SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON, D.C.
                             ---------------------

                                  FORM 10-K/A

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934 (FEE REQUIRED)

                   For the Fiscal Year Ended October 3, 1998

[_]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934 (NO FEE REQUIRED) FOR THE TRANSITION PERIOD
      FROM _______________ TO _______________


                           Commission File No. 1-6635
                             ----------------------


                         APPLIED MAGNETICS CORPORATION
                         -----------------------------
            (Exact name of registrant as specified in its charter)


           Delaware                                      1-6635
           --------                                      ------
(State or other jurisdiction of                 (Commission file number)
incorporation or organization)


                                  95-1950506
                                  ----------
                     (I.R.S. Employer Identification No.)


                      75 Robin Hill Road, Goleta, CA 93117
                   ------------------------------------------
               (Address of principal executive office) (Zip Code)


       Registrant's telephone number, including area code: (805) 683-5353
                                                           --------------

         Securities registered pursuant to Section 12 (b) of the Act:

                                                 Name of Each Exchange on
      Title of Each Class                             Which Registered
      -------------------                             ----------------
      Common Stock, $.10 par value               New York Stock Exchange
      Preferred Stock Purchase Rights            New York Stock Exchange






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       Securities registered pursuant to Section 12 (g) of the Act: None

                               (Title of Class)

      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 or Regulation S-K is not contained herein and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or in any
amendment to this Form 10-K. [_]

      The aggregate market value of the Common Stock held by non-affiliates of
registrant was $185,317,135 as of December 17, 1998.


                   Common Stock (Par Value $.10) 24,106,294

                      DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Proxy Statement for the registrant's 1999 Annual Meeting
of Stockholders, to be filed pursuant to Regulation 14A within 120 days
following the registrant's fiscal year ended October 3, 1998 are incorporated by
reference into Part III of this Form 10-K.

      The undersigned hereby amends Item 1, Item 7 and Item 8 of its Annual
Report on Form 10-K filed with the Commission on December 23, 1998.























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ITEM 1.  BUSINESS

General

      Applied Magnetics Corporation (the "Company" or "Applied Magnetics") was
incorporated in California in 1957 and was reincorporated in Delaware in 1987.

      The Company presently operates in one industry segment namely, components
for the computer peripheral industry with one major product group, recording
heads for hard disk drives which are used in computer applications.

      Applied Magnetics is an independent manufacturer of magnetic recording
heads and of head stack assemblies for disk drives. The Company manufactures
advanced inductive thin film ("thin film") disk head products and is in the
process of qualifying its 4.3 gigabyte per 3.5 inch disk magnetoresistive ("MR")
disk head products, in each case, primarily to supply to manufacturers of 3.5
inch hard disk drives. The Company's products compete on the basis of price,
performance, quality and availability. The Company has also begun development of
disk head products based on the technology of giant magnetoresistance ("GMR"),
also intended for computer drive applications. See "Technology" and "Products"
sections for discussion of these products.

       Multimedia personal computers and high end computer applications such as
network servers (Internet and Intranet), workstations and mainframes are driving
the continued demand for greater data storage capacity and performance. In
addition, the market growth of notebook and sub-notebook computers has increased
demand for smaller form factor disk drives. In fiscal 1998 the industry
accelerated the shift from inductive thin film to MR technology due to
requirements for greater storage capacity and performance. MR disk heads, which
generally permit greater storage capacities per disk and provide higher data
transfer rates than thin film disk heads, now represent the fastest growing
segment of the recording head industry.

      The disk drive industry entered into a general slowdown late in the first
quarter of fiscal 1998 and simultaneously accelerated the transition from disk
drives using advanced inductive thin film recording heads to magnetoresistive
recording heads. The Company's largest customer at the time, Western Digital
Corporation ("Western Digital"), sharply reduced its production schedules as a
reaction to the hard disk drive oversupply in the industry's distribution
channel. As a result, the Company experienced significant cancellations,
production reschedules and price reductions that impacted revenue, operating and
financial results throughout fiscal 1998. The Company was late to market with
its 2.1, 2.8, and 3.4 gigabyte per 3.5 inch disk MR products. As a result, MR
head shipments were not a significant source of revenue in fiscal 1998. The

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Company expects to ship inductive thin film products at the 2.1 gigabyte per
3.5 inch disk capacity point through the third quarter of fiscal 1999. During
fiscal 1998, market conditions in the disk drive industry served by the Company
were characterized by continued short product life cycles and intense
competition. The industry product life cycle is currently running approximately
9 to 12 months.

      In response to reductions in production schedules, the Company reduced
expenditures, including capital spending, in order to realign costs to the
decreased level of business. In addition, the Company shut down its
manufacturing facility in Ireland in order to consolidate foreign manufacturing
operations. A pre-tax restructuring charge of $8.4 million was recorded during
the first quarter of fiscal 1998, primarily related to the shutdown of the
Ireland facility. Included in the charge was the write-down of certain tooling
and equipment. The Company also decreased worldwide headcount from approximately
8500 to 5200 employees by the end of fiscal 1998.

      The Company has focused its long-range growth strategy on MR and GMR disk
head technologies and believes that GMR disk heads, which ultimately afford
greater recording densities and other performance advantages as compared to
either thin film or MR heads, represent the next important magnetic recording
head technology.

      Fiscal 1999 will be another year of significant technology transition, as
the Company continues its product evolution from predominantly inductive thin
film to MR and GMR technology. The Company made significant technology
investments in fiscal 1998 and strengthened its MR development infrastructure,
by reorganizing its Wafer Development group, adding new management and
engineering personnel with significant MR experience, expanding its MR and GMR
wafer fabrication facilities and converting its inductive thin film wafer
fabrication facility and equipment to have the capability of manufacturing the
inductive thin film write element for MR and GMR heads. A successful transition
will, however, require the Company's engineering and production resources to
meet their targeted design and process development plans, achieve timely
qualification on customer MR and GMR drive programs and execute planned
production ramps of these products. Failure to achieve program qualification in
a timely manner could have a material adverse effect on the Company's financial
results.

      The Company announced plans to merge with DAS Devices, Inc., on November
25, 1998. DAS was founded in 1996, primarily as a research and development
center focused on MR and GMR product development. The combination of the two
companies seeks to combine DAS Devices' proprietary and patented state-of-the-
art wafer technology with the Company's high volume manufacturing capability.
The merger is expected to allow the Company to accelerate its time to market
performance and enhance the production readiness of GMR technology at areal
densities up to 5 gigabytes per square inch, capable of recording 6.4 gigabytes
on a 3.5 inch disk. Prototype units for GMR products targeting both 6.4 and 8.5
gigabytes per 3.5 inch disk have been made available for customer evaluation.

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Disk Drive Industry

      Hard disk drives are the predominant high capacity data storage device
used in all classes of computers. Hard disk drives typically include one to ten
disks onto and from which data is recorded and retrieved by two to twenty
recording heads. These heads are positioned by an actuator assembly to fly
within a microinch, or less, on one or both sides of each disk. The head (or
"slider") attached to a suspension assembly comprises a head gimbal assembly
("HGA"). Multiple HGAs, assembled together with other components, comprise a
head stack assembly ("HSA"). The Company supplies both HGAs and HSAs to disk
drive manufacturers.

      Disk drive manufacturers are constantly developing higher capacity and
higher performance products. Independent head suppliers, such as the Company,
work with the drive manufacturers to develop customized HGAs and HSAs for each
new drive program. Head suppliers seek to have their products "designed-in" for
a particular drive program, thus becoming a "primary supplier". Achieving
primary supplier status usually offers a competitive advantage, manifested as
higher internal yields and more favorable pricing, compared to entering the
program later in its product life cycle.

      The Company experienced a sudden drop in the demand for its family of
inductive thin film heads starting in the middle of its first fiscal quarter of
1998. This drop in demand was due in part to an overall softening in the disk
drive industry, demand for recording heads and in part due to a rapid industry
wide adoption of MR based recording head technology in the desktop platform. The
Company was unable to respond to this shift and as a result failed to achieve
qualification on several desktop programs at the 2.8 and 3.4 gigabyte per 3.5
inch disk capacity points. As a result, the Company experienced a rapid
sequential decline in revenue each quarter during fiscal 1998. The overall
market demand entering fiscal 1999 has improved as excess disk drive inventory
that has been present in the channel for most of the past year appears to have
been reduced to normal levels. As a result, many disk drive manufacturers have
generally indicated a firming in demand for their products and growth should
more closely parallel the forecasted growth in PC unit shipments.

      The disk drive industry is cyclical and historically has experienced
periods of oversupply and reduced production levels, resulting in significantly
reduced demand for disk heads, as well as pricing pressures. The effect of these
cycles on suppliers, including the Company, has been magnified by hard disk
drive manufacturers' practice of ordering components, including disk heads, in
excess of their needs during periods of rapid growth, which increases the

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severity of the drop in the demand for components during periods of
reduced growth or contraction.

      The disk drive industry is intensely competitive and largely dependent on
sales to a limited number of major disk drive manufacturers and systems
companies. Due to the small number of disk drive manufacturers and systems
companies requiring independent sources of supply for magnetic recording heads,
the Company's customer base is likely to remain concentrated. In addition, the
customer base may become more concentrated if disk drive manufacturers that do
not have their own internal capabilities for designing and producing disk heads
adopt and implement further vertical integration strategies (such as producing
components that can also be purchased from independent manufacturers). The
Company believes that industry conditions and economic factors will continue to
create an environment in which drive manufacturers unable to produce their own
disc heads will require, as their primary source of supply, independent
suppliers of magnetic recording heads and in which disk drive, drive
manufacturers and systems companies capable of internally producing disc heads
will require alternative or "secondary" sources of supply. However, the further
consolidation or integration of one or more of the Company's major customers
with other disk drive or disk head firms could have an adverse effect on the
Company's business. Such occurrences, however, could potentially be offset by
the entry of new manufacturers in the disk drive market.
See "Competition" for further discussion.

Technology

      Magnetic disk heads are electromechanical devices that record ("write")
data onto and retrieve ("read") data from the magnetic layers of magnetic data
storage disks. The principal elements of an inductive magnetic recording head
are a magnetic core, which is interrupted by a non-magnetic gap, and an
electrically conducting coil wrapped or deposited in turns around the core. To
write data, a current is passed through the coil, thereby inducing a magnetic
field in the core. Since the core is interrupted by a non-magnetic gap, the
magnetic field must "fringe" out from the gap, and in doing so, it magnetizes a
segment of the disk. Reversing the direction of the current reverses the
polarity of the next magnetized segment of the disk as it passes by the gap of
the head, thus allowing data to be encoded as a pattern of reversing polarities.
To read data, the previously encoded disk is again passed by the head and the
reversing magnetic polarities induce reversing magnetic fields in the core.
These reversing magnetic fields in the core generate correspondingly reversing
currents in the coil, which are sensed and decoded by the drive circuitry.
Inductive thin film heads are produced with processes originally adapted from
semiconductor manufacturing, in which thin films of magnetic, conductive and
insulating materials are deposited on a nonmagnetic substrate to form the core
and the electrical coils of the head.


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      In contrast to an inductive disk head, which is typically designed to
"read" and "write" data using a single inductive element, an MR disk head uses
an inductive thin film element to "write" data onto the disk (as described
above) and a separate MR element to "read" data from the disk. The MR read
element incorporates a magnetoresistor whose electrical resistance changes in
the presence of a magnetic field. As the encoded disk is passed by the read
element, the disk drive circuitry senses and decodes the changes in electrical
resistance caused by the reversing magnetic polarities. The greater sensitivity
of MR read elements provides higher signal output per unit of recorded track
width on the disk surface. As a result, MR disk heads have certain design and
performance advantages over inductive heads, particularly in high performance
disk drive applications. In addition, MR disk heads can read data from a
rotating disk independent of the speed of rotation, thus allowing these devices
to read data more reliably from small form factor disks in which linear
velocities are inherently lower. MR disk heads also allow for optimization of
read and write gaps independently. Typical inductive heads incorporate a single
gap for both read and write functions. As with inductive thin film heads, MR
disk heads are produced utilizing semiconductor-like manufacturing processes to
deposit and pattern thin films of magnetic, conducting and insulating materials
on a nonmagnetic substrate to form the MR head elements.

      The Company believes that GMR disk heads represent the next important
magnetic recording head technology. As with an MR head, a GMR head utilizes a
separate inductive thin film write element in conjunction with the read element.
In this case, the read element is formed from smaller, more complex
magnetoresistive structures, which exhibit even higher (hence, "giant")
sensitivity to the reversing magnetic fields from the disk. This effect, known
as giant magnetoresistivity, allow GMR heads to achieve even higher areal
densities and performance levels than either inductive thin film or MR disk
heads.

      Disk drive storage capacity and performance are largely determined by the
magnetic properties and interface of the recording head and disk. The design
geometries and magnetic materials of the recording head are each optimized to
achieve required performance, and are selected to provide appropriate writing
and maximum readback signal levels. Higher data densities typically require that
the head fly both closer to the disk and at more uniform flying heights across
the disk or, alternatively, that the head maintain a light contact with the disk
at a point near the head's gap, with the disk sliding over this portion of the
head (known as contact recording). This is influenced by the size and mass of
the head and by its hydrodynamic air bearing design and performance
characteristics, which are also optimized to achieve required performance in the
disk drive.

      Historically, thin film disk heads have represented more cost-effective
design alternatives for hard disk drives than have MR disk heads. However, as
demand for higher capacities and higher performance from disk drives has grown,

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there has been a corresponding increase in demand for disk heads that provide
higher areal densities and data transfer rates. This technology and market shift
has resulted in disk head specifications that now predominantly require higher
performance MR heads. Further, the Company believes that rapidly increasing
areal density requirements will result in a demand for even higher performance
GMR heads, beginning in fiscal 1999.

Products

      During fiscal 1998, the Company qualified and made volume production
shipments on new disk drive programs which required inductive thin film
products. The Company's inductive thin film products are produced in volume for
3.5 inch disk drives to achieve areal densities of up to approximately 1.5
gigabits of data per square inch of disk surface, providing data storage
capacities of up to 2.1 gigabytes per 3.5 inch disk. However, this is expected
to represent the last new generation of inductive thin film products, as the
Company's product mix transitions to MR and GMR technology during fiscal 1999.

      During fiscal 1998, the majority of the disk head products supplied by the
Company were in the "picoslider" or "30%" form factor (in which the slider is
approximately 30% of the size, in each of its three dimensions, of the original
inductive thin film slider). The Company has been and continues to develop MR
products in both the picoslider and the larger "nanoslider" (or "50%") form
factor, as well as GMR products in the picoslider form factor.

      Development and commercialization of both MR and GMR disk heads continued
to be a major investment for the Company in fiscal 1998. During fiscal 1998, the
Company shipped prototype and qualification samples of MR disk head products to
selected customers for drive applications with recording densities of up to 3.4
gigabits per square inch, corresponding to storage capacities of up to 4.5
gigabytes per 3.5 inch disk. In addition, during fiscal 1998, the Company
shipped its first samples of GMR disk heads, aimed at products with densities up
to about 4.75 gigabits per square inch and capacities of about 6.5 gigabytes per
3.5 inch disk. During fiscal 1999, it is anticipated that both the MR and GMR
products at these capacity points will enter volume production. This will
require the Company's engineering and production resources to successfully meet
their targeted design and process development plans, achieve qualification on
customer drive programs and execute the planned production ramps. Failure to
achieve volume production for MR and GMR products on a timely basis may have a
material adverse effect on the Company's financial results.


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Manufacturing

 Wafer / Slider Fabrication

      MR, GMR and inductive thin film transducers are manufactured using a
semiconductor-like wafer fabrication process. This process involves
photolithography, vacuum deposition, wet chemical and plasma etching and
precision electroplating technologies. The Company's two wafer fabrication
facilities in Goleta, California, are based on 150mm (approximately six inch)
diameter round substrates. In fiscal 1997, production of inductive thin film
products transitioned from the nanoslider form factor, where approximately 8,400
individual (unyielded) sliders can be produced from each six inch wafer, to the
picoslider form factor, where approximately 14,700 individual (unyielded)
sliders can be produced from each wafer. The majority of the Company's revenue
in fiscal 1998 was from the inductive thin film picoslider form factor. During
fiscal 1998, the Company developed MR products which can be processed as either
nanoslider or picoslider form factor. GMR products will be processed in the
picoslider form factor and are expected to transition from the primarily
nanoslider footprint of MR in the later part of fiscal 1999.

      In the first fiscal quarter of 1998, the Company completed the second
phase of its wafer facility expansion in Goleta, California, which, when fully
equipped and tooled, will have the capacity to produce over 300 MR and/or GMR
wafers per week. Completed wafers are then sliced into row bars containing 29
sliders per bar for the nanoslider form factor and 44 sliders per bar for the
picoslider form factor. Row bars are then shipped to Penang, Malaysia for
further processing.

      Rows are converted into individual sliders in the Company's slider
fabrication facility in Penang, Malaysia. This process involves high precision
lapping as well as photolithography and ion milling technologies utilized to
define the critical air bearing geometries which allow the head to fly at about
one microinch above the disk surface. On inductive thin film products,
photolithography and ion milling technologies are also used to define pole tip
geometries and hence recording densities produced by the heads. For MR and GMR
products, a thin, hard carbon overcoat is vacuum deposited onto the air bearing
surface of the head in order to improve the performance of the head/disk
interface and to provide added protection for the magnetic elements of the head.

      All of the aforementioned processes and their process yields directly
define final production output and Company revenue. Typically, new head designs
require higher performance and place increasing demands on process technology.
The Company's ability to execute depends on its ability to develop new
processing technology, maintain control over its processes and ramp these new
products into production volume in a timely and cost effective manner. The
Company believes that development of new products involving MR and GMR
technologies will be critical to future revenue.

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      The Company believes that future demand for recording heads will continue
to grow. To meet this demand, it will be critical that wafer and slider output
increase. This increase will be dependent on the Company's ability to generate
the required capital funding. If the Company is unable to obtain the required
funds in sufficient amounts and at the required times, its future revenues could
be adversely affected. See "Liquidity and Capital Resources" under Item 7.

Assembly and Test

      The Company assembles all of its volume production of HGAs and HSAs
outside of the United States. Principal manufacturing sites are in Penang,
Malaysia; Chung-Ju, South Korea ("Korea"); and Beijing, Peoples Republic of
China ("China").

      In HGA assembly, wire elements or flexible circuitry are attached to bond
pads on the slider and the slider is then bonded to the stainless steel
flexure/suspension. The Company then tests the head's read/write capability and
the circuit integrity of the magnetic elements. The HGAs, along with the
actuator coil and a flexible printed circuit cable are mounted on the actuator
to form a headstack assembly ("HSA") which allows the heads to be positioned
within the disk drive. The HSA also includes a write/read preamplifier and head
selection circuitry and may include other miscellaneous parts such as bearings,
a voice coil and a connector, depending on the design of the customer's disk
drive. In fiscal 1998, the Company completed various projects to mitigate
electrostatic discharge ("ESD") effects on sensitive MR and GMR elements, and
control of contamination sources due to lower flying height sensitivity.

      The Company also maintains contractual relationships with unaffiliated
parties that provide manufacturing space and contract labor in Korea, Malaysia,
China and the Philippines. The Company plans on continuing such relationships in
the future, as required by production demand.

      The Company closed its Dublin, Ireland assembly plant in fiscal 1998 due
to decreasing production volume. The Company terminated approximately 300
employees at the Ireland plant and incurred severance expenses of $2.9 million
in connection with those terminations.

      The Company terminated several sub-contract assembly relationships in
Malaysia in fiscal 1998 due to decreasing production volume. The Company did not
incur material losses as a result of terminating those sub-contract
relationships.

      From time to time, during periods of growth, the Company has experienced a
shortage of direct labor related to manufacturing. However, it is anticipated
that existing manufacturing facilities and contract labor relationships are
adequate to meet the Company's projected market and customer demand during
fiscal 1999.

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      The Company's foreign operations can be subject to risks associated with
currency exchange fluctuations, government approvals, political instability,
currency restrictions, trade restrictions, labor unrest, changes in tariff, and
the like. In fiscal 1991, the Korea facility was affected by a labor disruption
due to union activities. Production was impacted for approximately one quarter.
Experience indicates that these factors have not produced significant liability,
but there can be no certainty that these factors will not impact the Company's
future operations.

      The HSA business carries certain risks and demands in addition to those of
the HGA business. Among those risks are lower gross margins, slower inventory
turns, increased exposure to inventory obsolescence due to the larger number of
parts required for an HSA and the fact that each HSA program requires unique
components with long lead-time purchasing cycles, and varying product life spans
between different HSA models. There can be no assurance that the Company's HSA
operations will continue to be successful; the failure of such operations would
have a material adverse effect on the Company's business, operating results and
financial condition.

      The cost of purchased components incorporated into the Company HSAs
represents a substantial percentage of the total cost of manufacturing such
products. Accordingly, the Company's ability to maintain adequate margins in the
face of constant price erosion is principally a function of its ability to
obtain price reductions from its component vendors, to continuously improve
manufacturing yields and to improve productivity. Additionally, the Company
anticipates lower manufacturing yields and higher costs during the initial
production phase of MR and GMR heads in comparison to inductive thin film heads
primarily due to the process learning curve associated with the introduction of
the newer technology. As the Company continues to advance along the process
learning curve as it relates to MR and GMR head production, manufacturing yields
are expected to increase during fiscal 1999. There can be no assurance that the
Company will be able to achieve component cost levels, manufacturing yields and
productivity levels necessary to achieve adequate profitability.

Research and Development

      The Company commits substantial resources to technology, product and
process development in order to meet its customers' continuing demands for
higher performance disk heads for successive disk drive product families.
Technology development activities relate to creating technological advances
required for new product development and the advancement of production processes
required in new product manufacturing (e.g., development of smaller form factor
products, advanced materials and structures, constant flying height, contact

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air bearing recording technologies and the development of MR and GMR
technologies). In addition, development activities focus on conceptual
formulation, design and testing of new product alternatives and construction of
prototypes. Development activities relating to advanced disk head products are
predominantly performed at the Company's Goleta, California location. In
addition, the Company also has engineering and technical staff located at
various production operations worldwide to provide manufacturing process and
integration support.

      The Company's future success in achieving "design-in" positions and/or
program qualifications depends heavily on the successful and timely completion
of its product and process development efforts. While the Company is devoting
substantial resources to these efforts, there can be no assurance that the
Company will realize satisfactory product and process development results. To
the extent that the Company is unable to do so, there could be an adverse effect
on the Company's operating results.

      The Company's recent research and development ("R&D") efforts have been
primarily devoted to commercialization of MR and GMR disk head technology
products. Research and development expenses were $114.7 million, $52.5 million
and $50.9 million in fiscal years 1998, 1997 and 1996, respectively. The Company
believes that its existing cash resources, existing credit facilities, lease
financing arrangements and expected operating results will provides sufficient
financial resources to fund its ongoing research and development activities in
fiscal 1999. The Company expects to spend approximately $98 million in research
and development activities in fiscal 1999.

      On November 25, 1998, the Company announced plans to merge with DAS
Devices Inc. ("DAS"). DAS was founded in 1996, primarily as a research and
development center focused on MR and GMR product development. The Company and
DAS, have entered into a definitive agreement whereby a wholly owned subsidiary
of the Company will merge with and into DAS, which will then become a wholly
owned subsidiary of the Company. Upon completion of the merger, the stockholders
of DAS will receive approximately 13 million registered shares of the common
stock of the Company. The Company also entered into an agreement with certain
institutional investors to raise $20 million dollars simultaneously with the
completion of the merger, through a private placement of common equity.

      The merger of the two companies will combine DAS Devices' proprietary and
patented state-of-the-art wafer technology with the Company's high volume
manufacturing capability. It is anticipated that the merger will allow the
Company to accelerate its time to market performance and enhance the production
readiness of GMR technology at areal densities up to 5 gigabytes per square
inch, capable of recording 6.4 gigabytes on a 3.5 inch disk. Prototype

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units for GMR products targeting both 6.4 and 8.5 gigabytes per 3.5 inch disk
have been shipped to customers for initial evaluation.

Sources of Supply

      The Company relies on Sumitomo Corporation as its principal supplier of
substrates which are used to produce wafers for the Company's thin film and MR
and GMR disk heads and on multiple independent suppliers for other materials
used in the manufacturing process. The Company purchases suspension assemblies
from Hutchinson Technology, Incorporated and various other manufacturers. The
Company also manufactures suspension assemblies internally. Although the Company
has not experienced significant limitations on the availability of these
materials, shortages could occur in the future. Such developments could disrupt
the Company's production volume and have an adverse effect on the Company's
operations.

      For most customers, the HSA component materials (non-HGA) are typically
sourced, negotiated and controlled by the customer and not the Company. Failure
by the Company's customers to properly develop such component suppliers'
technology and install sufficient capacity could have a material adverse effect
on the Company's revenue.

Customers and Marketing

      The Company's customers in fiscal 1998 included, among others, Western
Digital and Samsung Electronics Co., Ltd., ("Samsung").

      The Company's magnetic recording disk heads are sold in the United States
and foreign countries by its direct sales personnel, with the exception of
Japan, where Hitachi Metals, Ltd. ("HML") acts as the Company's sales
representative.

      Western Digital represented approximately 72% of net sales during the year
ended October 3, 1998. During the first fiscal quarter of 1998, Western Digital
announced expected lower revenues and profits for that quarter, the action was
taken as a result of Western Digital's response to disk drive oversupply in the
industry's distribution channel and to increasing pricing pressures. The Company
was then notified of significant reductions to its order backlog due to Western
Digital's plan to substantially transition from thin film to MR disk drive
productions by the end of the third fiscal quarter of 1998.

      Samsung represented approximately 27% of net sales during fiscal 1998.
Samsung has been among the fastest growing suppliers of hard disk drives in 1998
and continues to manufacture drives based on both inductive thin film and MR
recording head technology.

      In October 1998, Quantum Corporation ("Quantum") and Matsushita Kotobuki
Electronics Industries, Ltd. ("MKE") announced an agreement to dissolve the
MKE-Quantum Components LLC ("MKQC") recording head joint venture and attempt

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to sell its U.S. operations. MKE announced its intent to continue to make slider
and HGA and HSA assemblies in its Batam, Indonesia facility in support of its
drive production relationship with Quantum. The Company derived less than 1% of
revenue from Quantum during fiscal 1998.

      MR and GMR program qualifications are under way with new customers in
order to increase the size of the Company's customer base. The Company's ability
to obtain new orders from customers depends on its ability to anticipate
technological changes, develop products to meet individualized customer
requirements and to achieve delivery of products that meet customer
specifications at competitive prices. In addition, the disk drive industry is
also intensely competitive and disk drive manufacturers may quickly lose market
share as a result of successful deployment of new technologies by their
competitors or various other factors. A significant reduction in orders or the
loss of a major customer, which could occur for a variety of reasons, including
bankruptcy, could have a material adverse effect on the Company's future
operating results. In addition, there can be no assurance that disk drive and
systems companies will not continue to vertically integrate and acquire the
ability to produce disk heads for their own use. Further consolidation of the
disk drive industry may reduce the number of disk drive programs requiring the
Company's products and may increase credit risks for the Company due to the
concentration of its customers. As a result, there is no assurance that vertical
integration of disk drive and system companies and consolidation within the disk
drive industry will not have a material adverse effect on the Company's future
operating results.

      The Company believes that the most effective means of marketing and
selling magnetic recording disk heads is by establishing close customer
relationships at the engineering level, which permits technical collaboration
and may result in the Company's heads being "designed-in" for particular disk
drives. Through its product planning and marketing efforts, the Company seeks to
identify those disk drive programs it believes will achieve high volume in order
to concentrate its engineering resources on these programs.

      The Company needs to be successful in achieving "design-in" positions with
certain customers on certain disk drive programs. There can be no assurance that
the Company will successfully obtain "design-in" positions on a sufficient
number of the new disk drive programs that it is currently pursuing or that it
expects to pursue, or that, after having achieved this position on any given
customer program, it will not experience difficulties in obtaining desired
levels of production volumes on a timely basis. The failure to secure and
satisfactorily perform against orders for volume shipments of MR and GMR disk
heads could result in customer cancellations, reschedules and diversion of
certain orders to the Company's competitors. To the extent any significant
orders for the Company's MR disk or GMR heads are canceled, rescheduled or
diverted, such actions could have a material adverse effect on the Company's
operations. See "Disk Drive Industry" for further discussion.

                                      -14-

<PAGE>





Competition

      The Company competes with other independent recording head suppliers, as
well as disk drive companies and systems companies that produce magnetic
recording heads used in their own products. Fujitsu, Ltd., Hitachi, Ltd., IBM
and Seagate Technology, Inc. ("Seagate"), produce some or all disk heads for
their own use. All of these companies have significantly greater financial,
technical and marketing resources than the Company.

      IBM has made its recording head products available in the original
equipment manufacturers ("OEM") market to competing drive manufacturers. During
1997, IBM expanded its disk drive and disk components business, including its MR
technology, by selling to OEM's. Historically, IBM had been a vertically
integrated company, producing heads only for internal use. The Company's
competitive position could be adversely affected if IBM continues to be
successful in marketing its advanced MR and GMR products at competitive prices.
On April 30, 1998, Western Digital and IBM entered into a letter of intent for a
broad-based hard drive component supply and technology licensing agreement. IBM
plans to supply Western Digital with its GMR heads and other components for
desktop hard drives. Western Digital introduced desktop hard drives based on IBM
products and designs in the first quarter of calendar year 1999. However, the
agreement does not preclude other head suppliers, such as the Company, from
competing on future non-IBM desktop programs at Western Digital, as well as on
all Enterprise Storage Group ("ESG") programs.

      The Company believes that disk drive customers and systems companies that
are not vertically integrated continue to represent significant opportunities
for sales of the Company's disk head products for competitive and other reasons.
Moreover, the Company believes that certain vertically integrated companies will
continue to rely on independent suppliers of disk head products as alternative
sources of supply, or in some cases, as primary sources of supply for individual
disk drive programs.

      Read-Rite Corporation ("Read-Rite") has had substantially greater sales of
disk head products than the Company and has been one of its largest competitors
among independent disk head manufacturers. Read-Rite and Sumitomo Metal
Industries, Ltd. ("SMI"') have a joint venture in Japan to make disk head
wafers.

      Currently, several large Japanese companies, each with considerably more
resources than the Company, compete in the independent head market and have had
considerable success in gaining market share. Alps Electric Corporation, Ltd.,
TDK Corporation (and its SAE Magnetics, Ltd. subsidiary,) and Yamaha Corporation
continue to aggressively develop and market recording heads.

                                      -15-

<PAGE>



      Other independent recording head manufacturers that are shipping, or
intend to ship, to the OEM marketplace include Headway Technologies, Inc.,
Silmag, Kaifa Technology, Inc. and Hitachi Metals Ltd.

      The principal competitive factors in the markets the Company addresses are
price, product performance, quality, product availability, responsiveness to
customers and technological sophistication. The disk head industry is intensely
competitive and largely dependent on sales to a limited number of disk drive
manufacturers and systems companies. See "Customers" for further discussion.

Backlog

      The Company's backlog of open orders scheduled for delivery within six
months at October 3, 1998 was approximately $10.8 million, compared to
approximately $137.5 million at September 27, 1997. Backlog includes only firm
orders for which the customers have released a specific purchase order and a
specified delivery schedule. Backlog decreased year to year as a result of
failure to qualify on MR programs and rapid transition away from inductive thin
film products.

      The Company receives purchase orders from its customers which express the
customers intentions to purchase, at stated unit prices, certain quantities of
products during a specified period, generally for one to two quarters. Orders
are subject to rescheduling provisions which permit increases or decreases in
volume of shipments during a specified period. In addition, at times of supply
shortages, the Company believes it is a common practice for disk drive
manufacturers to place orders in excess of actual requirements. Conversely,
during periods of soft demand the Company has experienced cancellation and
rescheduling of orders, reductions in quantities, shorter order lead time and
repricing as customer requirements change.

      The contractual agreements between the Company and most of its customers
permit the Company to assert claims for cancellation costs and expenses in these
circumstances. However, resolution of these claims is often a lengthy and
extensive process, resulting in a compromise arrangement in which, among other
things, the Company and the customer may agree that the claimed amount to be
paid is reduced or that the Company will continue to deliver and the customer
will accept all or part of the cancelled order over an extended period of time
at reduced unit prices. In fiscal 1998, we made a claim for $1.6 million in
connection with the cancellation of a master purchase order from Western
Digital. The claim was accepted and paid by Western Digital in fiscal 1998. The
customer is invoiced once agreement is reached on settlement of the particular
cancellation claim. There have not been any significant cancellation claims
during any of the three fiscal years ended October 3, 1998 or during the first
half of fiscal 1999. When we are notified by a customer that a contract is to be
cancelled, we review all inventory on hand to determine if we will be able to
recover our costs through the remainder of the contract. If we believe that our
inventory carrying costs may not be fully recoverable, we write the inventory
down, with a charge to income, to the amount that we believe will be
recoverable. All costs and expenses specifically incurred in connection with
cancellation claims are expensed as incurred.

                                      -16-

<PAGE>





      In previous years, particularly those in which the disk drive industry was
experiencing overcapacity and intense price competition conditions, certain of
the Company's customers reduced order backlog, delayed shipment dates and
requested extended payment terms and price concessions. In December of 1997,
Western Digital reduced its order backlog as it transitioned from inductive thin
film to MR disk drive production sooner than planned. These circumstances could
continue to occur in future periods which could adversely affect the Company's
revenues and profitability. Further, as a result of the foregoing factors, the
Company's backlog may not be indicative of product shipments in any future
period.

Employees

      As of October 3, 1998, the Company had approximately 5,200 employees of
whom approximately 1,000 were located in California and approximately 4,200 were
located in Asia. The Company's employees located in Korea are represented by a
labor union, and the Company's Korean operations have, from time to time in past
years, been affected by labor disruptions and slow downs. In response to the
accelerated product transition from inductive thin film to MR, as well as the
reduction in production schedules experienced in fiscal 1998, the Company closed
its facility in Ireland and reduced employment in Goleta and Asia by
approximately 3000 employees.

Intellectual Property and Proprietary Rights

      The Company regards elements of its manufacturing processes, product
designs, and equipment as proprietary and seeks to protect its proprietary
rights through a combination of employee and third party nondisclosure
agreements, internal procedures and patent protection. The Company has been
issued a number of United States and foreign patents and has additional patent
applications pending. There is no assurance that patents will be issued with
respect to such applications or that any patents issued to the Company will
protect the Company's competitive position. The Company believes its competitive
position is more dependent on the technological know-how and creative skills of
its personnel than on patent rights.

      The Company and IBM hold cross licenses with respect to certain patents
held by each of them. Such cross licenses do not include any patents filed by
IBM after January 1, 1991, nor any patents filed by the Company after July 1,
1991.

      In November 1993, the Company and Hutchinson Technology, Incorporated
("HTI") entered into a Cross-License and Joint Research and Development
Agreement (the "HTI Agreement"), under which the Company and HTI hold licenses


                                      -17-

<PAGE>




with respect to certain patents held by each of them, concerning suspension
assemblies, to make, use and sell such products. The Company's purpose of
entering into the HTI Agreement was to avoid possible future infringements,
thereby reducing the prospects for disputes and litigation. See also "Sources of
Supply."

      In September 1992, the Company and Hitachi Metals, Ltd ("HML") entered
into a License and Technology Development Agreement under which HML received
licenses to certain of the Company's patents. This agreement also provided for
joint ownership of jointly developed inventions, and the Company has several
U.S. patents and pending patents jointly held with HML.

      In December, 1994, the Company and Seagate entered into a broad cross
license with respect to certain patents held by each of them and with respect to
certain future patents which may be issued on applications filed prior to
December 10, 1999.

      The Company currently has several U.S. and foreign patents jointly held
with NGK Insulators, Ltd.

      The Company believes that its success depends on the innovative skills and
technological competence of its employees and upon proper protection of its
intellectual properties. The Company has, from time to time, been notified of
claims that it may be infringing patents owned by others. If it appears
necessary or desirable, the Company may seek licenses under patents which it is
allegedly infringing. Although patent holders commonly offer such licenses, no
assurance can be given that licenses will be offered or that the terms of any
offered licenses will be acceptable to the Company. The failure to obtain a key
patent license from a third party could cause the Company to incur substantial
liabilities and/or to suspend the manufacture of the products utilizing the
patented invention.

Environmental Regulations and Water Supply Restrictions

      The Company uses certain hazardous chemicals in its manufacturing process
and is subject to a variety of environmental and land use regulations related to
the use, storage and disposal of such chemicals and the conduct of its
manufacturing operations. The State of California "Permit by Rule" legislation
requires the Company to obtain permits for any treatment or transportation of
materials considered to be hazardous wastes. Although the Company believes it
will receive the necessary permits prior to the time required by this
legislation, there is no assurance that such permits will be issued in a timely
manner or at all. A failure by the Company to comply with present or future
regulations could subject it to liability or result in production suspension or
delay. In addition, environmental or land use regulations could restrict the
Company's ability to expand its current production facilities or establish
additional facilities in other locations, or could require the Company to


                                      -18-

<PAGE>



acquire costly equipment, or to incur other significant expenses for compliance
with environmental regulations or to clean up prior discharges. The Company,
which is subject to water use regulations, uses a significant amount of water in
its manufacturing process. Although to date the Company has been able to obtain
sufficient water supplies without significantly increased costs, stricter water
use regulations may be mandated and additional expenditures for water
reclamation and conservation may be required.

      The Company has been identified as a potentially responsible party at a
hazardous waste facility operated by the Omega Chemical Company in Whittier,
California. Omega Chemical was employed by the Company for purposes of waste
chemical disposal from 1987 to 1990 and was subsequently cited for stockpiling
waste chemicals and for allowing leaking containers to contaminate their site.
Omega has declared bankruptcy and a cleanup order was issued to the Company
along with other customers of Omega. A site remediation plan is being prepared
for submission to the U.S. Environmental Protection Agency ("EPA"). While the
U.S. EPA cannot predict how they will respond to the remediation plan, it is
expected that they should respond within the next two years.

      On July 13, 1994 the California Regional Water Quality Control Board
("CRWQCB") issued a clean up and abatement order to the Company concerning
property previously used and owned by the Company on Ward Drive in Goleta,
California. As a result of the order, the Company has been required to carry out
an environmental study to determine the extent of contamination related to
chemicals used by the Company at this site. This study involved taking a number
of soil samples and sinking several test wells to test the ground water and
monitor the water's condition over a twelve month period. The soil sample work
is complete and showed no metal or volatile organic compound ("VOC")
contamination. Ground water samples showed low levels of VOC contamination.
These contaminants have either remained constant or declined in concentration
over the past twelve month period. The CRWQCB has extended the monitoring
requirements to an adjacent site and has required the Company to continue
monitoring at a reduced sample frequency. Further testing indicates a slight
increase in water contaminants and the CRWCB has required the Company to
implement a remediation project. The Goleta environmental study and subsequent
clean-up efforts are expected to have a total financial implication to the
Company of approximately $200,000. The monitoring phase of the activity will be
completed in fiscal 1999 and is expected to cost the Company approximately
$100,000. The clean-up phase will take an additional year and is estimated to
cost the Company an additional $100,000.

                                      -19-

<PAGE>



Certain Additional Business Factors

Technological Changes

      The magnetic recording head industry has been characterized by rapidly
changing technology, short product life cycles and price erosion. The demand for
greater data storage capacity requires disk drive and disk head manufacturers to
continue to build greater performance into their respective products. There is
no assurance that the Company's products will achieve such performance or that
the Company will continue to qualify for disk drive manufacturers' programs.
During fiscal 1995, the Company shifted from production of ferrite disk heads to
thin film disk heads, which offered superior performance characteristics over
ferrite disk heads and were competitively priced. The Company furthered its
technological development from the thin film microslider to the nanoslider form
factor and during fiscal 1995, substantially all thin film shipments were
nanoslider products. During fiscal 1996 and continuing through fiscal 1997, the
Company experienced increased customer demand and significant revenue growth and
profitability with its inductive thin film products. This success was due
primarily to continued timely production ramps on a number of thin film programs
and successful transition to advanced inductive thin film disk head products as
a result of achievement of profitable yields. During fiscal 1997, the Company
developed and began to produce in volume thin film picoslider products and
during fiscal 1998, the majority of all thin film shipments were picoslider
products. During fiscal 1998, the Company faced reduced customer demand and
significant reductions in revenue and profitability, due in part to the
Company's inability to qualify its MR products on customer programs. During
fiscal 1999, the Company faces technology evolutions from thin film to MR and
GMR disk head technologies. There can be no assurance that the Company will
successfully qualify for disk head manufacturing programs or that it will not
experience manufacturing and product quality problems in the future. The
Company's future success depends in large part on its ability to develop and
qualify new products on a timely basis and to manufacture them in sufficient
quantities that compete effectively on the basis of price and performance.

Significant Capital Needs

      The recording disk head industry is capital intensive and requires
significant expenditures for research and development in order to develop and
take advantage of technological improvements and new technologies such as MR and
GMR disk head products. The Company believes that, in order to achieve its
objectives, it will need significant additional resources over the next several
years for capital expenditures, working capital and research and development.
The Company expanded production facilities and purchased manufacturing equipment
in fiscal 1998 totaling $39.2 million. In addition, the Company leased $40.3
million of production equipment through operating and capital leases, with terms
of up to five years. During fiscal 1999, the Company plans to purchase or enter

                                      -20-

<PAGE>



into lease financing for approximately $40 million of manufacturing equipment
and facility improvements. The Company believes that it will be able to fund
future expenditures from a combination of existing cash balances, cash flow from
operations, existing credit facilities and lease financing arrangements. The
Company may need additional sources of capital to meet requirements in future
years. There is no assurance that such additional funds will be available to the
Company or, if available, upon terms and conditions acceptable to the Company.
If the Company were unable to obtain sufficient capital, it would need to
curtail its operating and capital expenditures, which could materially adversely
affect the Company's future operating results.

Short Term Borrowings

      At October 3, 1998, the Company had outstanding approximately $55.5
million of short term borrowings in floating rate demand loan facilities from
banks in Malaysia, where it has substantial manufacturing operations. The
facilities are callable on demand and have no termination date. The loan
facilities are used for manufacturing equipment and for working capital
purposes. While the Company has no reason to believe the loan facilities will be
called, there is no assurance that the banks will continue to make this credit
available.

Fluctuations in Quarterly and Annual Operating Results

      The Company's operating results have fluctuated and may continue to
fluctuate from quarter to quarter and year to year. The Company experienced
substantial losses in fiscal 1998. The Company's sales are generally made
pursuant to individual purchase orders and production is scheduled and
customer-specific materials are ordered on the basis of such purchase orders. As
customer programs mature, the Company may have to write-down inventory and
equipment. In addition, the Company must qualify on future programs to sell its
products. The Company experienced cancellation and rescheduling of orders and
reductions in quantities ordered in fiscal 1998. As a result, the Company closed
its Ireland facility to consolidate offshore operations and recorded an $8.4
million pre-tax restructuring charge. Cancellation, rescheduling and reductions
of
orders in the future could result in inventory losses, under-utilization of
production capacity and write-downs of tooling and equipment which would have a
material adverse effect on the Company's future operating results. The Company's
operating results have in the past and likely will in the future be adversely
affected during periods when production capacity is underutilized.

Dependence on Foreign Operations

      The Company conducts substantially all of its production, assembly and
test operations in its facilities in Korea, Malaysia and China. In addition, the
Company has contractual relationships with unaffiliated parties who conduct

                                      -21-

<PAGE>




manufacturing and assembly operations for the Company in Korea, Malaysia, and
the Philippines. The Company's operations, from time to time in recent years,
have been affected by labor disruptions, slow downs and labor shortages. In
addition to risks of labor disruption, civil unrest and political instability,
the Company's foreign operations subject it to delays in obtaining governmental
permits and approvals, currency exchange fluctuations, currency restrictions,
trade restrictions and transportation problems.

Volatility of Stock Price

      The market price of the Company's common stock has been volatile, with
closing market prices ranging from $4.00 to $33.25 per share during fiscal 1998.
The trading price of the Company's common stock has fluctuated in response to
quarter-to-quarter operating results, industry conditions, awards of orders to
the Company or its competitors, new product or product development announcements
by the Company or its competitors, general market and economic conditions and
other events or factors. In addition, the volatility of the stock markets in
recent years has caused wide fluctuations in trading prices of stocks of
technology companies independent of their individual operating results. The
market price of the Company's common stock at any given time may be adversely
affected by factors independent of the Company's operating results. The
volatility of the stock price may reduce the ability of the Company to raise
additional operating funds through equity offerings.

Executive Officers of the Registrant

      The following table sets forth information as to the name, age, and
office(s) held by each executive officer of the Company as of December 17, 1998:

      Name                Age  Position or Office
      ----                ---  ------------------

      Craig D. Crisman    57   Chairman of the Board and Chief Executive Officer
      Peter T. Altavilla  45   Corporate Controller and Secretary

      Craig D. Crisman became an employee of the Company on August 1, 1995.
Prior to that time, since 1981, he was a member in the consulting firm of
Grisanti, Galef & Goldress, Inc. ("GG&G"). GG&G was engaged by the Company on
August 1, 1994, to provide crisis management and turnaround services to the
Company. The turnaround engagement was determined to have been successfully
completed on July 27, 1995. Mr. Crisman was elected Chief Executive Officer and
a Director of the Company on August 1, 1994. He was elected Chairman of the
Board on November 3, 1995. During the five years preceding his appointment as
Chief Executive Officer and a Director of the Company, Mr. Crisman was a partner
of GG&G. In that capacity he had been engaged, as a crisis management
consultant, in business turnaround assignments involving a number of different
enterprises in various industries.

                                      -22-

<PAGE>





      Peter T. Altavilla has been employed by the Company since 1987. He served
as Assistant Controller until August 1, 1994, when he was elected to his present
position as Corporate Controller. Mr. Altavilla was elected Secretary on
February 9, 1996.


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

      In fiscal 1998, the disk drive industry entered a period of slowdown
coupled with an accelerated transition from the use of inductive thin film to MR
disk head products. The Company experienced purchase order cancellations,
production reschedules and price reductions related to the industry slowdown and
is late to market with its MR products, which resulted in a net loss of $155.4
million for the year ended October 3, 1998, compared to a net profit of $96.1
million for the year ended September 27, 1997, and $32.2 million for the year
ended September 28, 1996. Net sales decreased 62.9% in fiscal 1998 from fiscal
1997, but increased 43.5% in fiscal 1997 from fiscal 1996. The Company's
financial performance continued to be impacted by this technology transition in
the first half of fiscal 1999. The Company is late in qualifying on
magnetoresistive head products and has incurred a loss of $133.1 million for the
first half of fiscal 1999 as compared to $71.7 million loss in the same period
of the previous fiscal year.

      Inductive thin film products represented 96.9% of fiscal 1998 revenue.
During fiscal 1998, the Company successfully transitioned from inductive thin
film head products at the 1.7 gigabytes per 3.5 inch disk capacity point to
inductive thin film head products at 2.1 gigabytes per 3.5 inch disk. Our 2.1
gigabyte per 3.5 inch disk product was the last generation of inductive thin
film heads. The Company plans to make inductive film shipments through the third
fiscal quarter of 1999, which makes fiscal 1999 another significant technology
transition year for the Company. Magnetoresistive head products accounted for
2.5% of revenue in fiscal 1998 as compared to 4.9% in fiscal 1997. The Company
is currently working on magnetoresistive head product qualifications with two
customers at the 4.3 gigabyte per 3.5 inch disk capacity point and expects to
begin volume production shipments of these products in the fourth fiscal quarter
of 1999. The Company is continuing its commitment to magnetoresistive and giant
magnetoresistive head products with the addition of technical personnel, capital
investments, and research and development.

      In fiscal 1998, the Company experienced a significant decrease in net
sales and demand for inductive thin film head products, which resulted in a
significant loss and negative cash flow from operations as the Company continues

                                      -23-

<PAGE>



to transition from inductive thin film to magnetoresistive and giant
magnetoresistive head technology. The Company's ability to fund its operating
and capital requirements for fiscal 1999 is heavily dependent on the Company's
ability to receive qualification and begin volume production of its
magnetoresistive and giant magnetoresistive head products on a timely basis. As
of June 1, the Company is in the final stages of qualification for one of its
magnetoresistive head products and expect to begin volume production shipments
in the fourth quarter of fiscal 1999. The Company is also attempting to raise
capital, which is required immediately to fund current operating activities, and
the Company will be required to raise significant additional capital in the near
term to fund the anticipated magnetoresistive head production ramp up and
related working capital requirements. If the Company is unable to achieve
magnetoresistive head production shipments during the fourth quarter of fiscal
1999 or raise sufficient capital in the near term, there will be a material
adverse effect on the Company's financial condition, competitive position and
ability to continue as a going concern. Due to the significant uncertainties
described above, the Company's auditors have re-issued their report on our
October 3, 1998 financial statements. The re-issued report, dated June 1, 1999,
includes an uncertainty paragraph regarding the Company's ability to continue as
a going concern. The Company's auditors have also advised management that based
on current conditions, it is likely that this going concern uncertainty will
also be continued with respect to the Company's fiscal 1999 financial
statements.

      On February 11, 1999, the Company completed its merger with DAS Devices
Inc., a research and development company. The consideration exchanged was
13,051,872 shares of the Company's common stock for all of the outstanding
preferred and common shares of DAS. The acquisition was accounted for as a
purchase, and the acquisition price of approximately $99.7 million was allocated
to assets acquired, including the fair value in-process technology, and
liabilities assumed based on their fair values. It was determined that
in-process technology of $28.7 million was acquired. Since the technology has no
future economic value to the Company, it was written-off during the three months
ended April 3, 1999. The excess of the purchase price plus related transaction
costs over the fair value of tangible and intangible assets acquired and
liabilities assumed has been allocated to (1) developed technology and know-how
of approximately $30.1 million, which will be amortized on a straight line bases
over 3 years, the estimated period of future benefit and (2) goodwill of
approximately $39.6 million (including a value of $1.6 million associated with
assembled workforce), which will be amortized on a straight line basis over the
estimated period of future benefit of 7 years. Concurrent with this acquisition
and contingent on the merger, a private investor group purchased 4,641,089
shares of the Company's common stock in exchange for $18.75 million.


                                      -24-

<PAGE>



      Revenues, shipment volumes, operating and financial results for fiscal
1999 will continue to be impacted by the reduced levels of inductive thin film
shipments while the Company seeks to achieve qualification on the MR 4.3
gigabyte per 3.5 inch disk product, to execute it's production ramp and improve
the associated processes and production yields. See "Products" under Item 1.

      During fiscal 1997, the Company's revenue growth and profitability as
compared to fiscal 1996 were attributable to strong customer demand for its
inductive thin film products which represented 93.1% of total net sales for that
year. During the first fiscal quarter of 1997, the Company shipped inductive
thin film products primarily using the nanoslider ("50%") form factor on 1.0
gigabytes per 3.5 inch disk products. By the end of the fourth quarter of fiscal
1997 the Company completed its transition to more advanced inductive thin film
disk head technology using the picoslider form factor on 1.4 gigabytes and 1.7
gigabytes per 3.5 inch disk products.


























                                      -25-

<PAGE>



Annual Results of Operations

      The following table sets forth certain financial data for the Company as a
percentage of net sales for the last three fiscal years.

                                               FOR THE YEARS ENDED
                                    -------------------------------------------

                                    OCTOBER 3,    SEPTEMBER 27,   SEPTEMBER 28,
                                       1998         1997             1996
                                    ----------    -------------   -------------
Net sales                              100.0%         100.0%       100.0%
Cost of sales                          108.2%          66.1%        73.0%
Gross margin                            (8.2)%         33.9%        27.0%
Operating expenses
   Research and development             62.5%          10.6%        14.8%
   Selling, general and administrative   3.5%           1.7%          19%
   Provision for customer bankruptcy      --            0.8%           --
   Terminated merger costs                --            0.6%           --
   Restructure charges                   4.6%           --             --
   Total operating expenses             70.6%          13.7%        16.7%
Income (loss) from operations          (78.8)%         20.2%        10.3%
Interest income                          3.2%           1.7%         1.2%
Interest expense                         6.9%           2.5%         2.6%
                                   --------------------------------------
Other income, net                        0.8%           0.5%         0.6%
Income before taxes                    (83.3)%         19.9%         9.5%
Provision for income taxes               1.3%           0.4%         0.2%
Net income                             (84.6)%         19.4%         9.3%

      Net Sales: Net sales of $183.6 million decreased 62.9% in fiscal 1998 from
net sales of $494.8 million in fiscal 1997 primarily due to the decrease in
shipments of inductive thin film products. The disk drive industry entered into
a period of general slowdown in the first quarter of fiscal 1998 and the
Company's largest customer at that time, Western Digital, reduced its production
schedule resulting in purchase order cancellations, production reschedules and
price reductions for the Company. The Company was also late to market with its
MR products in the 2.1, 2.8 and 3.4 gigabyte per 3.5 inch disk capacity points.
As a result, the Company had $4.6 million of MR product revenue in fiscal 1998
as compared to $24.1 million in fiscal 1997. The Company is currently working
with several customers at the 4.3 gigabyte per 3.5 inch disk capacity point and
could begin volume production of these products in the second quarter of fiscal
1999.

      Net sales of $494.8 million increased 43.5% in fiscal 1997 from net sales
of $344.8 million in fiscal 1996 primarily due to an increase in shipments of
inductive thin film products. This was achieved as a result of strong customer
demand and an increase in shipments of head stack assemblies ("HSAs") as
compared to head gimbal assemblies ("HGAs"). Inductive thin film head net sales

                                      -26-

<PAGE>



represented 93.1% of total net sales in 1997 compared to 76.0% in 1996. The
Company shipped $24.1 million of MR heads in 1997, or 4.9% of total net sales.
Other products represented 2.0% of total net sales and included tape products
and disk head products for which the Company only performed final assembly of
HSAs using thin film and MR disk heads purchased from other manufacturers.

      Gross Margin: The gross margin was a negative 8.2% for fiscal 1998 as
compared to 33.9% for fiscal 1997. The decrease was primarily due to the
reduction in inductive thin film shipments related to the slowdown in the disk
drive industry and the Company's market timing with its MR products. The Company
reduced operating expenses, excluding depreciation, during fiscal 1998 to
partially offset the decrease in sales.

      The increase in gross margins from fiscal 1997 compared to fiscal 1996 was
due to higher inductive thin film disk head sales volumes, resulting in
economies of scale, coupled with cost controls.

      Research and Development: Research and development expenses ("R&D") were
$114.7 million, $52.5 million, and $50.9 million for fiscal years 1998, 1997 and
1996, respectively. These expenses represented 62.5%, 10.6% and 14.8% of net
sales, respectively, for such periods.

      R&D expenses increased $62.2 million in fiscal 1998 from fiscal 1997. The
Company increased its level of expenditures as it focused its efforts on new
production program qualifications using MR technology and on development of GMR
technology and products. In fiscal 1998, the Company made initial deliveries of
GMR evaluation units to customers that are targeted for products at the 6.4
gigabyte per 3.5 inch disk capacity point.

      R&D expenses increased by $1.6 million in fiscal 1997 from 1996. The
Company maintained its level of R&D investment during 1997, as engineering
efforts shifted from advanced thin film technology development during the first
half of the fiscal year to MR technology and production process development and
the initiation of GMR technology development.

      The Company continues to invest in advanced technology products and
processes, but expects that expenditures generally will decrease on an absolute
dollar basis during fiscal 1999 as MR and GMR technology and process development
efforts result in product qualifications and shipments to customers.

      Selling, General and Administrative Expenses: Selling, general and
administrative ("SG&A") expenses in absolute dollars were $6.5 million, $8.3
million and $6.5 million in fiscal 1998, 1997 and 1996, respectively. These
expenses represented 3.5%, 1.7%, and 1.9% of net sales, respectively, for such
periods. SG&A expenses in 1996 were partially offset by a bad debt recovery of
$0.5 million, related to a final payment of a 1990 bankruptcy settlement with a
previous customer.

                                      -27-

<PAGE>





      Valuation Allowance for Uncollectible Accounts: The Company's allowance
for uncollectible accounts receivable at October 3, 1998, September 27, 1997 and
September 28, 1996 was $0.9 million, $4.9 million and $0.8 million,
respectively. The Company's allowance for uncollectible accounts receivable of
$4.9 million at September 27, 1997 included a provision for customer bankruptcy
of $4.2 million. On November 10, 1997, Singapore Technologies Pte Ltd. announced
plans to shut down its subsidiary, Micropolis (S) Pte Ltd., one of the Company's
customers. As a result, the Company recorded the charge in the fourth quarter of
fiscal 1997.

      Restructuring Charge: The Company recorded an $8.4 million restructuring
charge in the first quarter of fiscal 1998. The charge was primarily related to
the shut down of the Ireland facility, as part of a plan to consolidate foreign
manufacturing operations. The shut down of the Ireland plant was completed in
March 1998. Included in the charge was the write-down of certain tooling and
equipment.

      Terminated Merger Costs: Terminated merger costs of $2.9 million for
fiscal 1997 include legal and accounting fees, financial advisory fees and
miscellaneous expenses related to the February 1997 proposed business
combination between the Company and Read-Rite Corporation. On March 14, 1997,
the Company announced its withdrawal of the proposal.

      Interest Income and Expense: Interest income was $5.9 million, $8.3
million and $4.2 million in fiscal 1998, 1997 and 1996, respectively. Interest
income decreased $2.4 million in fiscal 1998 from fiscal 1997 due to investment
of lower average cash balances. Interest income increased in fiscal 1997 from
fiscal 1996 due to investment of higher average cash balances. Interest expense
was $12.6 million, $12.3 million and $9.1 million in fiscal 1998, 1997 and 1996,
respectively. Interest expense increased $0.3 million in fiscal 1998 from fiscal
1997 as the Company maintained similar average outstanding debt. Interest
expense increased $3.2 million in fiscal 1997 for 1996 due to higher debt
outstanding. This increase was primarily as a result of the Company's issuance
of $115.0 million 7% Convertible Subordinated Debenture due in 2006.

      Other Income (Expense): Other expense was $1.5 million in fiscal 1998
compared to other income of $2.4 million and $2.0 million in fiscal 1997 and
1996, respectively. Other expense included $1.4 million in foreign exchange and
net transaction losses compared to $2.1 million in net gains in fiscal 1997.
Other income in fiscal 1996 included $1.3 million in final proceeds from the
sale of the Company's Tape Head business unit to Seagate and $0.5 million in
foreign exchange and net transaction gains.


                                      -28-

<PAGE>



      Provision for Income Taxes: The fiscal 1998, 1997 and 1996 provision for
income taxes included alternative minimum state and federal taxes and provision
for foreign income taxes.

      The Company has not provided U.S. federal income taxes on unremitted
foreign earnings as the Company expects to permanently reinvest such earnings in
foreign jurisdictions. In addition, the Company has minimal foreign tax credits
available to offset the U.S. tax impact of repatriating foreign earnings.
Accordingly, if such foreign earnings were repatriated to the U.S., these
earnings would generally be taxed at the U.S. statutory rates.

      The Company currently operates under a tax holiday in Malaysia. The tax
holiday is effective through August 31, 2004. The Malaysian Industrial
Development Authority has approved a "Common Pioneer" tax status for the
subsequent five-year period whereby 70% of the Malaysian income would be exempt
from taxes. The Company is continuing to negotiate with the Malaysian
Authorities to improve the income exemption and extend the term.

      When the Company utilizes its remaining net operating loss carryforwards,
future U.S. earnings will be taxed at the U.S. statutory rates less available
tax credits. See Note 4 of Notes to Consolidated Financial Statements.

Liquidity and Capital Resources

      As of October 3, 1998, the Company's cash and cash equivalents balance
decreased to $71.7 million from $162.3 million at September 27, 1997. During
fiscal 1998, the Company experienced a net use of cash in the amount of $64.6
million from operating activities, comprised primarily of the net effect of the
following: i) $155.4 million due to net loss, which included $44.6 million of
depreciation and amortization expense; ii) $8.4 million restructuring charge;
iii) net decrease in the accounts receivable balance of $45.6 million as a
result of the decrease in net sales for fiscal 1998 compared to fiscal 1997; iv)
decrease in inventories of $38.4 million and v) decrease in the accounts payable
balance of $32.7 million. The additional $26 million decrease in cash and cash
equivalents was due to use of $32 million for investment activities primarily
associated with the purchase of capital equipment partially offset by a $7.4
million increase due to proceeds from financing primarily related to the
increase in borrowings with the Malaysian banking facilities.

      During fiscal 1998, the Company completed the expansion of its production
facilities in Goleta, California and purchased manufacturing equipment totaling
$39.2 million. In addition, the Company leased $40.3 million of production
equipment through operating and capital leases, with terms up to five years. The
Company completed the second phase of the cleanroom expansion of the MR
fabrication facility in the second quarter of fiscal 1998, however, due to lower
than anticipated production volumes, the fabrication facility was not fully
equipped.


                                      -29-

<PAGE>





      During fiscal 1998, net cash of $7.4 million was generated from financing
activities, consisting primarily of increases in borrowings of $6.9 million and
net proceeds from stock option exercises of $.5 million.

      During fiscal 1998, the Company also increased its Malaysian borrowings to
$55.5 million. All the credit facilities are callable on demand and have no
termination date. Credit facilities with one bank, which have been in place
since June 1990, are secured by the Company's real property holdings in Malaysia
and include certain covenants which preclude the Company from granting liens and
security interests in other assets in Malaysia. Credit facilities with four
other banks, established by the Company's Malaysian subsidiary during fiscal
1997 are unsecured. Unused borrowings available under all the facilities was
approximately $5.2 million at October 3, 1998. While the Company has no reason
to believe the loan facilities will be called, there is no assurance that the
banks will continue to make this credit available. Should all or any significant
portion of the Malaysian credit facilities become unavailable for any reason,
the Company would need to pursue alternative financing sources. There is no
assurance that such additional funds will be available to the Company or, if
available, upon terms and conditions acceptable to the Company. Also included in
total debt is $115.0 million of 7.0% Convertible Subordinated Debentures, due
2006.

      The Company has a secured, asset-based revolving line of credit from CIT
Group/Business Credit, Inc. ("CIT") that has been in place since January 1995.
This line of credit provides for borrowings up to $35.0 million based on
eligible trade receivables at various interest rates over a three-year term and
is secured by trade receivables, inventories and certain other assets. In
December 1997 the Company extended the line of credit to January, 2001. As of
October 3, 1998, the total amount available for future borrowings was $1.2
million. As of October 3, 1998, the Company was not in compliance with the
financial covenants under this line of credit, but has received
notification from the Company's lender waiving the area of non-compliance until
July 31, 1999, and expects to successfully renegotiate the terms of the
covenants with the lender. During fiscal 1998, the Company used $4.2 million of
this line of credit to secure equipment leases with two of its lessors.


      The recording disk head industry is capital intensive and requires
significant expenditures for research and development in order to develop and
take advantage of technological improvements and new technologies such as MR and
GMR disk head products. In fiscal 1999, the Company plans approximately $40.0
million in capital expenditures, including equipment to be obtained through
operating leases, primarily to continue development and production of MR and GMR
technologies and products and increase overall production capacity. Capital
equipment purchase commitments totaled $3.6 million at October 3,1998.


                                      -30-

<PAGE>





      The Company's accounts receivable and inventory balances are currently
heavily concentrated with one customer, Samsung. Sales to Samsung accounted for
approximately 27% of the Company's sales in 1998. The Company anticipates that
Samsung will continue to represent one of its largest customers during fiscal
1999. Program qualifications are under way with several other customers that, if
successful, will provide a broadened customer base. However, further
consolidation of the disk drive industry may reduce the number of disk drive
programs requiring the Company's products and may increase credit risks for the
Company due to the concentration of its customers. See "Customers and Marketing"
under Item 1.

      The Company operates in a number of foreign countries. Purchases of
certain supplies and certain labor costs are paid for in foreign currencies. The
Company is not currently hedging against potential foreign exchange risk.
Fluctuations of foreign currency to the dollar could have a significant effect
on reported cash balances. The effect of foreign currency exchange rate changes
on cash and equivalents was a decrease of $.7 million and $.6 million for fiscal
1998 and 1997, respectively.

      The Company continues to work with its customers to qualify on
magnetoresistive head programs and believes it will receive qualification on its
4.3 gigabyte per 3.5 inch magnetoresistive head product and begin volume
production during the fourth quarter of fiscal 1999. However, as of June 1,
1999, the Company had not received qualification and did not have any sales
backlog for its 4.3 gigabyte per 3.5 inch magnetoresistive head products. The
Company's liquidity and ability to fund our operating and capital expenditure
requirements during fiscal 1999 are heavily dependent on its ability to receive
qualification and begin volume production of our magnetoresistive and giant
magnetoresistive head products on a timely basis. Although the Company has
completed its plant capacity expansion and conversion of its existing
fabrication facilities to enable manufacturing of magnetoresistive and giant
magnetoresistive heads and are devoting substantial engineering and
manufacturing resources to these efforts, there can be no assurances that the
Company will receive qualification and achieve planned production levels on a
timely basis. Additional fourth quarter planned financing arrangements are
required in order to fund the Company through the second half of fiscal 1999
magnetoresistive and giant magnetoresistive head production ramp up.
If the Company is unable to achieve any of the factors on which the second half
of fiscal 1999 liquidity depends on a timely basis and are unable to obtain
adequate alternative financing, there will be a material adverse effect on the
Company's financial condition, competitive position and ability to continue as a
going concern.


                                      -31-

<PAGE>



Market Risks

       The Company is exposed to market risks, which include changes in U.S.
interest rates as well as changes in currency exchange rates as measured against
the U.S. dollar. The Company does not actively hedge against these risks using
derivative transactions. The Company manages its interest rate risk by
maintaining a large portion of its debt on a fixed-rate basis. The Company
attempts to manage its foreign currency exposure primarily by balancing monetary
assets and liabilities and maintaining cash positions only at levels necessary
for operating purposes. The Company's foreign currency denominated assets and
liabilities are not significant. The Malaysian debt facilities are denominated
in U.S. dollars. The Company uses the U.S. dollar as the functional currency in
Malaysia. Therefore, there is no current foreign currency transaction loss
exposure associated with the Malaysian debt. The effect of foreign exchange
transactions in foreign currencies is included in periodic income. The net
foreign currency gain (loss) was $(1.4) million, $2.1 million and $ .5 million
for 1998, 1997 and 1996, respectively.

Recent Accounting Pronouncements

      In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128"). SFAS 128 replaces the presentation of primary earnings per share ("EPS")
with the presentation of basic EPS. It also requires dual presentation of basic
and fully diluted EPS on the face of the income statement for all entities with
complex capital structures. This statement was adopted for financial statements
of the Company in the first quarter of fiscal 1998. The adoption of SFAS 128 did
not have a material impact on the Company's EPS disclosure.

      In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards
for the way the Company reports information about operating segments in annual
financial statements and requires that the Company report selected information
about operating segments in interim financial reports to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. It amends Financial Accounting Standards
Board Statement No. 14, "Financial Reporting for Segments of a Business
Enterprise", but retains the requirement to report information about major
customers. It amends Financial Accounting Standards Board Statement No. 94
"Consolidation of All Majority-Owned Subsidiaries", to remove the special
disclosure requirements for previously unconsolidated subsidiaries. This
Statement will become effective for financial statements of the Company in
fiscal 1999.


                                      -32-

<PAGE>



      The Company's effort to address Year 2000 issues began in 1997. In fiscal
1998, the Company spent $7.5 million to complete the implementation of a
worldwide management information system that addresses the Year 2000 issue and
also provides fully integrated manufacturing and financial capabilities. In
addressing the issues, the Company has employed a five-step process consisting
of 1) conducting a company-wide inventory, 2) assessing Year 2000 compliance, 3)
remediation of non-compliant hardware and software, 4) testing of remediation
hardware and software and 5) certifying Year 2000 compliance. Personnel from
operations and from functional disciplines, as well as information technology
professionals, are involved in the process. Inventory and assessment activities
are estimated at approximately 85 percent complete. This data is continuously
updated as new information becomes available and the Company expects this to
continue. Overall remediation efforts are estimated at approximately 60 percent
complete. Management believes that the remaining remediation efforts will be
completed by September 1999. Based on the results of testing performed to date,
we believe that we are appropriately addressing the Year 2000 issues. Critical
systems supplied by outside vendors have undergone testing not only by us, but
other customers of the vendors as well. Communication with customers and
suppliers to determine the extent of their Year 2000 efforts is an integral part
of the program. The Company is tracking the progress of its key suppliers toward
their Year 2000 compliance. Sumitomo Corporation and Hutchinson Technology,
Incorporated are critical suppliers of components. These suppliers have
indicated that they will complete their Year 2000 compliance in the second
quarter of 1999. Sumitomo supplies substrates for wafer production and
Hutchinson Technology, Incorporated supplies suspension assemblies. The Company
has no means of ensuring that the suppliers will be Year 2000 compliant. Costs
for Year 2000 efforts are not being accumulated separately. Much of the cost is
being accounted for as part of normal operating budgets. Overall, the costs are
not expected to have a significant effect on the Company's financial condition
or results of operations. The Company believes it will not have significant
exposure to Year 2000 issues and that the risk to its operations and financial
condition is minimal.

      While the Company currently expects that the Year 2000 issue will not pose
significant operational problems, delays in the implementation of changes in or
replacements of information systems or a failure to fully identify all Year 2000
dependencies in the Company's systems and in the systems of its suppliers,
customers and financial institutions could have material adverse effect on the
Company's business, financial condition and results of operations. As a
contingency plan related to information systems, the Company is in the process
of developing internal operating procedures that would enable departments to
function for a period of time until the primary system could be restored to
operations. The Company anticipates that the worst case scenario would be the
inability of water and power utilities and/or the inability of our key suppliers
to deliver their products. A contingency plan is being developed to place a
limited amount of finished goods as well as key supplier components on hand to
enable the Company to continue its revenue generation, if this were to occur.


                                      -33-

<PAGE>



Forward-looking Information

      When used in this annual report on Form 10-K, the words "believe",
"estimate", "anticipate", "expect" and similar expressions are intended to
identify forward-looking statements within the meaning of Section 27A of the
Securities Act and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). These forward looking statements speak only as of
the date hereof. All of the forward-looking statements are based on estimates
and assumptions made by management of the Company, which, although believed to
be reasonable, are inherently uncertain and difficult to predict: therefore,
undue reliance should not be placed upon such estimates. Such statements are
subject to certain risks and uncertainties inherent in the Company's business
that could cause actual results differ materially from those projected. These
factors include, but are not limited to: (i) successful transition to volume
production of MR and GMR disk head products with profitable yields: (ii) the
relatively limited number of customers and customer changes in short range and
long range plans; (iii) competitive pricing pressures; (iv) the Company's
ability to control inventory levels; (v) domestic and international competition
in the Company's product areas; (vi) risks related to international
transactions; (vii) Y2K issues; and (viii) general economic risks and
uncertainties.















                                      -34-

<PAGE>



                           APPLIED MAGNETICS CORPORATION


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements


Financial Statements:

Report of Independent Public Accountants.....................................F-2

Consolidated Balance Sheets as of October 3, 1998 and September 27, 1997.....F-3

Consolidated Statements of Operations for the years ended October 3,
 1998, September 27, 1997 and September 28, 1996.............................F-5

Consolidated Statements of Shareholders' Investment for the years ended
 October 3, 1998, September 27, 1997 and September 28, 1996..................F-6

Consolidated Statements of Cash Flows for the years ended October 3,
 1998, September 27, 1997 and September 28, 1996 ............................F-7

Notes to Consolidated Financial Statements ..................................F-8


















                                      F-1

<PAGE>



                     REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


      To the Board of Directors and Shareholders of Applied Magnetics
Corporation:

      We have audited the accompanying consolidated balance sheets of Applied
Magnetics Corporation (a Delaware corporation) and subsidiaries as of October 3,
1998 and September 27, 1997, and the related consolidated statements of
operations, shareholders' investment and cash flows for each of the three years
in the period ended October 3, 1998. These financial statements are the
responsibility of the Company' s management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

      In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Applied
Magnetics Corporation and subsidiaries as of October 3, 1998 and September 27,
1997, and the results of their operations and their cash flows for each of the
three years in the period ended October 3, 1998, in conformity with generally
accepted accounting principles.

      The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered significant losses and negative
cash flows from operations due to its inability to transition to current product
technology. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.


                                          ARTHUR ANDERSEN LLP




Los Angeles, California
June 1, 1999


                                      F-2

<PAGE>
                           APPLIED MAGNETICS CORPORATION
                            CONSOLIDATED BALANCE SHEETS
                  (In Thousands, except share and par value data)

                                      ASSETS

                                                             As of
                                                    ---------------------------
                                                     October 3,   September 27,
                                                        1998           1997
                                                     ----------   -------------
Current assets:
   Cash and equivalents                               $  71,674    $ 162,302
   Accounts receivable, less allowances of $904
      in 1998 and $4,942 in 1997                          7,291       52,924
   Inventories, net                                      13,054       51,438
   Prepaid expenses and other                            15,590       11,420
                                                      ---------    ---------
                                                        107,609      278,084
                                                      ---------    ---------
Property, plant and equipment, at cost:
   Land                                                   2,340        2,556
   Buildings                                            100,810       92,962
   Manufacturing equipment                              201,515      193,217
   Other equipment and leasehold improvements            26,684       32,433
   Construction in progress                              34,120       50,056
                                                      ---------    ---------
                                                        365,469      371,224
                                                      ---------    ---------
Less-accumulated depreciation and amortization         (188,022)    (181,732)
                                                        177,447      189,492
                                                      ---------    ---------
Other assets, net                                        14,462       10,412
                                                      ---------    ---------
                                                      $ 299,518    $ 477,988
                                                      =========    =========

                    LIABILITIES AND SHAREHOLDERS' INVESTMENT

Current liabilities:
   Current portion of long-term debt                  $   1,610    $     513
   Bank notes payable                                    58,468       50,188
   Accounts payable                                      16,409       49,103
   Accrued payroll and benefits                           8,070       11,287
   Other current liabilities                              9,653        5,829
                                                      ---------    ---------
                                                         94,210      116,920
                                                      ---------    ---------
Long-term debt, net of current portion                  116,767      116,030
                                                      ---------    ---------
Other long-term liabilities                               2,581        4,257
                                                      ---------    ---------






                                      F-3

<PAGE>
                           APPLIED MAGNETICS CORPORATION
                            CONSOLIDATED BALANCE SHEETS    (Continued)
                  (In Thousands, except share and par value data)





Shareholders' Investment:
   Preferred stock, $.10 par value, authorized
   5,000,000 shares, none issued and outstanding           --           --
Common stock, $.10 par value, authorized 80,000,000
   shares, issued 24,103,294 shares at October 3,
   1998 and 23,976,711 shares at September 27, 1997       2,410        2,398
Paid-in capital                                         191,225      191,185
Retained earnings (deficit)                            (106,065)      49,303
                                                      ---------    ---------
                                                         87,570      242,886

Treasury stock, at cost (130,233 shares at
October 3, 1998 and 128,384 shares at
September 27, 1997)                                      (1,577)      (1,554)
Unearned restricted stock compensation                      (33)        (551)
                                                      ---------    ---------
                                                         85,960      240,781
                                                      ---------    ---------
                                                      $ 299,518    $ 477,988
                                                      =========    =========
























      The accompanying Notes to Consolidated Financial Statements are an
      integral part of these consolidated balance sheets.

                                      F-4

<PAGE>



                           APPLIED MAGNETICS CORPORATION
                       CONSOLIDATED STATEMENTS OF OPERATIONS
                       (In Thousands, except per share data)

                                                For the Years Ended
                                                -------------------
                                      October 3,  September 27, September 28,
                                        1998          1997          1996
                                      ----------  ------------- -------------
Net sales                             $ 183,597    $ 494,839    $ 344,754
Cost of sales                           198,742      326,990      251,503
                                      ---------    ---------    ---------
  Gross profit (loss)                   (15,145)     167,849       93,251
                                      ---------    ---------    ---------
Research and development expenses      (114,659)     (52,532)     (50,867)
Selling, general and administrative
           expenses                      (6,514)      (8,330)      (6,533)
Provision for customer bankruptcy          --         (4,200)        --
Terminated merger costs                    --         (2,906)        --
Restructuring charges                    (8,400)        --           --
Interest income                           5,877        8,316        4,228
Interest expense                        (12,627)     (12,346)      (9,056)
Other income (expense), net              (1,495)       2,384        2,047
                                      ---------    ---------    ---------
Income (loss) before provision for
           income taxes                (152,963)      98,235       33,070
Provision for income taxes                2,405        2,119          852
                                      ---------    ---------    ---------
  Net income (loss)                   $(155,368)   $  96,116    $  32,218
                                      =========    =========    =========
Net income (loss) per share:
  Income (loss) per common share      $   (6.49)   $    4.08    $    1.41
                                      =========    =========    =========
  Income (loss) per common share--
         assuming dilution            $   (6.49)   $    3.37    $    1.21
                                      =========    =========    =========
Weighted average number of common
shares outstanding:
  Common shares                          23,931       23,567       22,913
                                      =========    =========    =========
  Common shares--assuming dilution       23,931       31,011       30,173
                                      =========    =========    =========

         The accompanying Notes to Consolidated Financial Statements are an
         integral part of these consolidated financial statements.










                                      F-5

<PAGE>

                          APPLIED MAGNETICS CORPORATION
               CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT
                      (In Thousands, except share amounts)
<TABLE>
<CAPTION>
                                  Common Stock                                       Treasury Stock
                                  ------------                                       --------------
                                                                                                        Unearned
                                  Number                               Retained     Number             Restricted
                                    of                     Paid-In     Earnings       of                 Stock       Shareholders'
                                  Shares        Amount     Capital     (Deficit)    Shares    Amount  Compensation     Investment
                                  ------        ------     -------     ---------    ------    ------  ------------   -------------
<S>                                <C>         <C>        <C>         <C>            <C>      <C>         <C>          <C>
Balance, September 30,
       1995                        22,619,205  $   2,262  $ 181,191   $  (79,031)    96,603   $   (830)   $  --        $ 103,592
       Stock options
         exercised                    582,772         58      2,945         --          --          --       --            3,003
       Purchase of treasury
         stock, net                      --         --         --           --        20,392      (364)      --             (364)
       Litigation settlement           81,070          8      1,242         --          --          --       --             --
       Net income                        --         --         --         32,218        --          --       --           32,218
                                   ----------   --------  ---------   ----------     -------  --------    -------      ---------
Balance, September 28,
       1996                        23,283,047      2,328    185,378      (46,813)    116,995    (1,194)      --          139,699
       Stock options
         exercised                    668,296         67      5,008         --          --          --       --            5,075
       Purchase of treasury
         stock, net                      --         --          --          --        11,389      (360)      --             (360)
       Restricted stock
         issuance, net                 25,368          3        799         --          --          --       (802)          --
       Amortization of
         unearned restricted
         stock compensation,
         net                             --         --          --          --          --          --        251            251
       Net income                        --         --          --        96,116        --          --       --           96,116
                                   ----------   --------  ---------   ----------     -------  --------    -------      ---------
Balance, September 27,
       1997                        23,976,711      2,398    191,185       49,303     128,384     (1,554)     (551)       240,781
       Stock options
         exercised                    128,650         13        640        --           --           --      --              653
       Purchase of treasury
         stock, net                      --         --         --          --          1,849        (23)     --              (23)
       Restricted stock
         issuance, net                 (2,067)        (1)      (600)       --           --           --       550            (51)
       Amortization of
         unearned restricted
         stock compensation,
         net                             --         --         --          --           --           --       (32)           (32)
       Net loss                          --         --         --       (155,368)       --           --      --         (155,368)
                                   ----------   --------  ---------   ----------     -------  --------    -------      ---------
Balance, October 3,
       1998                        24,103,294   $  2,410  $ 191,225   $ (106,065)    130,233  $ (1,577)   $   (33)     $  85,960
                                   ==========   ========  =========   ==========     =======  ========    =======      =========
</TABLE>

         The accompanying Notes to Consolidated Financial Statements are an
         integral part of these consolidated financial statements.

                                      F-6
<PAGE>


                               APPLIED MAGNETICS CORPORATION
                           CONSOLIDATED STATEMENTS OF CASH FLOWS
                                      (In Thousands)
<TABLE>
<CAPTION>
                                                                                           For the Years Ended
                                                                                           -------------------
                                                                                 October 3, September 27,  September 28,
                                                                                   1998         1997           1996
                                                                                 ----------  ------------  -------------
<S>                                                                             <C>          <C>           <C>
Cash Flows from Operating Activities:
Net income (loss)                                                               $(155,368)   $  96,116     $ 32,218
Adjustments to reconcile net income (loss) to net cash
   provided by (used in) operating activities:
    Depreciation and amortization                                                  44,627       38,757       28,891
    Gain on sale of business and assets                                              (414)        --           --
    Provision for customer bankruptcy                                                --          4,200         --
    Restructuring charges                                                           8,400         --           --
    Changes in assets and liabilities:
      Accounts receivable                                                          45,633      (13,721)      (6,832)
      Inventories                                                                  38,384      (15,458)      (3,253)
      Prepaid expenses and other                                                   (4,170)      (1,290)        (750)
      Accounts payable                                                            (32,694)      16,789      (12,221)
      Accrued payroll and benefits                                                 (3,217)         396        1,705
      Other assets and liabilities                                                 (5,752)      (1,706)         (86)
                                                                                ---------    ---------    ---------

      Net cash provided by (used in) operating activities                         (64,571)     124,083       39,672
                                                                                ---------    ---------    ---------
      Cash Flows from Investing Activities:
      Additions to property, plant and equipment                                  (35,876)     (96,065)     (69,900)
      Proceeds from sale of businesses and property, plant and equipment, net       3,025         --         15,122
      Notes receivable                                                                126          106        1,803
                                                                                ---------    ---------    ---------
       Net cash used in investing activities                                      (32,725)     (95,959)     (52,975)
                                                                                ---------    ---------    ---------
        Cash Flows from Financing Activities:
        Proceeds from issuance of convertible subordinated debentures                --           --        115,000
        Proceeds from issuance of debt                                            273,711      239,200      144,214
        Repayment of debt                                                        (266,876)    (236,403)    (164,787)
        Payment of debt issuance costs                                               --           --         (4,274)
        Proceeds from stock options exercised,  net                                   515        4,605        2,574
                                                                                ---------    ---------    ---------
       Net cash provided by financing activities                                    7,350        7,402       92,727
                                                                                ---------    ---------    ---------
Effect of exchange rate changes on cash and equivalents                              (682)        (624)        (260)
                                                                                ---------    ---------    ---------
Net increase (decrease) in cash and  equivalents                                  (90,628)      34,902       79,164
Cash and equivalents at beginning of period                                       162,302      127,400       48,236
                                                                                ---------    ---------    ---------
Cash and equivalents at end of period                                           $  71,674    $ 162,302     $127,400
                                                                                =========    =========    =========
Supplemental Cash Flow Data:
    Interest Paid                                                               $  12,626    $  12,346     $  8,698
    Income Taxes paid                                                           $     317        2,239          541
</TABLE>

                                      F-7

<PAGE>


                         APPLIED MAGNETICS CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                         APPLIED MAGNETICS CORPORATION

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.    Nature of the Business

      Applied Magnetics Corporation and subsidiaries (the "Company") was
incorporated in California in 1957 and was reincorporated in Delaware in 1987.
The Company manufactures advanced inductive thin film ("thin film") disk head
products and magnetoresistive ("MR" ) disk head products, in each case,
primarily to supply to manufacturers of 3.5 inch hard disk drives.

      In fiscal 1998, the Company experienced a significant decrease in net
sales and demand for its inductive thin film products, which resulted in a
significant loss and negative cash flow from operations as the Company
transitions from thin film to magnetoresistive head and giant magnoresistive
head technology. The Company's ability to fund its operating and capital
requirements for fiscal 1999 is heavily dependent on its ability to receive
qualification and begin volume production of its magnetoresistive head and giant
magnoresistive head products on a timely basis. As of June 1, 1999, the Company
is in the final stages of qualification for one of its magnoresistive head
products and expects to begin volume production shipment in the fourth quarter
of fiscal 1999. The Company is also attempting to raise capital, which is
required immediately to fund current operating activities, and will be required
to raise significant additional capital in the near term to fund the anticipated
magnoresistive head production ramp up and related working capital requirements.
If the Company is unable to achieve magnoresistive head production or raise
sufficient capital in the near term, there will be a material adverse effect on
the Company's financial condition, competitive position and ability to continue
as a going concern.

2.    Summary of Significant Accounting Policies

      Principles of Consolidation: The consolidated financial statements include
the accounts of Applied Magnetics Corporation and its subsidiaries. All
significant intercompany accounts and transactions have been eliminated. Certain
1996 accounts have been reclassified to conform with the 1997 and 1998
presentation.

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

                                      F-8

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)

these estimates. Management believes that these estimates and assumptions
provide a reasonable basis for the fair presentation of the consolidated
financial statements.

      Foreign Currencies: Financial statements and transactions of subsidiaries
operating in foreign countries are measured in U.S. dollars in accordance with
Statement of Financial Accounting Standards No. 52. The functional currency for
all subsidiaries is the U.S. dollar. The effect of reporting assets and
liabilities stated in foreign currency is included as a component of "Other
Income (expense), net" in the Consolidated Statements of Operations. A net
foreign currency loss of $1.4 million in 1998 and net gains of $2.1 million in
1997 and of $.5 million in 1996 were included in operations.

      The Company operates in a number of foreign countries. The relative impact
of foreign currency fluctuations on revenue is not significant as product
pricing is generally based on the U.S. dollar. Purchases of certain raw
materials and certain labor costs are paid for in foreign currencies. As a
result, effects of currency rate fluctuations can affect results of operations.
Fluctuations may also have a significant effect on reported cash balances.
Malaysian debt maturities are not currently hedged, as the credit facilities are
held in U.S. dollars. As a result, there is no current foreign transaction
exposure associated with the Malaysian debt.

      Depreciation and Amortization Policies: Plant, property and equipment are
accounted for on a historical cost basis and are depreciated or amortized over
their estimated useful lives using the straight-line method except for leasehold
improvements which are amortized over the life of the lease.


      Estimated useful lives are as follows:

                                                             Average Useful Life
                                                             -------------------
     Buildings                                                       15-16 Years
     Manufacturing equipment                                           2-5 Years
     Other equipment                                                   1-5 Years
     Leasehold improvements                                        Term of Lease

      Depreciation and amortization expense from operations amounted to $44.6
million, $38.8 million and $28.9 million in 1998, 1997 and 1996, respectively.
Property tax expense amounted to approximately $1.9 million, $1.5 million and
$1.6 million in 1998, 1997 and 1996 respectively.



                                      F-9

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)



      The Company follows the policy of capitalizing expenditures that
materially increase asset lives. Maintenance and minor replacements are charged
to operations when incurred. Maintenance and repair expenses charged to
operations were $7.9 million, $10.2 million and $9.0 million in fiscal 1998,
1997 and 1996, respectively. When assets are sold or otherwise disposed of, the
cost and related accumulated depreciation or amortization are removed from the
accounts, and any resulting gain or loss is included in results of operations.

      Long-lived Assets: In the first quarter of fiscal 1997, the Company
adopted Statement of Financial Accounting Standard No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
("SFAS 121"). In accordance with SFAS 121, long-lived assets used by the Company
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.

      Cash Equivalents: Cash equivalents consist primarily of money market
instruments maturing within 90 days of inception and are carried at cost, which
approximates market value. Cash equivalents were $63.3 million at October 3,
1998 and $154.1 million at September 27, 1997.

      Inventories: Inventories are stated at the lower of cost (first-in, first-
out method) or market. Market for purchased parts and manufacturing supplies is
based on replacement costs and for other inventory classifications on net
realizable value. Inventories consist of purchased materials and services,
direct production labor and manufacturing overhead.

      The components of inventory were as follows (in thousands):

                                               October 3,      September 27,
                                                  1998             1997
                                               ----------      -------------

Purchased parts and manufacturing supplies     $ 8,578            $24,187
Work in process                                  2,414             25,434
Finished goods                                   2,062              1,817
                                               -------            -------
                                               $13,054            $51,438
                                               =======            =======

      Revenue Recognition and Warranty Policies: Revenue is recognized at the
time the product is shipped to the customer. Under the Company's warranty terms,
customers are allowed to return products within the applicable warranty periods.
The Company reverses the net sales and associated costs upon receipt of returned
products and makes any appropriate adjustments to the associated warranty
reserve when experience indicates such adjustment is appropriate.



                                      F-10

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      Fair Value of Financial Instruments: The estimated fair values have been
determined by the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is required in
interpreting market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current market exchange.

      The fair value of the Company's debt instruments at October 3, 1998
approximates its carrying value.

      Net Income (Loss) per Common Share: Effective in fiscal 1998, the Company
adopted Statement of Financial Accounting Standards No. 128, "Earnings per
share" ("SFAS 128"). SFAS 128 replaces the presentation of primary income (loss)
per share ("EPS") with the presentation of basic EPS. Net income (loss) per
common share is computed by dividing net income by the weighted average number
of shares of common stock outstanding during the period. Net income per common
share assuming dilution is computed based on the weighted average number of
shares of common stock and common stock equivalents outstanding during the
period as if the Company's Convertible Subordinated Debentures ("Convertible
Debentures") were converted into common stock at the beginning of the period
after giving retroactive effect to the elimination of interest expense, net of
income tax effect, applicable to the Convertible Debentures. During a loss
period, the assumed exercise of in-the-money stock options and conversion of
Convertible Debentures have an antidilutive effect. As a result, these shares
are not included in the weighted average shares used in the calculation of
income (loss) per common share assuming dilution. Prior years EPS has been
conformed to current year presentation.

      Research and Development Expenses: The Company is actively engaged in
basic technology and applied research and development programs which are
designed to develop new products and product applications and related
manufacturing processes. The costs of these programs are classified as research
and development expenses and are charged to operations as incurred.

      Income Taxes: The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS 109"). SFAS 109 is an asset and liability approach that requires
the recognition of deferred tax assets and liabilities for the expected future
tax consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences, SFAS 109
generally considers all expected future events other than the proposed changes
in the tax law or rates. See Note 4.


                                      F-11

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      Stock Options: Proceeds from the sale of common stock issued upon the
exercise of stock options are credited to common stock and paid-in capital
accounts at the time the option is exercised. Income tax benefits attributable
to stock options exercised are credited to paid-in capital when realized. See
Note 5.

      Consolidated Statements of Cash Flows: In accordance with Statement of
Financial Accounting Standards No. 95, "Statement of Cash Flows," the Company
has selected the "indirect method" of presentation for reporting cash flows.

      Recent Accounting Pronouncements: In June 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 establishes standards for the way the Company reports
information about operating segments in annual financial statements and requires
that the Company report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers.

      Increase in Authorized Common Stock

      On February 6, 1998, the Company's shareholders approved the amendment to
Company's Certificate of Incorporation to increase the Company's authorized
common stock from 40 million shares to 80 million shares.

      Fiscal Year

      The Company's fiscal year ends on the Saturday closest to September 30.
Fiscal years 1998, 1997 and 1996 ended on October 3, 1998, September 27, 1997
and September 28, 1996, respectively.

Fiscal year 1998 included 53 weeks. References to years in this annual report
relate to fiscal years rather calendar years.

      This Statement supersedes FASB Statement No. 14, "Financial Reporting for
Segments of a Business Enterprise," but retains the requirement to report
information about major customers. It amends Statement of Financial Accounting
Standards No. 94 "Consolidation of All Majority-Owned Subsidiaries," to remove
the special disclosure requirements for previously unconsolidated subsidiaries.
This Statement will become effective for financial statements of the Company in
fiscal 1999.



                                      F-12

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


3.    Segments of Business

      The Company operates in one market: worldwide-components for
the computer peripheral industry. Sales to major customers are as
follows:

                                                For the Years Ended:

                                        October 3,  September 27,  September 28,
                                           1998         1997           1996
                                        ----------  -------------  -------------

     (As a Percentage of Sales)

Western Digital                            72%          79%           44%
Samsung                                    27%          --            --
NEC                                        --            6%           20%
Seagate (Conner)                           --           --            13%
Quantum                                    --            2%           10%
All Others                                  1%          13%           13%
                                          ---          ---           ---
Total                                     100%         100%          100%
                                          ===          ===           ===

         Export sales are made by the United States operations to the
following geographic locations (in thousands):


                                                  For the Years Ended:

                                   October 3,    September 27,    September 28,
                                      1998          1997             1996
                                   ----------    -------------    -------------

     Europe                         $   --        $    182         $    219
     Asia.........................   183,25        483,736          322,405
                                    -------       --------         --------
                                    $183,25       $483,918         $322,624
                                    =======       ========         ========


      The relative impact of foreign currency fluctuations on export sales is
not significant as product pricing and settlement are generally based on the
U.S. dollar.

                                      F-13

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)

      Information regarding the Company's domestic and foreign operations is as
follows (in thousands):

                                          United
                                          States       Foreign      Total
                                          ------       -------      -----

1998
Net sales                                $ 183,445    $     152    $ 183,597
                                         =========    =========    =========
Intercompany sales                       $ 193,875    $ 237,557    $    --
                                         =========    =========    =========
Operating loss                           $(121,967)   $ (24,246)   $(146,213)
Interest expense, net                                                 (6,750)
                                                                   ---------
    Loss before provision for income
        taxes                                                      $(152,963)
                                         =========    =========    =========
Identifiable assets                      $ 189,026    $ 110,492    $ 299,518
                                         =========    =========    =========
1997
Net sales                                $ 486,943    $   7,896    $ 494,839
                                         =========    =========    =========
Intercompany sales                       $ 317,055    $ 507,054    $    --
                                         =========    =========    =========
Operating profit                         $  42,974    $  59,291    $ 102,265
Interest expense, net                                                 (4,030)

    Income before provision for income
        taxes                                                      $  98,235
                                                                   =========
Identifiable assets                      $ 331,373    $ 146,615    $ 477,988
                                         =========    =========    =========
1996
Net sales                                $ 329,992    $  14,762    $ 344,754
                                         =========    =========    =========
Intercompany sales                       $ 207,023    $ 304,527    $    --
                                         =========    =========    =========
Operating profit                         $   9,887    $  28,011    $  37,898
Interest expense, net                                                 (4,828)
                                                                   ---------
    Income before provision for income
       taxes                                                       $  33,070
                                                                   =========
Identifiable assets                      $ 246,067    $ 113,383    $ 359,450
                                         =========    =========    =========


      A significant percentage of the Company's customers, located in the U.S.,
have production facilities primarily in Asia that receive the Company's
products. Most of the accounts receivable balance is from one of these
customers.


                                       F-14

<PAGE>

                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      Foreign operations primarily consist of manufacturing/assembly operations
in the Asia-Pacific region and sales invoicing responsibility resides with U.S.
operations.

      Results of operations for United States-based operations include all
research and development expenditures, thereby causing an unfavorable comparison
with the operating results of foreign-based operations. The U.S. based
operations include substantially all of the sales of the Company to its outside
customers.

4.    Income Taxes

      The provision for income taxes for the following fiscal years consists of
(in thousands):


                                   1998      1997      1996
                                   ----      ----      ----
Federal Income Taxes
      Current                    $  (463)   $ 1,290   $   527
      Deferred                      --         --        --
State Income Taxes
      Current                       (658)       780       181
      Deferred                      --         --        --
Foreign Income Taxes               3,526         49       144
                                 -------    -------   -------
                                 $ 2,405    $ 2,119   $   852
                                 =======    =======   =======

      Reconciliation of the actual provisions for income taxes to the income tax
calculated at the United States Federal rates for operations were as follows (in
thousands):

                                                  1998       1997       1996
                                                  --------------------------
Income tax (benefit) at the United States
      federal income tax rate                   $(53,537)  $ 34,382   $ 11,575
State income taxes, net of federal income tax
      benefit                                          1        507        118
Foreign income taxed at lower rate                12,377    (19,583)    (8,485)
Temporary differences/net operating losses
        (benefitted) not benefitted               43,564    (13,187)    (2,356)
                                                --------    -------   --------
                                                $  2,405   $  2,119   $    852
                                                ========    =======   ========


                                      F-15

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      The provision (benefit) for deferred income taxes results from temporary
differences which result from different tax bases for assets and liabilities
than their reported amounts in the financial statements. Such differences result
in recognition of income or expense in different years for tax and financial
statement purposes. The sources of these differences and the tax effect of each
at October 3, 1998 and September 27, 1997 were as follows (in thousands):

                                                         1998        1997
                                                      --------    --------
Inventory reserves                                    $  8,536    $  5,439
Other reserves                                           1,395      10,404
Net operating loss carryforwards                        58,500       3,035
Foreign tax & general business credit carryforwards      8,180       6,327
Unrepatriated foreign earnings                          (3,500)     (3,500)
Depreciation                                             2,635       2,750
Other, net                                              (4,718)        475
                                                      --------    --------
 Subtotal                                               71,028      24,930
Valuation allowance                                    (71,028)    (24,930)
                                                      --------    --------
Total net deferred tax asset (liability)              $    ---    $    ---
                                                      ========    ========


      SFAS 109 requires that all deferred tax balances be determined using the
tax rates and limitations expected to be in effect when the taxes will actually
be paid or recovered. Consequently, the income tax provision will increase or
decrease in the period in which a change in tax rate or limitation is enacted.
As of October 3, 1998, the Company had total deferred tax liabilities of $8.2
million and deferred tax assets of $79.2 million. The Company recorded a
valuation allowance in the amount of $71.0 million against the amount by which
deferred tax assets exceed deferred tax liabilities. The valuation reserve at
October 3, 1998 has been provided due to the uncertainty of the amount of future
domestic taxable income. The valuation allowance has been provided after
determining that under the criteria of SFAS No. 109, it was more likely than not
that the net deferred asset would not be realized in the foreseeable future. In
reaching this conclusion, management considered the Company's erratic earnings
history and its structure for income tax reporting purposes, whereby a
significant portion of its earnings are generated in foreign jurisdictions.

      The Company has not provided U.S. federal income taxes on unremitted
foreign earnings as the Company expects to permanently reinvest such earnings in
foreign jurisdictions. In addition, the Company has minimal foreign tax credits

                                      F-16

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)

available to offset the U.S. tax impact of repatriating foreign earnings.
Accordingly, if such foreign earnings were repatriated to the U.S., these
earnings would generally be taxed at the U.S. statutory rates.

      The Company currently operates under a tax holiday in Malaysia. The tax
holiday is effective through August 31, 2004. The Malaysian Industrial
Development Authority has approved a "Common Pioneer" tax status for the
subsequent five year period whereby 70% of the Malaysian income would be exempt
from taxes. The Company is continuing to negotiate with the Malaysian
Authorities to improve the income exemption and extend the term.

      The Company had federal net operating loss carryforwards available for tax
purposes of approximately $148.2 million as of October 3, 1998. To the extent
not used, the net operating loss carryforward expires in varying amounts
beginning in 2009.

5.    Stock Options and Long-term Incentive Plans

      The Company adopted stock option plans in 1988, 1992 and 1994. Incentive
or nonqualified stock options may be granted under the 1992 and 1994 plans while
the 1988 plan is limited to nonqualified options only. The options are issued at
exercise prices equal to the fair market value of the Common Stock at the date
of grant. At October 3, 1998, September 27, 1997 and September 28, 1996, there
were exercisable options outstanding under the option plans to purchase an
aggregate of 125,076 shares, 490,509 shares and 307,356 shares of Common Stock,
respectively.

      In 1994, the Company adopted a nonqualified stock option plan for non-
employee directors (the "1994 Directors' Plan"). Under this plan, directors who
are not employed by the Company are granted options to purchase 20,000 shares of
the Company's Common Stock upon being elected to the board and, thereafter, such
directors receive automatic annual grants of options to acquire 5,000 shares of
Common Stock on March 1 of each year, provided the person continues to serve as
a director. The options granted under the 1994 Directors' Plan are issued at
exercise prices equal to the fair market value of the Common Stock at the date
of grant and become exercisable on the first anniversary following the date of
grant. At October 3, 1998, the Company had reserved 140,000 shares of its $.10
par value Common Stock for future issuance under this plan, options for 160,000
shares were outstanding at prices from $3.00 to $43.13 per share, of which
149,993 shares were exercisable. During fiscal 1998, no options were exercised
or canceled under this plan.

                                      F-17

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)

      In December 1994, the Company granted 250,000 options to purchase the
Company's Common Stock, at $4.125, to Grisanti, Galef and Goldress, Inc.
("GG&G"), a consulting firm hired in August 1994 to provide the Company with
crisis management and turnaround assistance. The options would be exercisable if
the turnaround engagement was successfully completed, which the Company
determined to be so, in July 1995. The options became exercisable in whole or
part and will expire in five years from date of grant. The exercise price of the
options was set at the closing price of the Common Stock on the New York Stock
Exchange on the date of grant. During fiscal 1998, options for 30,000 shares
were exercised. At October 3, 1998, 125,000 options were exercisable under this
plan.

      Stock option activity under the option plans is as follows:

                                              Options Outstanding
                                              -------------------
                                         Number       Weighted Average
                                        Of Shares     Exercise Price
                                        ---------     --------------

Balance September 30, 1995              1,856,453     $    5.42

  Granted                               1,059,000     $   15.34
  Exercised                              (582,772)    $    5.19
  Canceled                                (62,861)    $    5.90
                                        ---------

Balance September 28, 1996              2,269,820     $   10.09
                                        ---------

 Granted                                1,736,006     $   35.26
 Exercised                               (668,296)    $    7.43
 Canceled                                (837,618)    $   37.62
                                        ---------

Balance September 27, 1997              2,499,912     $   19.06
                                        ---------

 Granted                                5,242,101     $    7.81
 Exercised                               (128,650)    $    5.05
 Canceled                              (4,295,704)    $   16.28
                                        ---------

Balance October 3, 1998                 3,317,659     $    5.42
                                        ---------


      The following table summarizes information about the Company's stock
options outstanding and exercisable as of October 3, 1998:



                                      F-18

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)
<TABLE>
<CAPTION>
                        Options Outstanding                                            Options Exercisable
                        -------------------                                            -------------------
                                                     Weighted
                                                      Average          Weighted                         Weighted
  Range of Exercise Prices         Number            Remaining          Average           Number         Average
       Exercise Price           Outstanding       Contractual Life   Exercise Price    Exercisable    Exercise Price
       --------------           -----------       ----------------   --------------    -----------    --------------

<S>   <C>                         <C>                  <C>             <C>               <C>              <C>
      $1.9048 - $ 4.25              202,041            2.22            $  3.79           202,041          $ 3.79
      $4.3750 - $ 4.38            2,841,022            9.96            $  4.38                --          $   --
      $5.1250 - $43.13              274,596            4.94             $17.44           216,928          $17.94
                                  ---------            ----             ------           -------          ------
                                  3,317,659            9.07             $ 5.42           418,969          $11.12
                                  =========            ====             ======           =======          ======
</TABLE>


      Pro Forma Information: In October 1995, the Financial Accounting Standards
Board released Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123"). SFAS 123 provides an alternative to
APB Opinion 25, "Accounting for Stock Issued to Employees" ("APB 25") and
requires additional disclosures. The Company has elected to follow APB 25 in
accounting for stock options. As a result, the Company generally recognizes no
compensation expense associated with its various stock option plans. SFAS 123
requires disclosure of pro forma fair market value of options granted, pro forma
net income and pro forma earnings per share as if the Company had accounted for
its stock options granted subsequent to September 30, 1995, under the fair value
method of that statement.

      The fair value of the Company's stock options granted to employees was
estimated using a Black Scholes pricing model assuming no expected dividends and
the following weighted-average factors:


                                                1998        1997
                                                ----        ----

     Option life (in years)                     2.75        2.83
     Risk-free interest rate                    5.05%       6.18%
     Stock price volatility                     0.59        0.57


      The weighted-average fair value of stock options granted in 1998 and 1997
under the Company's stock option plans was $3.19 and $14.60, respectively.

      In February of 1998, the Company modified 1,140,799 options with initial
exercise prices ranging from $15.25 to $35.5625 to a modified exercise price of
$11.9375 per option. In September of 1998, the Company modified 2,841,022

                                      F-19

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


options with initial exercise prices ranging from $5.875 to $31.625 to a
modified exercise price of $4.375 per option. In each case, the new price was
then prevailing market price of the Company's common stock.

      Had the Company determined compensation expense based on the fair value
method as described in SFAS 123, the Company's net income and net income per
share would have been reduced to the amounts indicated below:

                                           October 3,          September 27,
                                             1998                 1997
                                           ----------          -------------
Pro forma net income (in thousands)        $  (164,684)         $   88,963
Pro forma net income per share:
      Primary                              $     (6.88)         $     3.77
      Fully diluted                        $     (6.88)         $     2.87

      Pro forma net income (loss) and net income (loss) per share reflect only
options granted in the years ended October 3, 1998 and September 27, 1997.
Therefore, the full impact of calculating compensation expense for options under
SFAS No. 123 is not reflected in the pro forma net income amounts presented
above because compensation expense is reflected over the options' vesting period
and compensation expense for options granted before October 1, 1995 is not
considered.

      The Company adopted a long-term incentive plan in 1989. Under the 1989
plan, the Company grants shares of Common Stock at no cost to the participants.
These shares are subject to restrictions, which prohibit selling, transferring
assigning or otherwise disposing of the Common Stock. The restrictions
automatically expire ten years following the date of grant, or earlier if
certain performance objectives are achieved. The market value of Common Stock
issued is recorded as unearned restricted stock compensation and shown as a
separate component of shareholders' investment. This compensation is amortized
against income over the periods in which the participants perform services. At
October 3, 1998, 2,068 shares were available for future issuance under the 1989
plan and 10,617 shares remain subject to restrictions. During 1998, no shares
were issued, 2,067 shares were canceled and restrictions were removed from
12,684 shares under the 1989 plan. No compensation expense was required during
1998.


                                      F-20

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)

      The Company has authorized a class of Preferred Stock consisting of
5,000,000 shares, $.10 par value. The Board of Directors has authority to divide
the Preferred Stock into series, to fix the number of shares comprising any
series and to fix or alter the rights, privileges and preferences of the
Preferred Stock. No shares of the Preferred Stock were outstanding at October 3,
1998 or September 27, 1997. During 1988, the Board of Directors declared a
dividend of one Right for each outstanding share of Common Stock to stockholders
of record on November 4, 1988. Each Right entitles the holder to buy the
economic equivalent of one share of Common Stock in the form of one
one-hundredth of a share of the Preferred Stock at an exercise price of $20.00.
Under certain conditions, each Right will entitle its holder to purchase, at the
Right's exercise price, shares of the Company's Common Stock or common stock
equivalents having a market value of twice the Right's exercise price.

      As discussed in Note 1, the Company adopted SFAS 128 effective in fiscal
1998. The following table illustrates the computation of basic income (loss) per
common share and income (loss) per common share assuming dilution under the
provisions of SFAS 128.

                                                       For The Fiscal Year
                                                              Ended
                                                  ---------------------------
                                                  October 3,    September 27,
                                                     1998            1997
                                                  ---------------------------
Income (Loss) Per Share:
 Net income (loss)                                   $(155,368)   $  96,116
                                                     =========    =========
 Weighted average common shares outstanding             23,931       23,567
                                                     =========    =========
 Income (Loss) per common share                      $   (6.49)   $    4.08
                                                     =========    =========
Income (Loss) per Common Share--Assuming Dilution:
 Net income (loss) before adjustment                  (155,368)      96,116
 Add back subordinated debentures interest                --          8,050
 Add back subordinated debentures amortization            --            428
 Less tax impact                                          --           (175)
                                                     ---------    ---------
   Net income (loss) as adjusted                     $(155,368)   $ 104,419
                                                     =========    =========
 Shares
   Weighted average common shares outstanding           23,931       23,567

   Dilutive effect of stock options                       --          1,261
   Assuming conversion of convertible subordinated
     debentures                                           --          6,183
                                                     ---------    ---------
   Common shares--assuming dilution                     23,931       31,011
                                                     =========    =========
Income (Loss) per common share--assuming dilution    $   (6.49)   $    3.37
                                                     =========    =========

                                      F-21

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      Income (loss) per common share is computed by dividing net income (loss)
by the weighted average number of shares of common stock and common stock
outstanding during the period. Income (loss) per common share--assuming dilution
is computed based on the weighted average number of shares of common stock and
common stock equivalents outstanding during the period and as if the Company's
Convertible Subordinated Debentures ("Convertible Debentures") were converted
into common stock at the beginning of the period after giving retroactive effect
to the elimination of interest expense, net of income tax effect, applicable to
the Convertible Debentures. During a loss period, the assumed exercise of
in-the-money stock options and conversion of Convertible Debentures have an
antidilutive effect. As a result, those shares are not included in the weighted
average shares outstanding used in the calculation of basic and fully diluted
loss per common share as of October 3, 1998.


6.    Notes Payable and Long-term Debt

      Notes payable and long-term debt consists of the following (in thousands):

                                                  October 3,    September 27,
                                                     1998            1997
                                                  ----------    -------------

7.0% Convertible Subordinated Debentures, due March
 15, 2006                                             $114,999   $115,000
Secured Malaysian bank credit facilities, interest
 rates from 6.75% to 10.0%                              55,482     50,188
Mortgage payable, interest rate of 8.5%                     66         86
Bank advance, interest rate of 9.5%                      2,986       --
Capital leases                                           3,312      1,457
                                                      --------   --------
                                                       176,845    166,731
Less--current portion, including bank credit
 facilities                                             60,078     50,701
                                                      --------   --------
                                                      $116,767   $116,030
                                                      ========   ========

                                      F-22

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      The aggregate principal payments of bank notes payable and long-term debt
for the years subsequent to October 3, 1998 are: 1999--$60.1 million, 2000--
$1.5 million, 2001--$0.2 million, thereafter $115.0 million.

      The Company's $115.0 million 7.0% Convertible Subordinated Debentures (the
"Convertible Debentures") due in 2006 may be converted, at any time at a
conversion price of $ 18.60 per share.

      The Company has a secured, revolving line of credit from CIT
Group/Business Credit, Inc. ("CIT") that has been in place since January, 1995.
This line of credit provides for borrowings up to $35.0 million based on
eligible trade receivables at various interest rates and is secured by trade
receivables, inventories and certain other assets. As of October 3, 1998, the
total amount available for future borrowings was $1.2 million under this
facility. As of October 3, 1998, the Company was not in compliance with all
financial covenants but has received notification from the Company's lender
waiving the area of non-compliance until July 31, 1999, and expects to
successfully renegotiate the terms of the covenants with the lender. In December
1997, the Company extended the line of credit to January, 2001. For the year
ended October 3, 1998, $4.2 million of available funds were used to secure
equipment leases with two of the Company's lessors.

      The Company's Malaysian subsidiary has a credit facility with a Malaysian
bank that has been in place since June 1990, is callable on demand and has no
termination date. In May 1995, the Company and the Malaysian bank amended this
credit facility to include a security interest in the Company's real property
holdings in Malaysia and to include certain covenants which preclude the Company
from granting liens and security interests in other assets in Malaysia. Credit
facilities with four other banks, established by the Company's Malaysian
subsidiary during fiscal 1997 are unsecured. The borrowings under the new
facilities are also callable on demand, and have no termination date. The total
amount available to borrow under all the credit facilities was approximately
$60.7 million of which $55.5 million was outstanding at October 3, 1998. The
Company was in compliance with all financial covenants under these facilities.
The interest rates outstanding on these loan facilities ranged from 6.75% to
10.0%, at October 3, 1998 and had a weighted average interest of 8.58%. The
Company intends to continue its practice of repaying maturities with new
borrowings under these facilities.



                                      F-23

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)



7.    Dispositions

      During 1993, the Company sold its subsidiaries, Magnetic Data, Inc. and
Brumko Magnetics, which had been accounted for as a discontinued operation in
1992, to Delta Bravo, Inc. ("DBI"). A portion of the sales consideration
consisted of notes issued to the Company. DBI subsequently defaulted on several
note covenants and breached related pledge agreements with the Company. On July
17, 1996, the Company, through foreclosure proceedings, acquired all the common
stock of DBI and Magnetic Data Technologies ("MDT"), which was formed in
conjunction with the foreclosure for a $2.5 million reduction in debt owed to
the Company by DBI. All DBI note balances had been fully reserved by the Company
in previous years and the Company has no investment in DBI or MDT. The Company
has engaged a third party consulting firm to operate and facilitate the sale of
MDT. MDT was sold subsequent to October 3, 1998. See Note 13. MDT's financial
position and results of operations are immaterial to the Company's consolidated
financial statements.

8.    Commitments and Contingencies

      The Company has been identified as a potentially responsible party in
connection with a hazardous waste facility in Whittier, California. A site
remediation plan is being prepared for submission to the U.S. Environmental
Protection Agency. Separately, the California Regional Water Quality Control
Board ("CRWQCB") issued a clean up and abatement order to the Company concerning
property previously used and owned by the Company. As a result of this order,
the Company performed an environmental study to determine the extent of
contamination related to chemicals used by the Company at this site. The CRWQCB
required the Company to implement a remediation project. For these and other
environmental sites, the Company has accrued reserves at the most likely cost to
be incurred where it is probable that the Company will incur remediation costs
that can be reasonably estimated. As of October 3, 1998 and September 27, 1997,
the amounts accrued for environmental reserves were not significant. It is
impossible at this time to determine the ultimate liabilities that the Company
may incur resulting from the foregoing claims and contingencies. In management's
opinion, after taking into account reserves, it is unlikely that any of these
matters will have a material adverse effect on the Company's financial position
or results of operations.


                                      F-24

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      A portion of the Company's facilities and equipment are leased under
non-cancelable operating leases and certain equipment is leased under
capitalized leases. The terms of the leases for facilities and equipment expire
over the next five years with renewal options in certain instances. Future
minimum lease payments under capital and operating leases as of October 3, 1998
are as follows (in thousands):

                                                        Leases
                                          -------------------------------------
                                          Capital Leases       Operating Leases
                                          --------------       ----------------

1999                                         $ 1,763                $30,991
2000                                           1,606                 25,883
2001                                             236                 21,522
2002                                              --                 12,655
Thereafter                                        --                  2,260
                                             -------                -------

Total minimum payments                         3,605                $93,311
                                             =======                =======
Less imputed interest                           (293)
                                             -------

Present value of minimum payments under
  capital leases                               3,312
Less current portion                          (1,590)
                                             -------

Long-term lease
 obligation                                  $ 1,722
                                             =======


      Manufacturing and other equipment at October 3, 1998 include assets under
capitalized leases of $5.2 million with related accumulated depreciation of $0.1
million.

      Purchase commitments associated with capital expenditures were $3.6
million at October 3, 1998.

      The Company entered into $3.3 million of capital leases during fiscal
1998.

      The Company's Malaysian subsidiary has a credit facility with a Malaysian
bank that includes security interest in the Company's real property holdings in
Malaysia, with a net book value of $25.4 million at October 3, 1998.

                                      F-25

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)


      Total rental expense, net of sublease rental income, for the years ended
October 3, 1998, September 27, 1997 and September 28, 1996, including items on a
month-to-month basis, was approximately $32.5 million, $23.7 million and $15.2
million, respectively.

      One of the senior executives of the Company has a five year employment
agreement. Any changes to the agreement require approval by the Board of
Directors.

9.    Benefit Plans

      The Company has a qualified retirement plan (the "401(k) Plan") under the
provisions of section 401(k) of the Internal Revenue Code, in which eligible
employees may participate. Substantially all participants in this plan are able
to defer compensation up to the annual maximum amount allowable under Internal
Revenue Service regulations. Additionally, the Company has a profit sharing
plan, in which all eligible employees participate. Profit sharing amounts are
distributed as 75% in cash, except for foreign employees who receive all of
their profit sharing in cash, and 25% in cash which is contributed to employees
participating in the Company's 401(k) Plan. There was no compensation expense
recorded under the cash profit sharing plan and the Company made no 401(k)
contributions during fiscal 1998. Compensation expense recorded under the cash
profit sharing plan during 1997 and 1996 was approximately $4.5 million and $3.3
million, respectively, of which approximately $0.6 million and $0.5 million was
contributed to participating employees' 401(k) accounts, respectively.

10.   Terminated Merger Costs

      Terminated merger costs of $2.9 million for fiscal 1997 include legal and
accounting fees, financial advisory fees and miscellaneous expenses related to
the February 1997 proposed business combination between the Company and Read-
Rite Corporation. On March 14, 1997, the Company announced its
withdrawal of the proposal.

11.   Provision for Customer Bankruptcy

      On November 10, 1997, Singapore Technologies announced plans to shut down
its subsidiary, Micropolis, one of the Company's customers. As a result, the
Company recorded a provision for customer bankruptcy of $4.2 million in the
fourth quarter of fiscal 1997 related to potentially uncollectible accounts
receivable.

                                      F-26

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)



12.   Restructuring Charge

      The Company recorded a restructuring charge of approximately $8.4 million
in the first quarter of fiscal 1998. Of this amount, approximately $2.9 million
pertains to severance and related expenses at Ireland facility and approximately
$5.5 million represents the write-off of the unamortized book value of inductive
thin-film equipment. The shut down of the Ireland plant was completed in March
1998 as part of a plan to consolidate foreign manufacturing operations.
Approximately 300 employees were terminated at the Ireland plant. All amounts
for severance at the Ireland facility were paid during 1998. The restructuring
reserve balance was zero as of October 3, 1998. The inductive thin-film
equipment, which is no longer usable to the Company, has been abandoned due to
changing technology. Management separately isolated the idle equipment. Many of
the products have already been disposed of, and the remaining estimated cost of
disposal is expected to be approximately equal to the scrap value.

13.   Subsequent Events (Unaudited)

      On November 3, 1998, the Company entered into an agreement with Gleacher
Natwest Inc. ("Gleacher") giving Gleacher, through the issuance of common stock
purchase warrants, the right to purchase up to an aggregate of 1,200,000 shares
of the Company's Common Stock in exchange for providing financial advisory
services to the Company until February 12, 2000. The warrants will be issued in
six series and each series entitles the holders thereof to purchase 200,000 of
the Company's common stock at the lower of (i) the current market price on the
vesting date, as defined or (ii) $7.00, subject to adjustments defined in the
agreement. The warrants vest over the term of the agreement and are valued using
the Black Scholes pricing model. The Company records a corresponding liability
equal to the value of the warrants at each respective vesting date.

      On February 11, 1999, the Company completed its merger with DAS, a
research and development company. The consideration exchanged was 13,051,872
shares of the Company's common stock for all of the outstanding preferred and
common shares of DAS. The acquisition was accounted for as a purchase, and the
acquisition price of approximately $99.7 million was allocated to assets
acquired, including the fair value of in-process technology, and liabilities
assumed based on their fair values. It was determined that in-process technology
of $28.7 million was acquired. Since the technology has no future economic value


                                      F-27

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)

to the Company, it was written-off during the three months ended April 3, 1999.
The excess of the purchase price plus related transaction costs over the fair
value of tangible and intangible assets acquired and liabilities assumed has
been allocated to (1) developed technology and know-how of approximately $30.1
million, which will be amortized on a straight line basis over 3 years, the
estimated period of future benefit and (2) goodwill of approximately $39.6
million (including a value of $1.6 million associated with assembled workforce),
which will be amortized on a straight line basis over the estimated period of
future benefit of 7 years. Concurrent with this acquisition and contingent on
the merger, a private investor group purchased 4,641,089 shares of the Company's
common stock in exchange for $18.75 million.

      On April 12, 1999, the Company completed its previously announced sale of
its subsidiary, Magnetic Data Technologies, LLC ("MDT") to Dubilier & Company.
MDT is a leading provider of outsourced post-sales services to original
equipment manufacturers ("OEM's") of electronic components and systems. The
Company realized a gain from discontinued operations of approximately $25.9
million on the transaction in the third fiscal quarter of 1999.




















                                      F-28

<PAGE>


                         APPLIED MAGNETICS CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   (Continued)



14.   Summarized Quarterly Financial Data (Unaudited)

                                             Three Months Ended
                                ----------------------------------------------
                                December 27     April 4    July 4    October 3
                                -----------     -------    ------    ---------

(In Thousands, Except per Share Data)

1998
Net sales                         $ 74,412    $ 58,843    $ 33,579    $ 16,763
Gross profit (loss)                 (7,078)      3,721      (1,935)     (9,853)
Net loss                           (39,749)    (31,931)    (35,842)    (47,846)
Net loss per share:
  Loss per common share           $  (1.67)   $  (1.33)   $  (1.50)   $  (1.99)
  Loss per common share--assuming
   dilution                          (1.67)      (1.33)      (1.50)      (1.99)
Weighted average number of common
 shares outstanding:
  Common shares                      23,858     23,925      23,968      23,973
  Common shares--assuming
   dilution                          23,858     23,925      23,968      23,973

                                             Three Months Ended
                                ----------------------------------------------
                                December 28    March 29   June 28 September 27
                                -----------    --------   ------- ------------



(In Thousands, Except per
 Share Data)

1997
Net sales                         $121,627     $126,311   $124,073    $122,828
Gross profit                        46,597       48,549     39,884      32,819
Net income                          31,872       31,091     21,028      12,125
Net income per share:
  Income per common share         $   1.36     $   1.32   $   0.89    $   0.51
  Income per common share--
   assuming dilution                  1.10         1.06       0.75        0.46
Weighted average number of common
 shares outstanding:
  Common shares                     23,267       23,519     23,681      23,803
  Common shares--assuming
   dilution                         30,861       31,178     30,904      31,100





                                      F-29

<PAGE>


                                  SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Company and in
the capacities and on the dates indicated.

Date: July 8, 1999

                               APPLIED MAGNETICS CORPORATION

                               /s/ Craig D. Crisman
                               ------------------------------
                               Craig D. Crisman
                               Chairman of the Board and Chief Executive Officer
                               (Principal Financial Officer)

Date:  July 8, 1999

                               /s/ Peter T. Altavilla
                               ------------------------------
                               Peter T. Altavilla
                               Corporate Controller (Principal)


                               POWER OF ATTORNEY

      KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Craig D. Crisman and Jerry Goldress, and each of
them, his attorneys-in-fact, each with the power of substitution, for him in any
and all capacities, to sign any amendments to this report and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.

      Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Company and in
the capacities and on the dates indicated.

Signature                                             Date


    Craig D. Crisman                              July 8, 1999
------------------------------------
Craig D. Crisman, Chairman of the Board
and Chief Executive Officer
(principal executive officer, principal
financial officer)

    Peter T. Altavilla                            July 8, 1999
--------------------------------
Peter T. Altavilla, Secretary and
Controller (principal accounting officer)

    Harold R. Frank*                              July 8, 1999
------------------------------------
Harold R. Frank, Director and Chairman

                                      F-30
<PAGE>





    R. C. Mercure, Jr.*                           July 8, 1999
------------------------------------
R. C. Mercure, Jr., Director

    Herbert M. Dwight, Jr.*                       July 8, 1999
------------------------------------
Herbert M. Dwight, Jr., Director

    Jerry E. Goldress*                            July 8, 1999
------------------------------------
Jerry E. Goldress, Director


               Craig D. Crisman
    *By: ---------------------------------
               Craig D. Crisman
               Attorney-In-Fact





























                                      F-31