 
  (b) FINANCIAL STATEMENT SCHEDULES:
 
    Schedule II -- Valuation and Qualifying Accounts
 
  All other schedules are omitted because they are inapplicable or the
requested information is shown in the financial statements or notes thereto.
 
                                     II-3
<PAGE>
 
ITEM 17. UNDERTAKINGS.
 
  (a) Insofar as indemnification by the Issuer for liabilities arising under
the Act may be permitted to directors, officers and controlling persons of the
Issuer pursuant to the foregoing provisions, or otherwise, the Issuer has been
advised that in the opinion of the Commission such indemnification is against
public policy as expressed in the Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than
the payment by the Issuer of expenses incurred or paid by a director, officer
or controlling person of the Issuers in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Issuer will,
unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question of whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
 
  (b) The undersigned Company hereby undertakes that:
 
    (1) For purposes of determining any liability under the Act, the
  information omitted from the form of Prospectus filed as part of this
  Registration Statement in reliance upon Rule 430A and contained in a form
  of prospectus to be filed by the registration pursuant to Rule 424(b)(1) or
  (4) or 497(h) under the Act shall be deemed to be part of this Registration
  Statement as of the time it was declared effective.
 
    (2) For the purpose of determining any liability under the Act, each
  post-effective amendment that contains a form of prospectus shall be deemed
  to be a new registration statement relating to the securities offered
  therein, and the offering of such securities at that time shall be deemed
  to be the initial bona fide offering thereof.
 
                                     II-4
<PAGE>
 
                                  SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT, THE COMPANY HAS DULY
CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED IN THE CITY OF DALLAS, STATE OF TEXAS
ON THE 3RD DAY OF JUNE, 1996.
 
                                          DAL-TILE INTERNATIONAL INC.
 
                                             /s/ Howard I. Bull
                                          By: _________________________________
                                             HOWARD I. BULL
                                             PRESIDENT AND CHIEF EXECUTIVE
                                             OFFICER
 
  KNOW ALL MEN BY THESE PRESENTS, that each person whose name appears below
constitutes and appoints Howard I. Bull, Barry J. Kulpa and Carlos E. Sala,
and each of them, his true and lawful attorney-in-fact and agent with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments (including
post-effective amendments) to this Registration Statement, as well as any
related registration statement (or amendment thereto) filed pursuant to Rule
462(b) promulgated under the Securities Act of 1933, and to file the same,
with all exhibits thereto and other documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact
and agents, and each of them, 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, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them or his substitute or substitutes, may lawfully do or
cause to be done by virtue hereof.
 
  This Power of Attorney may be executed in multiple counterparts, each of
which shall be deemed an original, but which taken together shall constitute
one instrument.
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS
REGISTRATION STATEMENT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.
 
           SIGNATURE                         TITLE                   DATE
 
  /s/ Charles J. Pilliod, Jr.    Chairman of the Board of        May 30, 1996
- -------------------------------   Directors
    CHARLES J. PILLIOD, JR.
 
      /s/ Howard I. Bull         President and Chief             May 31, 1996
- -------------------------------   Executive Officer and
        HOWARD I. BULL            Director (Principal
                                  Executive Officer)
 
      /s/ Carlos E. Sala         Vice President and Chief        May 31, 1996
- -------------------------------   Financial Officer
        CARLOS E. SALA            (Principal Financial and
                                  Accounting Officer)
 
     /s/ John M. Goldsmith       Vice President and Director     May 30, 1996
- -------------------------------
       JOHN M. GOLDSMITH
 
                                     II-5
<PAGE>
 
           SIGNATURE                         TITLE                   DATE
 
     /s/ Henry F. Skelsey        Vice President and Director     May 31, 1996
- -------------------------------
       HENRY F. SKELSEY
 
- -------------------------------  Director                             , 1996
      E. MANDELL DE WINDT
 
        /s/ Drew Lewis           Director                        May 31, 1996
- -------------------------------
          DREW LEWIS
 
                                 Director                             , 1996
- -------------------------------
        VINCENT A. MAI
 
      /s/ George A. Lorch        Director                        May 31, 1996
- -------------------------------
        GEORGE A. LORCH
 
   /s/ Frank A. Riddick III      Director                        May 30, 1996
- -------------------------------
     FRANK A. RIDDICK III
 
                                 Director                             , 1996
- -------------------------------
    ROBERT J. SHANNON, JR.
 
                                      II-6
<PAGE>
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors
Dal-Tile International Inc.
 
  We have audited the consolidated financial statements of Dal-Tile
International Inc. as of December 31, 1994 and 1995, and for each of the three
years in the period ended December 31, 1995, and have issued our report thereon
dated March 15, 1996 (included elsewhere in this Registration Statement). Our
audits also included the financial statement schedule listed in Item 16(b) of
this Registration Statement. This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits.
 
  In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
 
                                          ERNST & YOUNG LLP
 
Dallas, Texas
March 15, 1996
 
                                      S-1
<PAGE>
 
                                                                     SCHEDULE II
 
                          DAL-TILE INTERNATIONAL INC.
 
                       VALUATION AND QUALIFYING ACCOUNTS
 
                  YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
 
  Allowance for Losses from Uncollectible Accounts:
 
<TABLE>
<CAPTION>
                                                               (c)
                                    ADDITIONS                  DTI         (b)(c)
                         BALANCE AT CHARGED TO            (WITHOUT AO)       AO            DTI
                         BEGINNING  COSTS AND     (a)      BALANCE AT    BALANCE AT    BALANCE AT
                         OF PERIOD   EXPENSES  DEDUCTIONS END OF PERIOD END OF PERIOD END OF PERIOD
                         ---------- ---------- ---------- ------------- ------------- -------------
                                                   (AMOUNT IN THOUSANDS)
<S>                      <C>        <C>        <C>        <C>           <C>           <C>
1993....................   $2,139     $4,955     $4,743      $2,351        $  --         $  --
1994....................    2,351      6,294      4,753       3,892           --            --
1995....................    3,892      5,111      4,374       4,629         4,760         9,389
</TABLE>
 
- --------
(a)Uncollectible accounts written off, net or recoveries.
(b)AO's bad debt allowance.
(c)"DTI" means Dal-Tile International Inc. "AO" means American Olean Tile
Company, Inc.
 
                                      S-2
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                             DESCRIPTION                              PAGE
 -------                           -----------                              ----
 <C>     <S>                                                                <C>
  * 1.1  Form of Underwriting Agreement.
    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.)
  * 3.1  Form of Restated Certificate of Incorporation of the Company.
  * 3.2  Form of Restated Bylaws of the Company.
  * 4.1  Specimen form of certificate for Common Stock.
  * 5.1  Opinion of Fried, Frank, Harris, Shriver & Jacobson, counsel to
         the Company, as to the legality of the securities being
         offered.
   10.1  Dal-Tile International Inc. 1990 Stock Option Plan, as amended.
         (Filed as Exhibit 10.1 to the Registrant's Registration
         Statement on Form S-1, Number 33-64140 and incorporated herein
         by reference.)
   10.2  Employment Agreement, dated June 1, 1990, between Ceramica
         Regiomontana, S.A. de C.V. and Howard L. Turk. (Filed as
         Exhibit 10.2.1 to the Registrant's Registration Statement on
         Form S-1, Number 33-64140 and incorporated herein by reference.)
   10.3  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, Number 33-64140 and incorporated herein by reference.)
   10.4  Employment Agreement, dated February 5, 1990, between Dal-Tile
         Corporation and Carlos E. Sala. (Filed as Exhibit 10.2.4 to the
         Registrant's Registration Statement on Form S-1, Number 33-
         64140 and incorporated herein by reference.)
   10.5  Employment Agreement, dated April 15, 1994, between Dal-Tile
         Corporation and Howard I. Bull. (Filed as Exhibit 10.2.5 to the
         Registrant's Annual Report on Form 10-K for the year ended
         December 31, 1994 and incorporated herein by reference.)
   10.6  Indenture dated as of August 11, 1993, between Dal-Tile
         International Inc. and Citibank, N.A., as trustee relating to
         the Zero Coupon Notes. (Filed as Exhibit 4.1 to the
         Registrant's Annual Report on Form 10-K for the year ended
         December 31, 1993 and incorporated herein by reference.)
   10.7  Pledge Agreement dated as of August 11, 1993, between Dal-Tile
         International, Inc. and Citibank, N.A., as Collateral Agent,
         relating to the Zero Coupon Notes. (Filed as Exhibit 4.2 to
         Dal-Tile International, Inc.'s Annual Report on Form 10-K for
         the year ended December 31, 1993 and incorporated herein by
         reference.)
   10.8  Bank Credit Agreement dated as of January 9, 1990, among Dal-
         Tile Group Inc., the Banks signatory thereto and National
         Westminster Bank USA, as agent. (Filed as Exhibit 10.3.1 to the
         Registrant's Registration Statement on Form S-1, Number 33-
         64140 and incorporated herein by reference.)
   10.9  Amendment to Bank Credit Agreement, dated April 17, 1991, among
         Dal-Tile Group Inc., National Westminster Bank USA, Credit
         Suisse and NationsBank (formerly NCNB Texas National Bank).
         (Filed as Exhibit 10.3.2 to the Registrant's Registration
         Statement on Form S-1, Number 33-64140 and incorporated herein
         by reference.)
  10.10  Amendment to Bank Credit Agreement, dated March 30, 1994, among
         Dal-Tile Group Inc., National Westminster Bank USA, Credit
         Suisse and NationsBank (formerly NCNB Texas National Bank).
         (Filed as Exhibit 10.3.3 to the Registrant's Annual Report on
         Form 10-K for the year ended December 31, 1993 and incorporated
         herein by reference.)
</TABLE>
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                             DESCRIPTION                             PAGE
 -------                           -----------                             ----
 <C>     <S>                                                               <C>
  10.11  10.625% Series A and 10.770% Series B Senior Note Purchase
         Agreement dated as of January 9, 1990, between Dal-Tile Group
         Inc. and the Purchasers named therein. (Filed as Exhibit 10.3.3
         to the Registrant's Registration Statement on Form S-1, Number
         33-64140 and incorporated herein by reference.)
  10.12  Amendment to 10.625% Series A and 10.770% Series B Note
         Purchase Agreement, dated March 24, 1994, between Dal-Tile
         Group Inc. and the Purchasers named therein. (Filed as Exhibit
         10.3.5 to the Registrant's Annual Report on Form 10-K for the
         year ended December 31, 1993 and incorporated herein by
         reference.)
  10.13  Form of Indemnification Agreement between the Company and its
         directors. (Filed as Exhibit 10.4 to the Registrant's
         Registration Statement on Form S-1, Number 33-64140 and
         incorporated herein by reference.)
  10.14  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, Number 33-
         64140 and incorporated herein by reference.)
  10.15  Shareholders Agreement, dated December 29, 1995, among Dal-Tile
         International Inc., AEA Investors Inc., Armstrong World
         Industries, Inc., Armstrong Enterprises, Inc. and Armstrong
         Cork Finance Corporation. (Filed as Exhibit 10.6 to the
         Registrant's Annual Report on Form 10-K for the year ended
         December 31, 1995 and incorporated herein by reference.)
   21.1  List of subsidiaries of the Company.
  *23.1  Consent of Fried, Frank, Harris, Shriver & Jacobson (included
         in Exhibit 5.1).
   23.2  Consent of Ernst & Young LLP.
   23.3  Consent of KPMG Peat Marwick LLP.
   24.1  Powers of Attorney (included on pages II-5 and II-6 of the
         Registration Statement).
</TABLE>
- --------
* To be filed by amendment.

<PAGE>
 
                                                                    EXHIBIT 21.1
 
                         SUBSIDIARIES OF THE REGISTRANT
 
<TABLE>
<CAPTION>
                                           JURISDICTION
                                                OF
          NAME OF SUBSIDIARY               INCORPORATION
          ------------------               -------------
       <S>                                 <C>
       Dal-Tile Group Inc.                   Delaware
       Dal-Tile Corporation                Pennsylvania
       R&M Supplies, Inc.                    Delaware
       Tileways, Inc.                        Delaware
       DTM/CM Holdings Inc.                  Delaware
       Dal-Minerals Company                  Delaware
       Dal-Tile of Canada Inc.                Ontario
       Materiales Ceramicos, S.A. de C.V.     Mexico
       Dal-Tile Mexico, S.A. de C.V.          Mexico
</TABLE>

<PAGE>
 
                                                                   EXHIBIT 23.2
 
              CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors
Dal-Tile International Inc.
 
  We consent to the reference to our firm under the caption "Experts" and to
the use of our reports dated March 15, 1996, in the Registration Statement
(Form S-1 No. 333-    ) and related Prospectus of Dal-Tile International Inc.
for the registration of shares of its common stock.
 
                                          Ernst & Young LLP
 
Dallas, Texas
June 3, 1996

<PAGE>
 
                                                                    EXHIBIT 23.3
 
                        CONSENT OF INDEPENDENT AUDITORS
 
The Board of Directors
Dal-Tile International Inc.:
 
  We consent to the use of our report included herein and to the reference to
our firm under the heading "Experts" in the prospectus.
 
KPMG Peat Marwick LLP
 
Philadelphia, Pennsylvania
June 3, 1996


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