UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998.

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from to .

Commission File Number 0-19431

ROYAL APPLIANCE MFG. CO.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

OHIO 34-1350353
- ----------------------------------------------------------- -----------------------------------------------------------
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER IDENTIFICATION)
ORGANIZATION)

650 ALPHA DRIVE, CLEVELAND, OHIO 44143
- ----------------------------------------------------------- -----------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(440) 449-6150
------------------------------------------------------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

Securities Registered Pursuant to Section 12(b) of the Act:

Common Shares, Without Par Value New York Stock Exchange
- ----------------------------------------------------------- -----------------------------------------------------------
(Title of Each Class) (Name of Each Exchange on which Registered)

Securities Registered Pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Sec. 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K [ ].

The aggregate market value of the voting shares held by non-affiliates of
the Registrant, as reported on the New York Stock Exchange, based upon the
closing sale price of Registrant's Common Shares on March 15, 1999 was
$48,220,324. Common Shares held by each officer and director have been excluded
in that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.

The number of outstanding shares of the Registrant's common shares as of
March 15, 1999 was 19,045,024.

DOCUMENTS INCORPORATED BY REFERENCE

Applicable portions of the Proxy Statement for the Annual Meeting of
Shareholders to be held on Tuesday, April 27, 1999 are incorporated by reference
in Part III of this form.

The Exhibit index appears on sequential page 35.
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PART I

ITEM 1. BUSINESS

General

Royal Appliance Mfg. Co. ("Royal" or the "Company"), an Ohio corporation
with its corporate offices in the Cleveland, Ohio metropolitan area, develops,
assembles and markets a full line of cleaning products for home and commercial
use under the Dirt Devil(R) and Royal(R) brand names. In 1984, the Company
introduced the first in a line of Dirt Devil(R) hand-held vacuum cleaners, which
the Company believes has become the largest selling line of hand-held vacuum
cleaners in the United States. The Company has used the Dirt Devil(R) brand name
recognition to gain acceptance for other Dirt Devil(R) products. The Company
continues to market certain metal vacuum cleaners for home and commercial use
under the Royal(R) brand name.

The Company's business strategy is primarily focused on leveraging the well
known Dirt Devil(R) brand to new and innovative products both inside and outside
the floor care industry. The Company's goal is to expand the number, visibility
and volume of its products sold by retailers, as well as to increase the number
of major retailers carrying its products. The Company also seeks to increase the
sale of its products through independent dealers by offering dealer-exclusive
product lines and cooperative promotional programs.

The Company's marketing strategy is essential to its success. The Company
uses television, print and cooperative advertising to build and maintain brand
awareness and consumer demand, as well as to gain shelf space for its product
lines from major retailers. In order to provide the retailers with distinct
product alternatives, the Company offers different Dirt Devil(R) products in a
variety of styles and colors and with various features. Major retailers
currently carrying some portion of the Dirt Devil(R) product line include Best
Buy, Canadian Tire, Circuit City, Kmart, Sears, Service Merchandise, Target, and
Walmart. The Company also sells its Dirt Devil(R) products through independent
dealers, who primarily sell the metal line of Royal(R) vacuum cleaners.

Products

The Company sells a full line of plastic and metal vacuum cleaners. The
Company's Dirt Devil(R) vacuum cleaners are intended for home use. The Company's
metal vacuum cleaners are intended for home and commercial use.

DIRT DEVIL(R) AND PLASTIC RELATED PRODUCT LINES. The Company's primary
retail product lines are sold under the Dirt Devil(R) name. The first Dirt
Devil(R) product, the Hand Vac, a corded, hand-held vacuum cleaner, was
introduced in 1984. The Dirt Devil(R) line has since been expanded by the
introduction of upright and canister vacuum cleaners, electric brooms and mops,
and non-electric sweepers. The Dirt Devil(R) line was expanded in 1998 by the
introduction of the Dirt Devil(R) Vision, a bagless upright, and the Scrub
Devil(TM), a cordless household scrubber.

During 1998, 1997, and 1996 plastic products accounted for approximately
88%, 90%, and 88%, respectively, of the Company's net sales.

METAL PRODUCT LINES. The Company has produced durable metal vacuum cleaners
since the early 1900's. Currently, the Company markets a full line of metal
upright and canister vacuum cleaners for home and commercial use. The Company
sells its metal vacuum cleaners exclusively through its network of independent
dealers. During 1998, 1997, and 1996, metal products accounted for approximately
4%, 4%, and 5%, respectively, of the Company's net sales.

OTHER PRODUCTS. The Company sells accessories, attachments, refurbished
cleaners and replacement parts for each of its product lines. These products are
sold through retailers and dealers, and are also available directly from the
Company. During 1998, 1997, and 1996, these products accounted for approximately
8%, 6%, and 7%, respectively, of the Company's net sales.

NEW PRODUCTS. The Company introduces new products and enhances its existing
products on a regular basis for both the retail and dealer markets. During the
third quarter of 1999, the Company will introduce the Dirt Devil(R) Easy
Steamer(TM), a carpet extractor. In order to support its product development
efforts, the Company

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engages in research and development activities, particularly with respect to new
product engineering. The Company's engineering and product development
expenditures were approximately, $4.6 million, $4.7 million and $3.9 million in
1998, 1997 and 1996, respectively.

In addition to internally developing products, the Company may purchase
product tooling, license product designs and patents, and outsource certain
product assembly for products to be marketed under the Dirt Devil(R)brand name.
The Company may also license its trademarks and patents.

Marketing and Customers

The Company markets its Dirt Devil(R) products primarily through major
retailers, including mass market retailers (e.g. Walmart, Target, and Kmart),
electronic chains (e.g. Best Buy, Circuit City, and Service Merchandise),
warehouse clubs (e.g. Sam's Club), regional chains and department stores. During
1998, Walmart (including Sam's Club), Target and Kmart accounted for
approximately 31.6%, 14.1% and 13.4%, respectively, of the Company's net sales,
compared to approximately 35.9%, 10.7% and 9.5%, respectively, of the Company's
net sales in 1997. These were the only customers who accounted for approximately
10% or more of the Company's net sales during such periods. During 1998 and
1997, the Company's net sales in the aggregate to its five largest customers
were 64.2% and 62.3%, respectively, of its total net sales. The loss of any of
these customers could have a significant impact on the Company's operations. The
Company anticipates that the significant percentage of the Company's net sales
attributable to a limited number of major retail customers will continue. The
Company believes that its relations with its customers are good. The Company
sells most of its products to retailers that are serviced directly by the
Company's internal sales staff.

Since Dirt Devil(R) products are targeted to sell to the mass market, the
Company believes that brand name recognition is critical to the success of these
products. The Company provides advertising and promotional support for its Dirt
Devil(R) products through television and cooperative advertising with retailers
and believes that these promotional activities, as well as those of its major
customers, affect brand name awareness and sales. The Company's cooperative
advertising program is established based upon planning with its mass market
retail customers. Some of the Company's advertising and promotional activities
are tied to holidays and also to specific promotional activities of retailers,
and historically have been higher during the Christmas shopping season. The
Company's advertising and promotional expenditures are not proportional to
anticipated sales. In addition, the Company has generated a small portion of its
sales from consumer direct orders using the Company's toll-free number and from
direct response television infomercials, in which consumers may order directly
from the Company.

The Company devotes considerable attention to the design and appearance of
its products and packaging in order to enhance their appeal to consumers and to
stand out among other brands on retailers' shelves. For example, Dirt Devil(R)
products sold by mass merchants are often bright red in color. In order to
increase the presence of its Dirt Devil(R) products in major retail outlets, the
Company provides retailers with distinct product alternatives by offering its
Dirt Devil(R) product lines in a variety of styles and colors and with various
features.

The Company also strives to meet the packaging and product merchandising
needs of retailers. The Company endeavors to have sufficient quantities of
products in stock in order to process and fill orders in a timely manner. Since
orders are typically shipped within 10 days of the receipt of a purchase order,
the Company does not have a significant order backlog. The Company permits
cancellation of orders up to 72 hours prior to shipment.

The Company's line of metal vacuum cleaners is sold exclusively through a
network of independent vacuum cleaner dealers. As part of its effort to support
its independent dealer network, the Company has attempted to meet independent
dealers' needs for distinctive product offerings not available to mass
merchants. The Company's metal product lines are targeted at consumers and
commercial customers who are interested in purchasing more durable and higher
quality vacuum cleaners. The Company focuses its promotional activities with its
independent dealers on cooperative advertising.

Many of the Company's independent dealers also provide warranty service for
Royal(R) and Dirt Devil(R)products. This allows the consumer to have prompt
access to local service outlets and is an important

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component of the Company's efforts to be responsive to consumers. The Company's
products are generally sold with a one to six-year limited warranty.

The Company has generally accepted over-the-counter product returns from
its retail customers for any reason, reflecting the retailers' return policies.

Each of the Company's products has a toll-free number printed on it that
consumers may use to contact a Company customer service representative. Through
its customer service computer system, the Company can provide a prompt response
to consumer inquiries concerning the availability of its products and service in
the consumer's vicinity.

Competition

The Company's most significant competitors are Hoover and Eureka and, in
the hand-held market, Black & Decker. These competitors and several others are
subsidiaries or divisions of companies that are more diversified and have
greater financial resources than the Company. The Company believes that the
domestic vacuum cleaner industry is a mature industry with modest annual growth
in many of its products but with a decline in certain other products.
Competition is dependent upon price, quality, extension of product lines, and
advertising and promotion expenditures. Additionally, competition is influenced
by innovation in the design of replacement models and by marketing and
approaches to distribution. The Company has experienced heightened competition
in the upright market segment as a result of increased advertising expenditures
and new product introductions by its competitors.

Trademarks and Patents

The Company holds numerous trademarks and holds or licenses the use of
patents registered in the United States and foreign countries for various
products and processes. The Company has registered trademarks in the United
States and a number of foreign countries for the Dirt Devil(R), Royal(R) and
other names and logos, which are used in connection with the sale of its vacuum
cleaners, other products and accessory parts. The Company considers the Dirt
Devil(R) trademark to be of considerable value and critical to its business. No
challenges to its rights to this trademark have arisen and the Company has no
reason to believe that any such challenges will arise in the future.

The Company holds or licenses the use of numerous domestic and
international patents, including design patents. The Company may also license
its trademarks and patents. The Company believes that its product lines are
generally not dependent upon any single patent or group of patents.

Seasonality

The Company's business is highly seasonal. The Company believes that a
significant percentage of certain of its products, particularly the Dirt
Devil(R) Hand Vac, the Dirt Devil(R) Broom Vac(R) and the Dirt Devil(R)Mop
Vac(R) are given as gifts and therefore, sell in larger volumes during the
Christmas shopping season. Because of the Company's continued dependency on its
major customers, the timing of purchases by these major customers could cause
quarterly fluctuations in the Company's net sales. As a consequence, results in
prior quarters are not necessarily indicative of future results of operations.

Production

The Company currently assembles most of its products in its facilities
located in the Cleveland, Ohio metropolitan area and Reynosa, Mexico. Unlike
many of its competitors, the Company currently does not manufacture component
parts for its products. Substantially all component parts for the Company's
products are manufactured by suppliers, frequently using molds and tooling owned
by the Company and built to its specifications. Since the Company's production
operations are currently limited to assembly, it believes that its fixed costs
are lower than many of its competitors. The Company also believes that this lack
of vertical integration permits it increased flexibility in the introduction and
modification of products. The Company also outsources some or all manufacturing
of certain products.

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The Company's engineering department is primarily responsible for the
design and testing of its products. The Company has computer-aided design
systems to assist its engineers in developing new products and modifying
existing products. The Company also retains outside design firms to assist its
engineers in designing new products. In addition to internally developing
products, the Company may purchase tooling, license intellectual property, or
otherwise sell products produced by others to the Company's specifications which
may be marketed under the Dirt Devil(R) brand name.

A majority of the raw materials purchased by the Company are component
parts, such as motors, bags, cords, and plastic parts, which are available from
multiple suppliers. The amount of time required by suppliers to fill orders
released by the Company varies from two to four months in the case of motors and
cords, from five to ten weeks for sourced products and one to four days for
plastic parts. The Company does not believe that it is dependent on any single
source for any significant portion of its raw material or component purchases,
with the exception of a component part for one of the Company's new products for
which there exists only one vendor. The Company believes that it has good
relationships with its suppliers and outsource manufacturers and has not
experienced any significant raw material or component shortages.

Employees

As of December 31, 1998, the Company employed approximately 680 full-time
employees, an increase of 10 employees from the prior year-end. In addition, the
Company generally utilizes temporary personnel during the period when the
Company is responding to its peak selling season. During 1998, the peak
temporary personnel level reached approximately 700. The Company's employees are
not represented by any labor union, except for the approximate 64 employees in
the Mexican assembly facility. The Company considers its relations with its
employees to be good.

The Company also has in effect a severance compensation plan that provides
for a severance payment to full-time employees, based on years of employment, if
within thirty-six months after a change-in-control of the Company their
employment is terminated for any reason other than death, permanent disability,
voluntary retirement or for cause. Executives who receive payments pursuant to
change-in-control and other employment arrangements will not receive duplicative
severance payments under the severance compensation plan.

Governmental Regulation

The Company's facilities are subject to numerous federal, state and local
laws and regulations designed to protect the environment from waste, emissions,
and from hazardous substances. The Company is also subject to the Federal
Occupational Safety and Health Act and other laws and regulations affecting the
safety and health of employees in the production areas of its facilities. The
Company is not a party to any investigation or litigation by the Environmental
Protection Agency or any state environment agency. The Company believes that it
is in compliance, in all material respects, with applicable environmental and
occupational safety regulations.

Business Segment Information

For description, see Note 13 of Notes to Consolidated Financial Statements.

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ITEM 2. PROPERTIES

On December 31, 1998, the Company and its subsidiaries owned or leased the
properties listed on the following table.

APPROXIMATE
SQUARE FOOTAGE
----------------- LEASE EXPIRATIONS
LOCATION AND ADDRESS OWNED LEASED (EXCLUDING RENEWALS) FUNCTION
-------------------- ------- ------ -------------------- --------

Corporate
650 Alpha Drive................. -- 57,000 01/01 Headquarters
Highland Heights, Ohio and Assembly
1340 East 289th Street.......... 106,000 -- 11/11 Assembly
Wickliffe, Ohio(1)
8120 Tyler Blvd................. 300,000 -- N/A Assembly and Shipping
Mentor, Ohio
855 E. Greg Street.............. -- 46,000 02/99 Shipping
Sparks, Nevada(2)
Brecha E-99..................... -- 40,000 04/03 Assembly
Reynosa, Tamquilpas, Mexico

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

(1) This leased property is reflected as owned because it contains a bargain
purchase option of $1. For further description, see Note 4 of Notes to
Consolidated Financial Statements.

(2) Based upon a plan adopted in 1999, the Company ceased to lease this facility
in February, 1999.

In addition, the Company utilizes public warehouses where appropriate. The
Company believes that these arrangements are more cost effective than leasing
its own warehouses.

In 1999, the Company expects to lease an approximate 100,000 square foot
assembly facility in Wickliffe, Ohio and an approximate 90,000 square foot
shipping and warehouse facility in Mentor, Ohio.

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in various claims and litigation arising in the
normal course of business. In the opinion of management, the ultimate resolution
of these actions will not materially affect the consolidated financial position,
results of operations, or cash flows of the Company.

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

None

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EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below is certain information with respect to all executive
officers of the Company.

POSITION AND OFFICES
NAME AGE WITH THE COMPANY
---- --- --------------------

Michael J. Merriman....................... 42 Chief Executive Officer and President
Gary J. Dieterich......................... 53 Senior Vice President -- Administration
James A. Holcomb.......................... 48 Vice President -- Marketing & Strategic
Planning
T. Keith Moone............................ 43 Vice President -- Sales
Richard G. Vasek.......................... 34 Chief Financial Officer, Vice President --
Finance and Secretary

The following is a brief account of the business experience during the past
five years of each such executive officer:

Michael J. Merriman was appointed Chief Executive Officer in July 1995,
President and Chief Operating Officer in January 1995, and Director in October
1993. From May 1992 until his appointment as President he served as Vice
President -- Finance, Treasurer and Secretary of the Company.

Gary J. Dieterich has been Senior Vice President -- Administration since
December 1994. Prior to that time, he served as the Company's Vice
President -- Information Systems from 1991 to 1994 and Director of Information
Systems from 1988 to 1991.

James A. Holcomb has been Vice President -- Marketing and Strategic
Planning since August 1994. Prior to that time, he served 2 years as Vice
President of Marketing and Strategic Planning with the Regina Company.

T. Keith Moone has been Vice President -- Sales since December 1995. Prior
to that he served as the Company's National Sales Manager from May
1994 -- December 1995. Prior to joining the Company, he was employed for 7 years
with Western Publishing as Director -- National Accounts.

Richard G. Vasek was appointed Chief Financial Officer and Vice
President -- Finance in September 1998, and Secretary in January 1996. From
February 1992 until his appointment as Chief Financial Officer and Vice
President -- Finance he served as the Company's Corporate Controller.

PART II

ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

The Company's common shares are quoted on the New York Stock Exchange
(NYSE) under the symbol RAM. The following table sets forth, for the periods
indicated, the high and low sales price for the Company's Common Shares as
reported by the New York Stock Exchange.

YEAR ENDED DECEMBER 31,
----------------------------
1998 1997
----------- -----------
HIGH LOW HIGH LOW
---- --- ---- ---

Quarters:
First..................................... 7 1/8 5 11/16 8 1/8 5 5/8
Second.................................... 6 3/8 4 3/4 8 11/16 5 1/2
Third..................................... 6 3/8 2 1/2 9 1/4 8
Fourth.................................... 5 3/16 2 1/4 9 5 5/8

The Company has not declared or paid any cash dividends and currently
intends not to pay any cash dividends in 1999. The Board of Directors intends to
retain earnings, if any, to support the operations, growth of the business and
to fund the stock repurchase program. The Company's credit agreement permits the
payment of cash dividends up to 50% of its net income from the preceding year.
The Company's credit agreement permits stock repurchases up to an additional
$3.8 million as of December 31, 1998.

On March 12, 1999, there were approximately 1,200 shareholders of record of
the Company's Common Shares, as reported by National City Corporation, the
Company's Registrar and Transfer Agent, which maintains its corporate offices at
National City Center, Cleveland, Ohio 44101-0756.

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data of the
Company. The selected Consolidated Statements of Operations and Consolidated
Balance Sheet data for each of the five years during the period ended December
31, 1998, are derived from the audited Consolidated Financial Statements of the
Company. Prior period amounts have been restated to reflect reclassifications to
conform to a 1995 change in the valuation method of accounting for inventory
from the LIFO method to the FIFO method and to conform to the 1998 presentation.
The data presented below should be read in conjunction with the Consolidated
Financial Statements and notes thereto included elsewhere herein.

YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

CONSOLIDATED STATEMENTS OF
OPERATIONS:
Net sales........................... $282,720 $325,417 $286,123 $270,564 $278,322
Cost of sales....................... 208,861 229,469 204,000 201,555 200,568
-------- -------- -------- -------- --------
Gross margin...................... 73,859 95,948 82,123 69,009 77,754
Advertising and promotion........... 43,562 47,626 40,443 40,496 42,298
Other selling....................... 7,947 8,448 8,977 11,898 12,914
General and administrative.......... 12,270 12,549 11,515 12,971 12,309
Engineering and product
development....................... 4,567 4,696 3,905 3,281 2,176
Special charges..................... -- -- -- 16,294 --
-------- -------- -------- -------- --------
Income (loss) from operations..... 5,513 22,629 17,283 (15,931) 8,057
Interest expense.................... 1,521 1,412 2,559 4,001 4,483
Receivable securitization and other
(income) expense, net............. (140) 1,033 (622) 311 460
-------- -------- -------- -------- --------
Income (loss) before taxes........ 4,132 20,184 15,346 (20,243) 3,114
Income tax expense (benefit)........ 1,606 7,777 5,910 (6,487) 1,152
-------- -------- -------- -------- --------
Net income (loss)................. $ 2,526 $ 12,407 $ 9,436 $(13,756) $ 1,962
======== ======== ======== ======== ========
BASIC EARNINGS PER SHARE
Weighted average number of common
shares outstanding (in
thousands)........................ 21,368 23,553 24,010 23,999 23,999
Earnings (loss) per share........... $ .12 $ .53 $ .39 $ (.57) $ .08

DILUTED EARNINGS PER SHARE
Weighted average number of common
shares and equivalents outstanding
(in thousands).................... 21,562 23,944 24,183 23,999 24,011
Earnings (loss) per share........... $ .12 $ .52 $ .39 $ (.57) $ .08

CONSOLIDATED BALANCE SHEET DATA (AT
END OF PERIOD)
Working capital................... $ 30,240 $ 32,486 $ 29,818 $ 46,045 $ 51,151
Total assets...................... 117,480 134,947 126,141 131,261 141,208
Long-term debt.................... 18,426 13,672 15,743 45,999 46,927
Shareholders' equity.............. 46,723 60,219 56,234 46,575 60,155

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The following table sets forth, for the years indicated, the percentages of
net sales of certain items in the Consolidated Statements of Operations and the
percentage change in such items as compared to the indicated prior year.

YEAR TO YEAR
YEAR ENDED DECEMBER 31, INCREASES (DECREASES)
------------------------ -----------------------------
1998 1997 1996 1998 VS. 1997 1997 VS. 1996
------ ------ ------ ------------- -------------

Net sales...................................... 100.0% 100.0% 100.0% (13.1)% 13.7%
Cost of sales.................................. 73.9 70.5 71.3 (9.0) 12.5
----- ----- ----- ----- -----
Gross margin.............................. 26.1 29.5 28.7 (23.0) 16.8
Advertising and promotion...................... 15.4 14.6 14.1 (8.5) 17.8
Other selling.................................. 2.8 2.6 3.1 (5.9) (5.9)
General and administrative..................... 4.3 3.9 4.0 (2.2) 9.0
Engineering and product development............ 1.6 1.4 1.4 (2.7) 20.2
----- ----- ----- ----- -----
Income from operations.................... 2.0 7.0 6.1 (75.6) 30.9
Interest expense............................... .5 .5 .9 7.7 (44.8)
Receivable securitization and other (income)
expense, net................................. N/M .3 (.2) N/M N/M
----- ----- ----- ----- -----
Income before income taxes..................... 1.5% 6.2% 5.4% (79.5)% 31.5%
===== ===== ===== ===== =====

1998 VS. 1997

Net sales for 1998 were $282,720, a decrease of 13.1% from 1997. The
overall decrease in net sales was due to lower sales of the Dirt Devil(R) Mop
Vac(R), which was introduced in 1997, and the Dirt Devil(R) Broom Vac(R). The
decrease in net sales was partially offset by increases in sales of the
Company's line of upright vacuum cleaners including the new Dirt Devil(R)
Vision, which was introduced in the third quarter of 1998. Despite lower
shipments to retailers in 1998, the Company believes that retailers' sales to
consumers of the Company's products increased over 1997. Overall sales to the
top 5 customers for 1998 (all of which are major retailers) accounted for
approximately 64.2% of net sales as compared with approximately 62.3% in 1997.
The Company believes that its dependence on sales to its largest customers will
continue. Recently, several major retailers have experienced significant
financial difficulties and some have filed for protection from creditors under
applicable bankruptcy laws. The Company sells its products to certain customers
that are in bankruptcy proceedings.

Gross margin, as a percent of net sales, decreased from 29.5% for 1997 to
26.1% in 1998. The gross margin percentage was negatively affected in 1998
primarily by lower sales of higher margin products and higher manufacturing
variances as a percent of sales.

Advertising and promotion expenses for 1998 were $43,562, a decrease of
8.5% from 1997. The decrease in advertising and promotion expenses was due
primarily to not incurring in 1998 expenses related to the 1997 launch of the
Fred Astaire Super Bowl advertising campaign and the direct response television
campaign launch of the Dirt Devil(R) Mop Vac(R). The Company intends to continue
emphasizing cooperative advertising and television as its primary methods of
advertising and promotion. In general, the Company's advertising expenditures
are not specifically proportional to anticipated sales. For example, the amount
of advertising and promotional expenditures may be concentrated during critical
retail shopping periods during the year, particularly the fourth quarter, and
during product and promotional campaign introductions.

Other selling expenses for 1998 were $7,947, a decrease of 5.9% from 1997.
The decrease is primarily due to lower compensation expenses and lower
commissions to manufacturer's representatives. The principal components of other
selling expenses are internal sales and marketing personnel costs.

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1998 VS. 1997 (CONTINUED)
General and administrative expenses for 1998 were $12,270, a decrease of
2.2% from 1997. The decrease is primarily due to lower compesation related
expenses partially offset by increases in professional services. General and
administrative expenses increased as a percentage of net sales from 3.9% to
4.3%. The principal components are compensation (including benefits), insurance,
travel, and professional services.

Engineering and product development expenses for 1998 were $4,567, a
decrease of 2.7% from 1997. The principal components are engineering salaries,
outside professional engineering and design services and other related product
development expenditures. The amount of outside professional engineering and
design services and other related product development expenditures are dependent
upon the number and complexity of new product introductions in any given year.
The decrease in 1998 was primarily due to fewer new product introductions in
1998.

Interest expense for 1998 was $1,521, an increase of 7.7% from 1997. The
increase in interest expense resulted, primarily, from higher levels of variable
rate borrowings to finance working capital, capital expenditures and share
repurchases, partially offset by a lower effective borrowing rate and the
receipt of proceeds from the sale of one of the Company's assembly facilities.

Receivable securitization and other (income) expense, net principally
reflects the cost of the Company's trade accounts receivable securitization
program and the effect of foreign currency transaction gains or losses related
to the Company's North American assets. The 1998 amount also includes the gain
from the sale of a facility of $1,168.

Due to the factors discussed above, the Company had income before income
taxes for 1998 of $4,132, as compared to income before income taxes for 1997 of
$20,184. The components of the Company's effective income tax expense rate of
38.9% are described in Note 6 of the Company's Consolidated Financial
Statements.

1997 VS. 1996

Net sales for 1997 were $325,417, an increase of 13.7% from 1996. The
overall increase in net sales was due primarily to sales of the Dirt Devil(R)
Mop Vac(R) and the Dirt Devil(R) Swivel Glide(TM). The increase in net sales was
partially offset by decreases in sales of the Dirt Devil(R) Broom Vac(R) and
certain other products in the Dirt Devil(R) vacuum line. Overall sales to the
top 5 customers for 1997 (all of which are major retailers) accounted for
approximately 62.3% of net sales as compared with approximately 59.3% in 1996.

Gross margin, as a percent of net sales, increased from 28.7% for 1996 to
29.5% in 1997. The gross margin percentage was positively affected in 1997
primarily by the introduction of new products and lower cost of certain
component parts and was partially offset by higher product returns and freight
costs as a percent of sales.

Advertising and promotion expenses for 1997 were $47,626, an increase of
17.8% from 1996. The increase in advertising and promotion expenses was due
primarily to the launch of the Fred Astaire advertising campaign and the direct
response television campaign launch of the Dirt Devil(R) Mop Vac(R).

Other selling expenses for 1997 were $8,448, a decrease of 5.9% from 1996.
The largest component of other selling expenses are internal sales and marketing
personnel compensation and commissions to manufacturers' representatives. The
Company continued to reduce its dependency on outside manufacturers'
representatives in 1997, resulting in the decrease in other selling expenses.

General and administrative expenses for 1997 were $12,549, an increase of
9.0% from 1996. General and administrative expenses decreased as a percentage of
net sales from 4.0% to 3.9%. The principal components are compensation
(including benefits), insurance, travel, provision for doubtful accounts, and
professional services. The increase is principally attributable to increases in
personnel, compensation related expenses, travel and supplies. Additionally, the
1996 expenses were reduced by bad debt insurance recoveries. The increase was
partially offset by decreases in professional services.

Engineering and product development expenses for 1997 were $4,696, an
increase of 20.2% from 1996, as the Company intensified its new product
innovation efforts. The principal components are engineering salaries, outside
professional engineering and design services and other related product
development expenditures. The amount of outside professional engineering and
design services and other related product development

10
11

1997 VS. 1996 (CONTINUED)
expenditures are dependent upon the number and complexity of new product
introductions in any given year. The increase in 1997 was primarily due to costs
associated with the three new product introductions in 1997 and new products to
be introduced in 1998.

Interest expense for 1997 was $1,412, a decrease of 44.8% from 1996. The
decrease in interest expense resulted, primarily, from lower levels of variable
rate borrowings due to increases in funds received from the revolving trade
accounts receivable securitization program and from a lower effective borrowing
rate.

Receivable securitization and other (income) expense, net principally
reflects the cost of the Company's trade accounts receivable securitization
program and the effect of foreign currency transaction gains or losses related
primarily to the Company's North American assets. The 1996 amount also includes
the gain from the sale of a facility of $638, and the proceeds from insurance
reimbursement of legal expenses of $319.

Due to the factors discussed above, the Company had income before income
taxes for 1997 of $20,184, as compared to income before income taxes for 1996 of
$15,346.

LIQUIDITY AND CAPITAL RESOURCES

The Company has used cash generated from operations to fund its working
capital needs, capital expenditures and share repurchases. Working capital was
$30,240 at December 31, 1998, a decrease of 6.9% over December 31, 1997 level.
Current assets decreased by $13,012 reflecting in part a $9,509 decrease of
trade accounts receivable and a $5,107 decrease of inventories, which were
partially offset by an increase in deferred income taxes of $1,598 and an
increase in prepaid expenses and other of $1,361. Current liabilities decreased
by $10,766 reflecting in part a $8,001 decrease of trade accounts payable, a
$3,451 decrease of accrued salaries, benefits, and payroll taxes, a $808
decrease of accrued advertising and promotion, a $600 decrease of accrued
warranty and customer returns, which were partially offset by increases in
accrued other of $1,279 and in accrued income taxes of $955.

In 1998, the Company utilized $10,291 of cash for capital expenditures,
including approximately $5,500 for tooling related to the Dirt Devil(R) Vision,
the Dirt Devil(R) Swivel Glide(TM), the Dirt Devil(R) Mop Vac(R), the Dirt
Devil(R) MAX and a carpet extractor and metal upright.

In April, 1998, the Company entered into a new three-year collateralized
revolving credit facility with availability of $45,000. Under the new agreement,
pricing options of the bank's base lending rate and LIBOR rate are based on a
formula, as defined. In addition, the Company pays a commitment fee based on a
formula, as defined, on the unused portion of the facility. The revolving credit
facility contains covenants which require, among other things, the achievement
of minimum net worth levels and the maintenance of certain financial ratios. The
Company was in compliance with all applicable covenants as of December 31, 1998.
The revolving credit facility is collateralized by the Company's inventories and
certain trade accounts receivable. The Company's effective interest rate was
8.45% and 8.63% for 1998 and 1997, respectively.

The Company also utilizes a revolving trade accounts receivable
securitization program to sell without recourse, through a wholly-owned
subsidiary, certain trade accounts receivable. Under the program, the maximum
amount allowed to be sold at any given time through December 31, 1998, was
$25,000. The maximum amount of receivables that can be sold is seasonally
adjusted. At December, 31, 1998, the Company received approximately $22,000 from
the sale of trade accounts receivable. The proceeds from the sales were used to
reduce borrowings under the Company's revolving credit facility. Costs of the
program, which primarily consist of the purchaser's financing cost of issuing
commercial paper backed by the receivables, totaled $916 and $892 in 1998 and
1997, respectively, and have been classified as Receivable securitization and
other (income) expense, net in the accompanying Consolidated Statements of
Operations. The Company's effective borrowing rate under this program was 6.79%
and 6.64% for the years 1998 and 1997, respectively. The Company, as agent for
the purchaser of the receivables, retains collection and administrative
responsibilities for the purchased receivables.

11
12

LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
During the third quarter of 1998, the Company sold one of its assembly
facilities for $7,100. Proceeds were used to pay off a variable rate mortgage
and pay down the Company's revolving credit debt. The net gain from this
transaction was $1,168.

In February 1998, the Company's Board of Directors authorized a common
share repurchase program that provides for the Company to purchase, in the open
market and through negotiated transactions, up to 2,300 of its outstanding
common shares. The Company completed the program repurchasing 2,300 shares for
an aggregate purchase price of $11,895 in October 1998. In October 1998, the
Company's Board of Directors authorized another common share repurchase program
that provides for the Company to purchase, in the open market and through
negotiated transactions, up to an additional 4,100 of its outstanding common
shares. As of December 31, 1998, the Company has repurchased approximately 1,025
shares for an aggregate purchase price of $4,345 under the new program. The
program is scheduled to expire on December 31, 1999. Prior to any amendments,
the Company's credit agreement permits stock repurchases up to an additional
$3.8 million as of December 31, 1998.

The Company believes that its revolving credit facilities along with cash
generated by operations will be sufficient to provide for the Company's
anticipated working capital and capital expenditure requirements for the next
twelve months, as well as additional stock repurchases, if any.

QUARTERLY OPERATING RESULTS (UNAUDITED)

The following table presents certain unaudited consolidated quarterly
operating information for the Company and includes all adjustments that the
Company considers necessary for a fair presentation of such information for the
interim periods.

THREE MONTHS ENDED
-----------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MARCH 31, DEC. 31, SEPT. 30, JUNE 30, MARCH 31,
1998 1998 1998 1998 1997 1997 1997 1997
-------- --------- -------- --------- -------- --------- -------- ---------

Net sales............... $106,006 $73,607 $51,259 $51,848 $118,354 $87,375 $ 61,070 $ 58,618
Gross margin............ 30,950 19,258 12,153 11,498 36,691 25,284 17,739 16,234
Net income (loss)....... 5,134 2,169 (2,234) (2,543) 6,793 4,089 919 606
Net income (loss) per
share (a) (b)......... $ .26 $ .10 $ (.10) $ (.11) $ .29 $ .17 $ .04 $ .02

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

(a) The sum of 1998 quarterly net income per common share does not equal annual
net income per common share due to the change in the weighted average number
of common shares outstanding due to share repurchases.

(b) Earnings per share is calculated based on the diluted method explained in
Note 12 to the Consolidated Financial Statements.

The Company's business is highly seasonal. The Company believes that a
significant percentage of certain of its products, particularly the Dirt
Devil(R) Hand Vac, Dirt Devil(R) Broom Vac(R), and Dirt Devil(R) Mop Vac(R), are
given as gifts and therefore, sell in larger volumes during the Christmas
shopping season. Because of the Company's continued dependency on its major
customers, the timing of purchases by these major customers and the timing of
new product introductions causes quarterly fluctuations in the Company's net
sales. The Company believes that in the first quarter of 1998 net sales were
negatively impacted by certain major customers lowering their retail inventory
levels. The Company believes the first quarter of 1999 net sales will be
positively impacted as retail customers restock inventory levels reduced by a
strong fourth quarter of 1998 sell-through. The strong sell-through continues in
the first quarter of 1999. As a consequence, results in prior quarters are not
necessarily indicative of future results of operations.

12
13

OTHER

The Company believes that the domestic vacuum cleaner industry is a mature
industry with modest annual growth in many of its products but with a decline in
certain other products. Competition is dependent upon price, quality, extension
of product lines, and advertising and promotion expenditures. Additionally,
competition is influenced by innovation in the design of replacement models and
by marketing and approaches to distribution. The Company's most significant
competitors are Hoover and Eureka, and in the hand-held market, Black & Decker.
These competitors and several others are subsidiaries or divisions of companies
that are more diversified and have greater financial resources than the Company.

INFLATION

The Company does not believe that inflation by itself has had a material
effect on the Company's results of operations. However, as the Company
experiences price increases from its suppliers, which may include increases due
to inflation, retail pressures may prevent the Company from increasing its
prices.

ACCOUNTING STANDARDS

The Company will be required to implement Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging
Activities, in the first quarter of 2000. The Company expects the implementation
of SFAS No. 133 will not have a material impact on its consolidated financial
position, results of operations, or cash flows.

The Company will be required to implement Statement of Position ("SOP")
98-1, Accounting for the Costs of Computer Software, in the first quarter of
1999. The Company expects that the implementation of SOP 98-1 will not have a
material impact on its consolidated financial position, results of operations,
or cash flows.

The Company adopted SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information, in the fourth quarter of 1998. The impact of
implementing SFAS No. 131 is discussed in Note 13 to the Consolidated Financial
Statements.

The Company adopted SFAS No. 130, Reporting Comprehensive Income, in the
fourth quarter of 1998. The implementation of SFAS No. 130 did not have a
material impact on its consolidated financial position, results of operations,
or cash flows.

YEAR 2000 COMPLIANCE

Many currently installed computer systems are not capable of distinguishing
the year 2000 from the year 1900. As a result, computer systems and/or software
used by many companies in a wide variety of applications will experience
operating difficulties unless they are modified or upgraded to adequately
process information involving, related to or dependent upon the century change.
Significant uncertainty exists concerning the scope and magnitude of problems
associated with the century change.

The Company has developed a Year 2000 Action Plan to address this concern.
A project team has performed a detailed assessment of all internal computer
systems and is developing and implementing plans to either convert or replace
the software or equipment that is not Year 2000 compliant. The Company expects
to complete these projects during 1999.

Year 2000 problems could affect many of the Company's production,
distribution, financial, administrative and communication operations, as well as
the processing of customer orders. The Company's internal business system was
modified to be Year 2000 compliant in the third quarter of 1998. Testing and
verification of the system will be performed throughout 1999. The Company has
completed its inventory of embedded systems and is currently in the assessment
phase for this critical area. In addition, the Company has asked vendors,
service suppliers, communications providers and banks to verify their Year 2000
readiness; their system failures could have a significant impact on the
Company's operations. Action is being taken based on individual responses.

External and internal costs directly associated with modifying internal use
software for Year 2000 compliance are expensed as incurred. As of December 31,
1998, the costs incurred for this project were primarily
13
14

YEAR 2000 COMPLIANCE (CONTINUED)
attributable to internal personnel costs and consulting fees which were
estimated at $50. The remaining costs to fix the Year 2000 problems are
estimated at approximately $330, which will be incurred in 1999. These costs do
not include normal system replacements and upgrades. The Company does not expect
Year 2000 compliance costs to have a material impact on the Company's
consolidated financial position, results of operations or cash flows.

The Company is uncertain of the above expectations. For example, if the
Company is unsuccessful in identifying or fixing all Year 2000 problems in the
Company's critical operations or if the Company is affected by the inability of
suppliers or major customers (such as one of our top 5 customers) to continue
operations due to such a problem, the Company's consolidated financial position,
results of operations, or cash flows could be materially impacted.

The total costs that the Company incurs in connection with the Year 2000
problems will be influenced by the Company's ability to successfully identify
Year 2000 systems' flaws, the nature and amount of programming required to fix
the affected programs, the related labor and/or consulting costs for such
remediation and the ability of third parties with whom we have business
relationships to successfully address their own Year 2000 concerns. These and
other unforeseen factors could have a material adverse effect on the Company's
consolidated financial position, results of operations, or cash flows.

Based on available information, the Company does not believe any material
exposure to significant business interruption exists as a result of Year 2000
compliance issues. The Company has begun the process to develop formal
contingency plans that will address mission critical activities as determined by
management in the event the Year 2000 project is not completed in a timely
manner. These contingency plans will be completed in the first half of 1999.

FORWARD LOOKING STATEMENTS

Forward-looking statements in this Form 10-K are made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from those projected. Readers
are cautioned not to place undue reliance on these forward-looking statements
which speak only as of the date hereof. Potential risks and uncertainties
include, but are not limited to, general business and economic conditions; the
financial strength of the retail industry particularly the major mass retail
channel; the competitive pricing environment within the vacuum cleaner segment
of the floor care industry; the cost and effectiveness of planned advertising,
marketing and promotional campaigns, the success at retail and the acceptance by
consumers of the Company's new products, including the Company's line of Dirt
Devil(R) Vision uprights with bagless technology, the dependence upon the
Company's ability to continue to successfully develop and introduce innovative
products and unforeseen technological issues associated with the Year 2000
compliance efforts.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company does not have any derivative financial instruments as of
December 31, 1998. The Company sells its products in various global markets. As
a result, the Company's cash flow and earnings are exposed to fluctuations in
foreign currency exchange rates. There were no forward exchange or currency swap
contracts outstanding as of December 31, 1998.

14
15

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Board of Directors of
Royal Appliance Mfg. Co.

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of Royal
Appliance Mfg. Co. and its Subsidiaries (the "Company") at December 31, 1998 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

PricewaterhouseCoopers LLP

Cleveland, Ohio
February 12, 1999

15
16

ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
(DOLLARS IN THOUSANDS)

ASSETS
Current assets:
Cash...................................................... $ -- $ 1,355
Trade accounts receivable, less allowance for doubtful
accounts of $1,500 and $1,400 at December 31, 1998 and
1997, respectively...................................... 37,536 47,045
Inventories............................................... 31,088 36,195
Deferred income taxes..................................... 4,148 2,550
Prepaid expenses and other................................ 4,572 3,211
-------- --------
Total current assets.................................... 77,344 90,356
-------- --------
Property, plant and equipment, at cost:
Land...................................................... 1,541 2,356
Buildings................................................. 7,777 13,117
Molds, tooling, and equipment............................. 64,865 58,236
Furniture and office equipment............................ 7,022 6,068
Assets under capital leases............................... 4,714 4,613
Leasehold improvements and other.......................... 3,718 3,049
-------- --------
89,637 87,439
Less accumulated depreciation and amortization.......... (52,837) (44,547)
-------- --------
36,800 42,892
-------- --------
Tooling deposits............................................ 2,770 1,146
Other....................................................... 566 553
-------- --------
Total assets............................................ $117,480 $134,947
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable.................................... $ 18,647 $ 26,648
Accrued liabilities:
Advertising and promotion............................... 8,768 9,576
Salaries, benefits and payroll taxes.................... 2,299 5,750
Warranty and customer returns........................... 8,100 8,700
Income taxes............................................ 1,930 975
Other................................................... 6,809 5,530
Current portions of capital lease obligations and notes
payable................................................... 551 691
-------- --------
Total current liabilities............................... 47,104 57,870
-------- --------
Revolving credit agreement.................................. 10,600 1,473
Capitalized lease obligations, less current portion......... 2,833 3,101
Notes payable, less current portion......................... 4,993 9,098
-------- --------
Total long-term debt.................................... 18,426 13,672
-------- --------
Deferred income taxes....................................... 5,227 3,186
-------- --------
Total liabilities....................................... 70,757 74,728
-------- --------
Commitments and contingencies (Notes 4 and 5)............... -- --
Shareholders' equity:
Serial preferred shares; authorized -- 1,000,000 shares;
none issued and outstanding............................. -- --
Common shares, at stated value; authorized -- 101,000,000
shares; issued -- 25,347,924 and 25,311,724 at December
31, 1998 and 1997, respectively......................... 211 211
Additional paid-in capital................................ 42,115 41,897
Retained earnings......................................... 42,544 40,018
Accumulated other comprehensive income.................... -- --
-------- --------
84,870 82,126
Less treasury shares, at cost -- 5,726,400 and 2,401,000
shares at December 31, 1998 and 1997, respectively...... (38,147) (21,907)
-------- --------
Total shareholders' equity.............................. 46,723 60,219
-------- --------
Total liabilities and shareholders' equity.............. $117,480 $134,947
======== ========

The accompanying notes are an integral part of these financial statements.
16
17

ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

1998 1997 1996
------------ ------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Net sales.............................................. $282,720 $325,417 $286,123
Cost of sales.......................................... 208,861 229,469 204,000
-------- -------- --------
Gross margin......................................... 73,859 95,948 82,123
Advertising and promotion.............................. 43,562 47,626 40,443
Other selling.......................................... 7,947 8,448 8,977
General and administrative............................. 12,270 12,549 11,515
Engineering and product development.................... 4,567 4,696 3,905
-------- -------- --------
Income from operations............................... 5,513 22,629 17,283
Interest expense, net.................................. 1,521 1,412 2,559
Receivable securitization and other (income) expense,
net.................................................. (140) 1,033 (622)
-------- -------- --------
Income before income taxes........................... 4,132 20,184 15,346
Income tax expense..................................... 1,606 7,777 5,910
-------- -------- --------
Net income........................................... $ 2,526 $ 12,407 $ 9,436
======== ======== ========
BASIC
Weighted average number of common shares outstanding
(in thousands).................................... 21,368 23,553 24,010
Earnings per share................................... $ .12 $ .53 $ .39
DILUTED
Weighted average number of common shares and
equivalents outstanding (in thousands)............ 21,562 23,944 24,183
Earnings per share................................... $ .12 $ .52 $ .39

The accompanying notes are an integral part of these financial statements.

17
18

ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

FOR YEARS ENDED DECEMBER 31,

COMMON SHARES ADDITIONAL
------------------- PAID-IN RETAINED
NUMBER AMOUNT CAPITAL EARNINGS
---------- ------ ---------- --------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)

Balance at December 31, 1995.. 25,200,000 $210 $41,583 $18,175
Translation adjustment......
Compensatory effect of stock
options................... (199)
Shares issued from stock
option plan............... 31,100 116
Net income.................. 9,436
---------- ---- ------- -------
Balance at December 31, 1996.. 25,231,100 210 41,500 27,611
Translation adjustment......
Compensatory effect of stock
options................... 81
Shares issued from stock
option plan............... 80,624 1 316
Purchase of treasury
shares....................
Net income.................. 12,407
---------- ---- ------- -------
Balance at December 31, 1997.. 25,311,724 211 41,897 40,018
Compensatory effect of stock
options................... 68
Shares issued from stock
option plan............... 36,200 150
Purchase of treasury
shares....................
Net income.................. 2,526
---------- ---- ------- -------
Balance at December 31, 1998.. 25,347,924 $211 $42,115 $42,544
========== ==== ======= =======

ACCUMULATED TREASURY SHARES TOTAL
OTHER COMPREHENSIVE -------------------- SHAREHOLDERS'
INCOME NUMBER AMOUNT EQUITY
------------------- --------- -------- -------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)

Balance at December 31, 1995.. $(413) 1,201,000 $(12,980) $ 46,575
Translation adjustment...... 306 306
Compensatory effect of stock
options................... (199)
Shares issued from stock
option plan............... 116
Net income.................. 9,436
----- --------- -------- --------
Balance at December 31, 1996.. (107) 1,201,000 (12,980) 56,234
Translation adjustment...... 107 107
Compensatory effect of stock
options................... 81
Shares issued from stock
option plan............... 317
Purchase of treasury
shares.................... 1,200,000 (8,927) (8,927)
Net income.................. 12,407
----- --------- -------- --------
Balance at December 31, 1997.. -- 2,401,000 (21,907) 60,219
Compensatory effect of stock
options................... 68
Shares issued from stock
option plan............... 150
Purchase of treasury
shares.................... 3,325,400 (16,240) (16,240)
Net income.................. 2,526
----- --------- -------- --------
Balance at December 31, 1998.. $ -- 5,726,400 $(38,147) $ 46,723
===== ========= ======== ========

The accompanying notes are an integral part of these financial statements.

18
19

ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR YEARS ENDED DECEMBER 31,

1998 1997 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)

Cash flows from operating activities:
Net income................................................ $ 2,526 $ 12,407 $ 9,436
-------- -------- --------
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization.......................... 9,390 9,407 8,719
Compensatory effect of stock options................... 68 81 (199)
Gain on sale of, property, plant and equipment, net.... (1,125) -- (467)
Deferred income taxes.................................. 443 3,186 --
(Increase) decrease in assets:
Trade accounts receivable, net......................... 9,509 (7,284) 3,797
Inventories............................................ 5,107 (2,143) (5,644)
Refundable and accrued income taxes.................... 955 1,474 8,573
Prepaid expenses and other............................. (1,361) (595) (1,468)
Other.................................................. (325) -- (125)
Increase (decrease) in liabilities:
Trade accounts payable................................. (8,001) 5,969 4,587
Accrued advertising and promotion...................... (808) (2,106) 4,429
Accrued salaries, benefits, and payroll taxes.......... (3,451) (230) 2,924
Accrued warranty and customer returns.................. (600) 725 375
Accrued other.......................................... 1,279 1,850 (47)
-------- -------- --------
Total adjustments.................................... 11,080 10,334 25,454
-------- -------- --------
Net cash from operating activities................... 13,606 22,741 34,890
-------- -------- --------
Cash flows from investing activities:
Purchases of tooling, property, plant, and equipment,
net.................................................... (8,667) (14,548) (9,677)
Proceeds from sale of property, plant and equipment....... 6,806 -- 2,237
(Decrease) increase in tooling deposits................... (1,624) 2,816 85
-------- -------- --------
Net cash from investing activities..................... (3,485) (11,732) (7,355)
-------- -------- --------
Cash flows from financing activities:
Proceeds (payments) on bank debt, net..................... 9,127 (1,413) (25,953)
Payments on notes payable................................. (4,280) (418) (398)
Proceeds from exercise of stock options................... 150 317 116
Payments on capital lease obligations..................... (233) (214) (293)
Purchase of treasury shares............................... (16,240) (8,927) --
-------- -------- --------
Net cash from financing activities..................... (11,476) (10,655) (26,528)
-------- -------- --------
Effect of exchange rate changes on cash..................... -- -- (6)
-------- -------- --------
Net (decrease) increase in cash............................. (1,355) 354 1,001
Cash at beginning of year................................... 1,355 1,001 --
-------- -------- --------
Cash at end of year......................................... $ -- $ 1,355 $ 1,001
======== ======== ========
Supplemental disclosure of cash flow information:
Cash payments for:
Interest.................................................. $ 1,687 $ 1,689 $ 3,018
======== ======== ========
Income taxes, net of refunds.............................. $ 208 $ 3,117 $ (2,663)
======== ======== ========
Supplemental schedule of noncash investing and financing
activities:
Assignment of capital lease obligation to buyer........... $ -- $ -- $ 3,690
======== ======== ========

The accompanying notes are an integral part of these financial statements.
19
20

ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ACCOUNTING POLICIES:

DESCRIPTION OF BUSINESS -- Royal Appliance Mfg. Co. ("Royal" or the
"Company"), an Ohio corporation with its corporate offices in the Cleveland,
Ohio metropolitan area, develops, assembles and markets a full line of cleaning
products for home and commercial use under the Dirt Devil(R) and Royal(R) brand
names. In 1984, the Company introduced the first in a line of Dirt Devil(R)
hand-held vacuum cleaners, which the Company believes has become the largest
selling line of hand-held vacuum cleaners in the United States. The Company has
used the Dirt Devil(R) brand name recognition to gain acceptance for other Dirt
Devil(R) products.

The following is a summary of significant policies followed in the
preparation of the accompanying Consolidated Financial Statements.

BASIS OF PRESENTATION -- The Consolidated Financial Statements include the
accounts of the Company and its wholly owned subsidiaries after elimination of
all intercompany accounts and transactions. The companies are hereinafter
referred to as "Royal" or the "Company".

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts and related disclosures. Actual results
could differ from those estimates.

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

Net income per common share is computed based on the weighted average
number of common shares outstanding for basic earnings per share and on the
weighted average number of common shares and common share equivalents
outstanding for diluted earnings per share.

The Company's revenue recognition policy is to recognize revenues when
products are shipped.

The Company's return policy is to replace, repair or issue credit for
product under warranty. Returns received during the current period are expensed
as received and a provision is provided for future returns based on current
shipments. All sales are final upon shipment of goods to the customers.

Foreign operations are conducted in their local currency. Assets and
liabilities of Royal's international operations are translated at current
exchange rates, and income and expenses are translated using weighted average
exchange rates. The effects of these translation adjustments are reported as a
separate component of shareholders' equity as Accumulated Other Comprehensive
Income. The net effect of currency gains and losses realized on business
transactions is included in the determination of net income.

As of December 31, Accumulated Other Comprehensive Income consisted of the
following:

1998 1997 1996
---- ---- ----

Foreign currency translation adjustments.................... $ -- $306 $107
Less: Reclassification adjustments.......................... -- (306) (107)
---- ---- ----
Accumulated Other Comprehensive Income...................... $ -- $ -- $ --
==== ==== ====

ADVERTISING AND PROMOTION -- Cost incurred for producing and communicating
advertising are expensed during the period incurred, including cost incurred
under the Company's cooperative advertising program.

INVENTORIES -- Inventories are stated at the lower of cost or market using
first-in, first-out (FIFO) method.

20
21
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. ACCOUNTING POLICIES: (CONTINUED)
Inventories at December 31 consisted of the following:

DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------

Finished goods............................................ $16,648 $23,319
Work in process and component parts....................... 14,440 12,876
------- -------
$31,088 $36,195
======= =======

PROPERTY, PLANT AND EQUIPMENT -- the Company capitalizes as additions to
property, plant and equipment expenditures at cost for molds, tooling, land,
buildings, equipment, furniture, and leasehold improvements. Expenditures for
maintenance and repairs are charged to operating expense as incurred. The asset
and related accumulated depreciation or amortization accounts are adjusted to
reflect retirements and disposals and the resulting gain or loss is included in
the determination of net income.

Plant and equipment are depreciated over the estimated useful lives of the
respective classes of assets. Leasehold improvements and assets held under
capital leases are amortized over their respective lease terms. Accumulated
amortization on assets under capital leases totaled $2,338 and $2,120 at
December 31, 1998 and 1997, respectively.

Depreciation for financial reporting purposes is computed on the
straight-line method using the following depreciable lives:

Buildings................................................... 40 years
Buildings under capital lease............................... 20 years
Molds, tooling, and equipment............................... 3-10 years
Furniture and office equipment.............................. 3-10 years
Vehicles.................................................... 3 years

Accelerated methods as permitted by the applicable tax law are used for tax
reporting purpose.

The Company reviews for impairment whenever events or changes in
circumstances indicates that the carrying amount of property, plant and
equipment may not be recoverable under the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long Lived Assets to be Disposed Of.

FAIR VALUE OF FINANCIAL INSTRUMENTS -- Financial instruments consist of a
revolving credit agreement and notes payable and are carried at amounts which
approximate fair value.

NEW ACCOUNTING PRONOUNCEMENTS -- The Company will be required to implement
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities, in the first quarter of 2000. The
Company expects the implementation of SFAS No. 133 will not have a material
impact on its consolidated financial position, results of operations, or cash
flows.

21
22
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. ACCOUNTING POLICIES: (CONTINUED)
The Company adopted SFAS No. 130, Reporting Comprehensive Income, in the
first quarter of 1998. The implementation of SFAS No. 130 did not have a
material impact on its consolidated financial position, results of operations,
or cash flows.

2. SPECIAL CHARGES:

In 1995, pursuant to a board approved plan, the Company recorded special
charges of $16,294, primarily related to losses from the disposal of certain
inventory, molds and tooling and other intangibles primarily resulting from a
decision to refocus the Company's primary operating and marketing efforts on the
North American market. The special charges included a $11,567 write-down to the
net realizable value of certain molds, tooling, inventory and other assets
disposed of or held for sale, $2,598 restructuring charge related to the
Company's sale of its European operations, and $2,129 of special charges related
to losses from the disposal of certain inventory and intangibles resulting from
discontinuing a product line and executive severance. The Company completed the
sale of its European operations in 1995 and liquidated its European real estate
in 1996.

As of December 31, 1998, the reserve balance was fully utilized and no
additional charges related to the above are anticipated. A summary of the
special charges reserve account is presented below:

1998 1997 1996
---- ---- ------

Reserve balance at beginning of year........................ $27 $369 $1,548
Realized loss on disposal of property, equipment and
inventories............................................ -- -- (666)
Severance and other cash outflows......................... (27) (342) (513)
--- ---- ------
Reserve balance at end of year.............................. $-- $ 27 $ 369
=== ==== ======

3. DEBT:

22
23
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. DEBT: (CONTINUED)
During the third quarter of 1998, the Company sold one of its assembly
facilities for $7,100. Proceeds were used to pay off a variable rate mortgage
and pay down the Company's revolving credit debt. The net gain from this
transaction was $1,168.

The Company has a 7.9% fixed rate mortgage note payable in the amount of
$5,270. The note is collateralized by the Company's assembly and distribution
facility. Monthly payments of principal and interest are payable through
November 1, 2000, at which time the balance of approximately $4,775 is due. The
carrying amount of the mortgage note payable approximates fair value.

Aggregate maturities of the notes payable and revolving credit facility at
December 31, 1998, are as follows:

1999............................................ $ 277
2000............................................ 4,993
2001............................................ 10,600
-------
$15,870
=======

4. LEASES:

Royal leases various facilities, equipment and vehicles under capital and
operating lease agreements. Operating lease payments totaled $602, $579 and $677
for the years ended December 31, 1998, 1997, and 1996, respectively.

Minimum commitments under all capital and operating leases at December 31,
1998 are as follows:

YEAR CAPITAL OPERATING
---- ------- ---------

1999............................................ $ 571 $ 440
2000............................................ 573 314
2001............................................ 334 188
2002............................................ 312 44
2003............................................ 315 12
Thereafter...................................... 1,855 5
------ ------
Total minimum lease payments.................... 3,960 $1,003
======
Less amount representing interest............... 853
------
Total present value of capital obligation....... 3,107
Less current portion............................ 274
------
Long-term obligation under capital leases....... $2,833
======

5. COMMITMENTS AND CONTINGENCIES:

At December 31, 1998, the Company estimates having contractual commitments
for future advertising and promotional expense of approximately $12,600
including commitments for television advertising through December 31, 1999.
Other contractual commitments for items in the normal course of business total
approximately $4,900.

The Company is self-insured with respect to workers' compensation benefits
in Ohio and carries excess workers' compensation insurance covering aggregate
claims exceeding $350 per occurrence.

23
24
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
The Company is involved in various claims and litigation arising in the
normal course of business. In the opinion of management, the ultimate resolution
of these actions will not materially affect the consolidated financial position,
results of operations, or cash flows of the Company.

6. INCOME TAXES:

The income tax expense consisted of the following:

1998 1997 1996
------ ------ ------

Current
Federal............................................... $ 873 $ 399 $4,643
State and local....................................... 290 190 589
Deferred................................................ 443 7,188 678
------ ------ ------
Total................................................... $1,606 $7,777 $5,910
====== ====== ======

Deferred income taxes reflect the impact for financial statement reporting
purposes of temporary differences between the financial statement carrying
amounts and tax basis of assets and liabilities. At December 31, 1998 and 1997,
the components of the net deferred tax liability were as follows:

1998 1997
------- ------

Deferred tax assets:
Warranty and customer returns............................. $ 3,315 $4,444
Bad debt reserve.......................................... 585 616
Inventory basis difference................................ 724 634
Accrued vacation, compensation and benefits............... 414 379
State and local taxes..................................... 625 729
Accrued advertising....................................... 20 22
Self insurance reserves................................... 156 315
Deferred compensation plan................................ 958 616
Other..................................................... 88 247
Deferred tax liabilities:
Accounts receivable mark to market........................ (2,493) (3,631)
Basis difference in fixed and intangible assets........... (4,558) (4,286)
State and local taxes..................................... (803) (707)
Other..................................................... (110) (14)
------- ------
Net deferred tax liability.................................. $(1,079) $ (636)
======= ======

As of December 31, 1998, the Company has state and local tax net operating
loss carryforward tax benefits of approximately $337 which will substantially
expire between 2008 and 2010.

24
25
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. INCOME TAXES: (CONTINUED)
The differences between income taxes at the statutory federal income tax
rate of 34% and those reported in the Consolidated Statements of Operations are
as follows:

YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
% OF % OF % OF
PRE-TAX PRE-TAX PRE-TAX
1998 INCOME 1997 INCOME 1996 INCOME
------ ------- ------ ------- ------ ------------

Tax expense at statutory rate..... $1,404 34.0% $6,862 34.0% $5,218 34.0%
Capital (gains) losses on
disposition of foreign
subsidiaries and other non
deductible expenses............. -- -- (93) (.5) 87 .6
State and local income taxes, net
of federal benefit.............. 186 4.5 1,008 5.0 257 1.7
Federal surtax on income over $10
million......................... -- -- -- -- 70 .5
Other, net........................ 16 .4 -- -- 278 1.7
------ ---- ------ ---- ------ ----
$1,606 38.9% $7,777 38.5% $5,910 38.5%
====== ==== ====== ==== ====== ====

7. MAJOR CUSTOMERS:

Royal's three largest customers represented approximately 31.6%, 14.1%, and
13.4% of total net sales in 1998. The Company's two largest customers
represented approximately 35.9% and 10.7% in 1997 and 33.0% and 11.3% of total
net sales in 1996. Additionally, a significant concentration of Royal's business
activity is with major domestic mass market retailers whose ability to meet
their financial obligations with Royal is dependent on economic conditions
germane to the retail industry. During recent years, several major retailers
have experienced significant financial difficulties and some have filed for
protection from creditors under applicable bankruptcy laws. The Company sells
its products to certain customers that are in bankruptcy proceedings.

The Company provides credit, in the normal course of business, to the
retail industry which includes mass market retailers, warehouse clubs, and
independent dealers. The Company performs ongoing credit evaluations of its
customers and establishes appropriate allowances for doubtful accounts based
upon factors surrounding the credit risk of specific customers, historical
trends and other information.

8. STOCK OPTIONS:

Under the terms of the Company's stock option plans for employees, outside
directors and consultants, all outstanding options have been granted at prices
at least equal to the then current market value on the date of grant, except for
50,000 options granted to a consultant below market value in November, 1996. The
compensation element of these 50,000 options was recognized as compensation
expense over the two year vesting period. Certain stock options granted become
exercisable in cumulative 20% installments, commencing one year from date of
grant with full vesting occurring on the fifth anniversary date, and expire in
ten years, subject to earlier termination in certain events related to
termination of employment. Other stock options granted vest at the end of five
years ("5 year cliff vesting") and expire in six years, subject to earlier
termination in certain events related to termination of employment. Vesting may
be accelerated in certain events relating to change of the Company's ownership.

25
26
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. STOCK OPTIONS: (CONTINUED)
The following summarizes the changes in the number of Common Shares under
option:

1998 1997 1996
--------------- --------------- ---------------

Options outstanding at beginning of the
year..................................... 2,302 2,486 1,141
Options granted during the year............ 100 173 1,639
Options exercised during the year.......... (36) (81) (31)
Options canceled during the year........... (115) (276) (263)
--------------- --------------- ---------------
Options outstanding at end of year......... 2,251 2,302 2,486
=============== =============== ===============
Options exercisable at end of the year..... 662 528 439
Option price range per share............... $2.50 to $10.25 $3.00 to $10.25 $3.00 to $10.25

The 662 exercisable options at December 31, 1998, are exercisable at an
average exercise price of $4.96. The Company's current option plans, which
provide for a total of 3,060 options, have 661 options remaining for future
grants at December 31, 1998.

The Company adopted the disclosure only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" in fiscal 1996. As permitted by SFAS
No. 123, the Company continues to measure compensation cost in accordance with
Accounting Principles Board ("APB") Opinion No. 25 and related interpretations
in accounting for its plans. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under these plans consistent with the method of SFAS 123, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below:

YEAR ENDED DECEMBER 31,
---------------------------
1998 1997 1996
------ ------- ------

Net income (in thousands) As reported.......................... $2,526 $12,407 $9,436
Pro forma............................ $2,289 $12,195 $9,100
Basic earnings per share As reported.......................... $ .12 $ .53 $ .39
Pro forma............................ $ .11 $ .52 $ .38
Diluted earnings per share As reported.......................... $ .12 $ .52 $ .39
Pro forma............................ $ .11 $ .51 $ .38

The effect on net income and earnings per share is not expected to be
indicative of the effects on net income and earnings per share in future years.
Since the SFAS No. 123 method of accounting has not been applied to options
granted prior to 1995, the resulting pro forma compensation costs may not be
representative of those to be expected in future years. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following assumptions:

YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------

Expected volatility............................. 38.9% 34.7% 37.8%
Risk-free interest rate......................... 5.26% 5.83% 6.36%
Expected life of options in years............... 7 years 7 years 7 years
Expected dividend yield......................... 0% 0% 0%

During fiscal years 1998, 1997 and 1996 the weighted average grant-date
fair value of options granted was $2.22, $3.16, and $1.16 per share,
respectively.

26
27
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. SHAREHOLDER RIGHTS PLAN:

The Company has a Shareholder Rights Plan which provides that under certain
circumstances each Right will entitle the shareholder to purchase one
one-hundredth of a share of Series A Participating Preferred Stock at an
exercise price of $40. Upon the occurrence of certain other events, including if
a "Person" becomes the beneficial owner of more than 20% of the outstanding
Common Shares or an "Adverse Person" becomes the beneficial owner of 10% of the
outstanding Common Shares, the holder of a Right will have the right to receive,
upon exercise, Common Shares of the Company, or Common Stock of the acquirer,
having a value equal to two times the exercise price of the Right. The
Shareholder Rights Plan is designed to deter abusive market manipulation or
unfair takeover tactics and to prevent an acquirer from gaining control of the
Company without offering a fair price to all shareholders. The Rights expire on
November 2, 2003, unless redeemed prior to that date. The Rights can be redeemed
at a price of $.01 per Right.

10. BENEFIT PLANS:

The Company sponsors a 401(k) defined contribution plan which covers
substantially all of its employees who have satisfied the plan's eligibility
requirements. Participants may contribute to the plan by voluntarily reducing
their salary up to a maximum of 15% of qualified compensation subject to annual
I.R.S. limits. All contributions vest immediately. For 1998, the matching
contribution was 100%, up to the first 2% of qualified compensation, and 50% of
the next 4% of such compensation. The Company has also made discretionary
contributions to the plan. The Company's provisions for matching and
discretionary contributions totaled approximately $788, $779 and $755 for the
years ended December 31, 1998, 1997 and 1996, respectively. Voluntary after-tax
contributions and certain rollover contributions are also permitted.

The Company also sponsors a non-qualified deferred compensation plan which
permits key employees to annually elect (via individual contracts) to defer a
portion of their compensation on a pre-tax basis until retirement. The
retirement benefit to be provided is based on the amount of compensation
deferred, Company match and investment earnings. All contributions vest
immediately. Although the Plan is designed to be unfunded, the Company has
funded the deferred compensation liability with investments in marketable
securities, primarily stock mutual funds, which are classified as current
assets. The Company's provisions for matching and discretionary contributions
totaled approximately $154, 163 and $42 for the years ended December 31, 1998,
1997 and 1996, respectively. The deferred compensation liability and related
assets recorded by the Company were $2,332 and $1,350 as of December 31, 1998
and 1997, respectively.

The Company does not offer any other post-retirement benefits, accordingly,
it is not subject to the provisions of SFAS No. 106, "Employers' Accounting for
Post Retirement Benefits Other Than Pensions."

11. SHARE REPURCHASE PROGRAM:

27
28
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. EARNINGS PER SHARE:

In the fourth quarter of 1997, the Company adopted SFAS No. 128, Earnings
per Share, which modifies the calculation of earnings per share. The Standard
replaces the previous presentation of primary and fully diluted earnings per
share to basic and diluted.

Basic earnings per share excludes dilution and is computed by dividing
income by the weighted average number of common shares outstanding for the
period. Diluted earnings per share includes the dilution of common stock
equivalents. All prior periods presented have been restated to reflect this
adoption.

1998 1997 1996
------ ------- ------

Net income.................................................. $2,526 $12,407 $9,436
====== ======= ======
BASIC:
Common shares outstanding, net of treasury shares,
beginning of year...................................... 22,911 24,030 23,999
Weighted average common shares issued during year......... 17 40 11
Weighted average treasury shares repurchased during
year................................................... (1,560) (517) --
------ ------- ------
Weighted average common shares outstanding, net of treasury
shares, end of year....................................... 21,368 23,553 24,010
====== ======= ======
Net income per common share................................. $ .12 $ .53 $ .39
====== ======= ======
DILUTED:
Common shares outstanding, net of treasury shares,
beginning of year...................................... 22,911 24,030 23,999
Weighted average common shares issued during year......... 17 40 11
Weighted average common share equivalents................. 194 391 173
Weighted average treasury shares repurchased during
year................................................... (1,560) (517) --
------ ------- ------
Weighted average treasury shares outstanding, net of
treasury shares, end of year.............................. 21,562 23,944 24,183
====== ======= ======
Net income per common share................................. $ .12 $ .52 $ .39
====== ======= ======

13. BUSINESS SEGMENT INFORMATION:

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information". The
provisions of this statement require disclosure of financial and descriptive
information about an enterprise's operating segments in annual and interim
financial reports issued to shareholders. The statement defines an operating
segment as a component of an enterprise that engages in business activities that
generate revenue and incur expense, whose operating results are reviewed by the
chief operating decision maker in the determination of resource allocation and
performance, and for which discrete financial information is available. The
Corporation adopted the provisions of this statement for the year ended December
31, 1998. Refer to Note 7 for disclosures related to major customers.

28
29
ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. BUSINESS SEGMENT INFORMATION: (CONTINUED)
Management has determined that the Company consists of a single operating
segment, therefore, the disclosure requirements of SFAS 131 consist only of
revenues and long lived assets by geographic location. All prior period
disclosures are also provided below:

1998 1997 1996
-------- -------- --------

Revenues, net:
United States............................ $268,227 $309,274 $275,214
All other countries...................... 14,493 16,143 10,909
-------- -------- --------
$282,720 $325,417 $286,123
======== ======== ========
Long Lived Assets, net:
United States............................ $ 31,325 $ 41,087 $ 36,927
All other countries...................... 5,475 1,805 356
-------- -------- --------
$ 36,800 $ 42,892 $ 37,283
======== ======== ========

29
30

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

None

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required by this Item with respect to Executive Officers of the
Company is set forth in Part I of this Annual Report on Form 10-K. Information
required by this Item with respect to members of the Board of Directors of the
Company contained under the headings "Nominees for Terms Expiring in 2001" and
"Directors whose Terms Expire in 2000" in the Company's Proxy Statement, dated
March 26, 1999, is incorporated herein by reference.

Information required by this Item with respect to compliance with Section
16 of the Exchange Act contained under the heading "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Proxy Statement, dated March
26, 1999, is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item relating to executive compensation
contained under the headings "Compensation of Directors", "Executive Officers'
Compensation", "Options Grants in 1998", "Aggregated Option Exercises in 1998
and Year-End Option Values", and "Change-in-Control and Other Employment
Arrangements" in the Company's Proxy Statement, dated March 26, 1999, is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item contained under the headings
"Security Ownership of Certain Beneficial Owners" and "Security Ownership of
Management", in the Company's Proxy Statement, dated March 26, 1999, is
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None

30
31

PART IV

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

PAGE
-----

(a)(1) FINANCIAL STATEMENTS
Report of Independent Accountants........................... 15
Consolidated Balance Sheets at December 31, 1998 and 1997... 16
Consolidated Statements of Operations -- Years Ended
December 31, 1998, 1997 and 1996............................ 17
Consolidated Statement of Shareholders' Equity -- Years
Ended December 31, 1998, 1997 and 1996...................... 18
Consolidated Statements of Cash Flows -- Years Ended
December 31, 1998, 1997 and 1996............................ 19
Notes to Consolidated Financial Statements.................. 20-29
(2) FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedule of
Royal Appliance Mfg. Co. and Subsidiaries is included in
Item 14(d):
Report of Independent Accountants on Financial Statement
Schedule.................................................... 33
Schedule II -- Valuation and Qualifying Accounts........... 34
All other schedules for which provision is made in the
applicable accounting regulations of the Securities and
Exchange Commission are not required under the related
instructions, are inapplicable, or the information has been
included in the Notes to Consolidated Financial Statements
(3) EXHIBITS
The exhibits filed herewith are set forth on the Index to
Exhibits filed as part of this report....................... 35-36
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
December 31, 1998........................................... --

31
32

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on this 15th day of
March, 1999.
ROYAL APPLIANCE MFG. CO.
Registrant

/s/ Michael J. Merriman

--------------------------------------
Michael J. Merriman
Chief Executive Officer and President

Date March 15, 1999

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated, as of the 15th day of March 1999.

SIGNATURE TITLE
--------- -----

/s/ MICHAEL J. MERRIMAN Chief Executive Officer, President and Director
- ------------------------------------------------ (Principal Executive Officer)
Michael J. Merriman

/s/ RICHARD G. VASEK Chief Financial Officer and Secretary
- ------------------------------------------------ (Principal Financial and Accounting Officer)
Richard G. Vasek

/s/ R. LOUIS SCHNEEBERGER* Chairman of the Board
- ------------------------------------------------
R. Louis Schneeberger

/s/ JACK KAHL JR.* Director
- ------------------------------------------------
Jack Kahl Jr.

/s/ E. PATRICK NALLEY* Director
- ------------------------------------------------
E. Patrick Nalley

/s/ J.B. RICHEY* Director
- ------------------------------------------------
J.B. Richey

/s/ JOHN P. ROCHON* Director
- ------------------------------------------------
John P. Rochon

* The undersigned, by signing his name hereto, does hereby sign this Form 10-K
on behalf of Royal Appliance Mfg. Co., and the above named directors and
officers of Royal Appliance Mfg. Co., pursuant to a Power of Attorney executed
on behalf of Royal Appliance Mfg. Co. and each of such directors and officers
and which has been filed with the Securities and Exchange Commission.

/s/ MICHAEL J. MERRIMAN
--------------------------------------
Michael J. Merriman, Chief Executive
Officer, President and Director, and
Attorney-in-Fact

32
33

REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE

To the Shareholders and Board of Directors of
Royal Appliance Mfg. Co.

Our audits of the consolidated financial statements referred to in our
report dated February 12, 1999, appearing on page 15 of the Form 10K also
included an audit of the financial statement schedule listed as Exhibit 27 of
this Form 10K. In our opinion, this financial statement schedule presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.

PricewaterhouseCoopers LLP

Cleveland, Ohio
February 12, 1999

33
34

ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR YEARS ENDED DECEMBER 31, 1996, 1997, AND 1998

BALANCE AT ADDITIONS CHARGED TO BALANCE AT
DESCRIPTION BEGINNING OF YEAR EXPENSES AND COSTS DEDUCTIONS END OF YEAR
----------- ----------------- -------------------- ---------- -----------
(DOLLARS IN THOUSANDS)

ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Year Ended
December 31, 1996............... $2,000 $ 144 $ 794(A) $1,350
Year Ended
December 31, 1997............... $1,350 $ 225 $ 175(A) $1,400
Year Ended
December 31, 1998............... $1,400 $ 134 $ 34(A) $1,500

INVENTORY RESERVE:
Year Ended
December 31, 1996............... $1,689 $ 760(B) $1,048(C) $1,401
Year Ended
December 31, 1997............... $1,401 $ 305(B) $ 712(C) $ 994
Year Ended
December 31, 1998............... $ 994 $1,339(B) $ 858(C) $1,475

Note: (A) Uncollectible accounts charged off, less recoveries.
(B) Reserve for product model changes.
(C) Disposal of obsolete inventory.

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35

ROYAL APPLIANCE MFG. CO. AND SUBSIDIARIES

INDEX TO EXHIBITS
FOR FORM 10-K

EXHIBIT DESCRIPTION
- ------- -----------

3(a) Articles of Incorporation, amended and restated May 4, 1992,
filed as Exhibit 3.1 of Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1992, filed with
the Commission on August 13, 1992, and incorporated herein
by reference.
3(b) Code of Regulations, amended and restated May 4, 1992, filed
as Exhibit 3.2 of Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1992, filed with the
Commission on August 13, 1992, incorporated herein by
reference.
3(c) Amendment to Amended and Restated Articles of Incorporation
October 21, 1993, filed as an Exhibit to Registrant's Form
8-K filed with the Commission on November 1, 1993, and
incorporated herein by reference.
4(a) Credit Agreement dated as of May 1, 1998, by and among the
Registrant and various banks including National City Bank as
administrative agent. Filed as Exhibit 4(a) of Registrant's
Quarterly Report on form 10-Q for the quarter ended June 30,
1998.
4(b) Receivable Purchase and Servicing Agreement dated as of
September 29, 1997, by the Registrant, Royal Appliance
Receivables, Inc., as Seller, and Llama Retail Funding L.P.,
as Purchaser. Filed as Exhibit 4(b) of Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997, filed with the Commission on November
12, 1997, and incorporated herein by reference.
The Registrant agrees to furnish copies of certain of its
other long-term debt to the Commission upon request.
4(c) Shareholder Rights Agreement dated as of October 21, 1993,
filed as an Exhibit to Registrant's Form 8-K filed with the
Commission on November 1, 1993, and incorporated herein by
reference.
10(a) Royal Appliance Mfg. Co. 1991 Stock Option Plan for Outside
Directors, filed as
Exhibit 10.12 to the Registrant's Registration Statement on
Forms S-1, filed with the Commission on August 6, 1991, file
number 33-41211 (the "Initial Registration Statement"),
incorporated herein by reference.
10(b) Royal Appliance Mfg. Co. Employees and Consultants Stock
Option Plan, filed as Exhibit 10.13 to the Initial
Registration Statement, incorporated herein by reference.
10(c) Form of Indemnity Agreement for Directors and Officers of
the Registrant, filed as Exhibit 10.38 to the Initial
Registration Statement, incorporated herein by reference.
10(d) Lease dated December 11, 1981 by and between Syndicated
Properties and the Registrant, as amended, filed as Exhibit
10.7 to the Initial Registration Statement, incorporated
herein by reference.
10(e) Annual Management Incentive Plan Description. Filed as
Exhibit 10(f) to the Annual Report on Form 10-K for the year
ended December 31, 1993, incorporated herein by reference.
10(f) Royal Appliance Mfg. Co. Key Executive Long-Term Incentive
Plan filed as Exhibit 10(f) to the Annual Report on Form
10-K for the year ended December 31, 1995, incorporated
herein by reference.
10(g) Form of Severance and Employment Agreement between the
registrant and Mssrs. Merriman, Dieterich, Holcomb, Moone
and Vasek, as Exhibit 10(g) to the Annual Report on Form
10-K for the year ended December 31, 1994, incorporated
herein by reference.

35
36

EXHIBIT DESCRIPTION
- ------- -----------

10(h) Employment Agreement dated September 15, 1995, between the
Registrant and Mr. Merriman filed as Exhibit 10(I) to the
Annual Report on Form 10-K for the year ended December 31,
1995, incorporated herein by reference.
10(i) Royal Appliance 401(k) Plus Plan, effective July 1, 1996,
filed as Exhibit 10(i) to the Annual Report on Form 10-K for
the year ended December 31, 1997, incorporated herein by
reference.
10(j) Royal Appliance Deferred Compensation Plan for Outside
Directors, filed as Exhibit 10(j) of Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998,
filed with the Commission on August 7, 1998 and incorporated
herein by reference.
21 Subsidiaries of Registrant
23 Consent of PricewaterhouseCoopers LLP regarding S-8
Registration.
24 Powers of Attorney of the Registrant, Directors and
Principal Financial Officer of the Registrant.
27 Financial Data Schedule for Current Period
99.1 Form 11-K Annual Report for Royal Appliance 401(k)
Retirement Savings Plan
99.2 Consent of independent accountants