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                      SECURITIES AND EXCHANGE COMMISSION
                               WASHINGTON, D.C.
 
                             ---------------------
 
                                   FORM 10-K
 
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
   ACT OF 1934 (FEE REQUIRED)
 
                 FOR THE FISCAL YEAR ENDED SEPTEMBER 27, 1997
 
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EX-
   CHANGE 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)
 
<TABLE>
<CAPTION>
                    DELAWARE                               95-1950506
     <S>                                     <C>
        (State or other jurisdiction of                 (I.R.S. Employer
         incorporation or organization)                Identification No.)
<CAPTION>
     75 ROBIN HILL ROAD, GOLETA, CALIFORNIA                  93117
     <S>                                     <C>
        (Address of principal executive
                    offices)                               (Zip Code)
</TABLE>
 
      Registrant's telephone number, including area code: (805) 683-5353
 
                             ---------------------
 
         Securities registered pursuant to Section 12 (b) of the Act:
 
<TABLE>
       <S>                                          <C>
          TITLE OF EACH CLASS                        NAME OF EACH EXCHANGE ON
       --------------------------                        WHICH REGISTERED
                                                    -------------------------
         Common Stock, $.10 par
                 value                               New York Stock Exchange
        Preferred Stock Purchase
                 Rights                              New York Stock Exchange
</TABLE>
 
       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 $294,715,457 as of December 15, 1997.
 
                   COMMON STOCK (PAR VALUE $.10) 23,002,182
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Portions of the Proxy Statement for the registrant's 1998 Annual Meeting of
Stockholders, to be filed pursuant to Regulation 14A within 120 days following
the registrant's fiscal year ended September 27, 1997 are incorporated by
reference into Part III on this Form 10-K.
 
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                                    PART I
 
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 a leading 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
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.
 
  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. As a
result, the Company experienced significant customer demand for its advanced
inductive thin film products during fiscal 1997. However, due to continued
industry trends towards even greater storage capacity and performance,
customer demand began to shift from inductive thin film product technology to
MR technology. By the end of fiscal 1997, some of the Company's customers had
discontinued development of new products based on thin film disk head
technology. 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
Company believes that demand for thin film disk heads peaked during the second
half of fiscal 1997.
 
  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.
 
  During fiscal 1997, 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. During the first half of fiscal 1997, the
Company experienced strong revenues and gross margins as it shipped earlier
generation inductive thin film products. During the second half of fiscal
1997, the Company began a transition to newer generations of higher
performance inductive thin film and MR heads, resulting in a sequential
quarterly decline in yields, which negatively impacted production volumes,
revenues and profits.
 
  Fiscal 1998 will be a year of significant technology transition, as the
Company's product mix evolves from predominantly inductive thin film to MR
technology. The Company has made a significant technology investment and has
recently strengthened its MR development infrastructure, both through the
reorganization of its Wafer Development group and through the addition of new
management and engineering personnel with significant MR experience. The
Company has invested, and continues to invest, in significant expansion of its
MR wafer fabrication facilities and equipment and has converted its inductive
thin film wafer fabrication facility and equipment to have the capability of
manufacturing the inductive thin film write element for MR 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 drive programs and execute planned
production ramps of these products.
 
                                       2
<PAGE>
 
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 two micro inches, 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 an actuator, or 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 was successful in achieving primary supplier status on a number
of programs in fiscal 1997, resulting in a net sales increase of 43.5% as
compared to fiscal 1996. However, the disk drive industry continues to be
highly competitive as product technology evolves from inductive thin film to
MR technology. The Company's fiscal 1998 revenue and shipment volume is
expected to be substantially less than the rate experienced in fiscal 1997 as
its thin film disk head products reach end of life and are replaced by MR disk
head products by the fourth quarter of fiscal 1998.
 
  In recent years, the disk drive industry has experienced significant growth,
and the Company has expanded its capacity during the last two fiscal years to
meet that growth. However, 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 severity of the drop in the
demand for components during periods of reduced growth or contraction. The
disk drive industry recently appears to be entering into an oversupply
condition, and as a result, head suppliers, including the Company, are
experiencing competitive pricing pressures for its inductive thin film heads.
In December 1997, Western Digital Corporation ("Western Digital"), the
Company's largest customer in fiscal 1997, notified the Company of significant
reductions to its order backlog due to Western Digital's plan to transition
from thin film to MR disk drive production substantially by the end of its
June 1998 quarter.
 
  In addition, the Company is evaluating manufacturing operations and plans to
take a pre-tax restructuring charge of approximately $8.0 million in its first
quarter of fiscal 1998, primarily in connection with planned realignment of
foreign operations. There is no assurance that the level of demand for disk
drives during fiscal 1998 will increase to previous levels, once the current
disk drive oversupply is corrected, or that future demand will be sufficient
to support existing and future capacity. A continued decline in demand for
hard disk drives may have a material adverse effect on the Company's future
operating results.
 
  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. While the Company believes that industry conditions and economic
factors will continue to create an environment in which drive manufacturers
will require, as their primary source of supply, independent suppliers of
magnetic recording heads and in which vertically integrated disk drive and
systems companies will require alternative or "secondary" sources of supply,
the further
 
                                       3
<PAGE>
 
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.
 
  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 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 recording 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. MR disk heads are
also 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.
 
  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 read-back signal levels. Higher data densities 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.
 
  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, 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 increasingly
require higher performance MR heads. Coupled with the increasing supply of
competitively priced MR heads and the tendency of major disk drive customers
to select MR products for new disk drive development programs, the Company
believes that demand for its inductive thin film heads peaked during the
second half of fiscal 1997. As a result, it is anticipated that MR products
will represent the majority of the Company's shipments by the third quarter of
fiscal 1998.
 
                                       4
<PAGE>
 
  The Company believes that GMR disk heads represent the next important
magnetic recording head technology. Like 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, will allow GMR heads to achieve even higher areal
densities and performance levels than either inductive thin film or MR disk
heads.
 
PRODUCTS
 
  During fiscal 1997, the Company qualified and made volume production
shipments on a number of new disk drive programs which require thin film
products. The Company's thin film products are produced in volume for 3.5 inch
disk drives to achieve areal densities of up to approximately 1,200 megabits
of data per square inch of disk surface, providing data storage capacities of
up to 1.7 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 technology during fiscal 1998.
 
  During fiscal 1997, the majority of the disk head products supplied by the
Company were in the "nanoslider" or "50%" form factor (in which the slider is
approximately 50% of the size, in each of its three dimensions, of the
original inductive thin film slider). The Company has been and continues to
develop products in the smaller "picoslider" or "30%" form factor, for
inductive thin film, MR and GMR disk heads. The Company successfully entered
volume production on picoslider inductive thin film heads during fiscal 1997
and they are expected to represent the majority of the Company's thin film
products during fiscal 1998.
 
  Development and commercialization of MR disk heads continued to be a major
investment for the Company in fiscal 1997. During fiscal 1997, the Company
continued production on its first volume MR disk head program and, in
addition, continued to ship prototype and qualification samples of MR disk
head products to selected customers for drive applications with recording
densities of up to 1,900 megabits per square inch. During fiscal 1998, MR
drive applications are expected to require areal densities of 2,500 megabits
per square inch or more in production. This will require the Company's
engineering and production resources to successfully meet their targeted
design and process development plans, achieve "design-in" on customer drive
programs and execute the planned production ramps.
 
  During fiscal 1997, the Company began development of GMR disk head
technology. It is expected that the Company will deliver GMR disk head samples
and begin customer program qualification cycles during fiscal 1998, but volume
production of GMR heads is not anticipated before fiscal 1999.
 
  For discussion of net sales and percentage of sales by product, see "Annual
Results of Operations" under Item 7.
 
MANUFACTURING
 
 Wafer / Slider Fabrication
 
  MR 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. During fiscal 1997 production of inductive thin
film products started to transition from the nanoslider form factor, where
approximately 8,400 individual (unyielded) sliders can be produced from each
six inch wafer, to the pico slider form factor, where approximately 14,700
individual (unyielded) sliders can be produced from each wafer. This
transition is expected to be completed during the first half of fiscal 1998.
Production of MR wafers is expected to continue in the nanoslider form factor
for all of fiscal 1998.
 
                                       5
<PAGE>
 
  In March 1997, the Company completed the first phase of expansion of its MR
wafer fab. The second phase of the expansion, which commenced in July, was
completed during the first quarter of fiscal 1998 and is expected to be fully
equipped by April 1998. This fab will have the capacity to produce over 500 MR
wafers per week.
 
  Completed wafers are sliced into row bars containing 29 sliders per bar for
the nanoslider form factor and 44 sliders per bar for the picoslider form
factor. After testing, row bars are 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 two microinches (or less) above the disk surface. On some of the
Company's products, photolithography and ion milling technologies are also
used to define pole tip geometries and hence recording densities produced by
the heads. For some programs, 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 (higher
performance) head designs 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 manner. The Company believes that
development of new products involving MR and GMR technologies will be critical
to future revenue growth.
 
  The Company believes that future demand for recording heads will continue.
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; Dublin, Ireland and Beijing, China.
 
  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.
 
  From time to time, during periods of growth, the Company has experienced a
shortage of direct labor at its manufacturing locations. 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 1998. In response to recent faster than planned
transition from thin film to MR disk head production, and reduced demand for
the Company's disk heads, the Company developed a plan to realign foreign
operations that will be implemented during the first half of fiscal 1998.
 
  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. Experience indicates that these factors have not produced
significant liability, but there can be no assurances that these factors will
not impact the Company's future operations.
 
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
 
                                       6
<PAGE>
 
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 and contact air bearing recording technologies and the
development of GMR technology). 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 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 technology development has been primarily devoted to
commercialization of advanced inductive thin film disk head technology and MR
disk head technology. Future research and development ("R&D") efforts will
continue with commercialization of MR product technology and development of
GMR technology. Research and development expenses were $52.5 million, $50.9
million and $33.7 million fiscal years 1997, 1996 and 1995, respectively. The
Company believes that its existing cash resources and expected operating
results will provide sufficient financial resources to fund its ongoing
research and development activities in a manner consistent with its current
operating plan.
 
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
disk heads and on multiple independent suppliers for other materials used in
the manufacturing process. The Company purchases suspension assemblies from
Hutchinson Technology, Incorporated ("Hutchinson") 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.
 
CUSTOMERS AND MARKETING
 
  The Company's customers in fiscal 1997 included, among others, Micropolis
(S) Pte Ltd., ("Micropolis"), NEC Corporation ("NEC"), Quantum Corporation
("Quantum") and Western Digital.
 
  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 79% of net sales during the year
ended September 27, 1997. All other customers were less than 10% of net sales.
The Company anticipates that Western Digital will continue to be its largest
customer during fiscal 1998. In December 1997, Western Digital announced
expected lower revenues and profits for its December 1997 quarter, as a result
of actions it is taking in response to current disk drive oversupply in the
industry's distribution channel and increasing pricing pressures. The Company
was then notified of significant reductions to its order backlog due to
Western Digital's plan to transition from thin film to MR disk drive
production substantially by the end of its June 1998 quarter.
 
  In February 1997, Quantum announced the sale of a majority interest in its
Recording Head Group to Matsushita-Kotobuki Electronics Industries Ltd.
("MKE"), Quantum's contract manufacturing partner for disk drives. The
resulting joint venture, MKE-Quantum Components ("MKQC"), in which Quantum
retains a
 
                                       7
<PAGE>
 
49% interest, supplies recording heads to MKE for use in Quantum disk drives.
Revenue from Quantum during fiscal 1997 was less than 2% of total revenues.
The Company does not expect a material impact to its future revenue growth.
 
  In June 1997, NEC announced plans to discontinue internally developed NEC
drives and engage in a contract manufacturing relationship with IBM. Revenue
from NEC during fiscal 1997 was less than 10% of total revenues. The Company
expects that revenue from NEC in fiscal 1998 will decline materially.
 
  During fiscal 1997, Micropolis, a subsidiary of Singapore Technologies,
continued to experience operating losses. On November 10, 1997, Singapore
Technologies announced plans to shut down its disk drive operations after a
review of the financial and market condition of Micropolis. As a result, the
Company recorded a provision of $4.2 million for customer bankruptcy related
to potentially uncollectible accounts receivable in the fourth quarter of
fiscal 1997. At the time of the shutdown, the Company had no active production
programs with Micropolis and, therefore, no revenue impact is expected to the
Company's operations during fiscal 1998. See "Management Discussion and
Analysis" under Item 7.
 
  Inductive thin film and MR program qualifications are under way with several
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 any
variety of reasons, including bankruptcy, could have a material adverse effect
on the Company's future operating results.
 
  The Company experienced a significant shift in its customer base during
fiscal 1997. Revenues from NEC and Quantum declined to less than 10% each
during fiscal 1997, as revenues from Western Digital increased. The disk drive
industry continues to experience significant consolidation. Certain disk drive
and systems companies, such as Quantum, have acquired or merged with magnetic
head companies in an effort to produce magnetic heads for their own use.
Seagate, a major manufacturer of both disk drive and recording heads, and
Conner Peripherals, Incorporated, ("Conner"), completed a merger of their
companies in fiscal 1996. Conner was the Company's largest customer in fiscal
1995. Revenues from Conner declined materially during fiscal 1996. 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 further 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 has been 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 advanced
inductive thin film or MR 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 thin film or MR disk heads
are canceled, rescheduled or diverted, such actions could have an adverse
effect on the Company's operations. See "Disk Drive Industry" for further
discussion.
 
                                       8
<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,
NEC, Quantum/MKE and Seagate produce some or all thin film and/or MR 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 1996,
IBM announced plans to expand its disk drive and disk components business,
including its MR technology, by selling to OEM's starting in 1997.
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 is successful in marketing its advanced MR products in the
market at competitive prices.
 
  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
thin film and MR disk head products than the Company and has been its largest
competitor among independent thin film disk head manufacturers. Read-Rite and
Sumitomo Metal Industries, Ltd. ("SMI") have a joint venture in Japan to make
thin film and/or MR 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.
 
  Other independent recording head manufacturers that are shipping, or intend
to ship, to the OEM marketplace include Headway Technologies, Incorporated,
DAS Devices, Incorporated and Silmag.
 
  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 September 27, 1997 was approximately $137.5 million, compared to
approximately $116.3 million at September 28, 1996, before the reduction in
order backlog by Western Digital in December 1997. Backlog increased year-to-
year as a result of increased customer demand for thin film and MR disk head
products. Backlog includes only firm orders for which the customers have
released a specific purchase order and a specified delivery schedule.
 
  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 and repricing as customer
requirements change.
 
  The contractual arrangements between the Company and most of its customers
permit the Company to assert claims for cancellation costs and expenses in
these circumstances. However, the resolution of these claims is
 
                                       9
<PAGE>
 
often a lengthy and extensively negotiated 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 canceled
order over an extended period of time at reduced unit prices.
 
  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. Western Digital
recently reduced its order backlog as it transitions from thin film to MR disk
drive production sooner than planned. These circumstances could continue to
reoccur 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 September 27, 1997, the Company had approximately 8,500 employees of
whom approximately 1,100 are located in California, approximately 7,100 are
located in Asia and approximately 300 are located in Ireland. 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. To meet planned fiscal 1998 production
requirements, the Company completed facility expansion during fiscal 1997 of
its factories in Malaysia and China, established an additional subcontractor
in the Philippines and expanded operations at its established subcontractors
in China and Malaysia. The Company also completed expansion of its factory in
California, which is expected to be fully equipped by April 1998.
 
  During fiscal 1998, management has been evaluating manufacturing capacity in
light of recent events with its customers and the disk drive industry. In
addition, the Company announced in December 1997 that it would take a pre-tax
restructuring charge of approximately $8.0 million in the first quarter of
fiscal 1998 in connection with planned realignment of foreign operations.
 
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 non-disclosure
agreements, internal procedures and patent protection. The Company has been
issued a number of United States 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.
 
  Under an agreement (the "Hutchinson Agreement") with Hutchinson, the Company
and Hutchinson hold licenses 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 Hutchinson 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 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 several resulting joint patents are
currently pending.
 
  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.
 
                                      10
<PAGE>
 
  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 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.
 
  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 for a further twelve months. At the
end of the study the CRWQCB will assess the need, if any, for further
investigation or cleanup and may issue another order at that time.
 
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.
 
                                      11
<PAGE>
 
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 1998, the Company
faces another technology evolution from inductive thin film to MR disk head
technology. There can be no assurance that the Company will continue to
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 1997 totaling $96.1 million. In addition,
the Company leased $35.1 million of production equipment through operating
leases, with terms of up to five years. During fiscal 1998, the Company plans
to purchase or enter into lease financing for approximately $170.0 million of
manufacturing equipment and facility improvements. However, due to recent
changes in the disk drive industry and to the Company's order backlog, it is
reviewing all planned expenditures for fiscal 1998, but will focus on its
investment in MR and GMR technology. 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 adversely affect the Company's future operating results.
 
 Short Term Borrowings
 
  At September 27, 1997, the Company had outstanding approximately $50.2
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. As recently as the first
half of fiscal 1995, the Company experienced substantial losses. 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 has also, on occasion, experienced
cancellation and rescheduling of orders and reductions in quantities ordered
as customer requirements change. 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. Moreover,
the Company and several of its major competitors have announced large capital
expenditure programs, and there is no assurance that market demand will be
adequate to absorb this expanded capacity. 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.
 
                                      12
<PAGE>
 
 Dependence on Foreign Operations
 
  The Company conducts substantially all of its production, assembly and test
operations in its facilities in Ireland, Korea, Malaysia and the People's
Republic of China ("PRC"). In addition, the Company has contractual
relationships with unaffiliated parties who conduct manufacturing and assembly
operations for the Company in Korea, Malaysia, the Philippines and the PRC.
The Company's operations in Korea have, from time to time in recent years,
been affected by labor disruptions and slow downs. The Company's production
facility in Malaysia faced potential labor shortages during fiscal 1996 and
may face potential labor shortages in the future, as other disk drive and
component manufacturers expand their production facilities in Malaysia. 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.
 
 Management of Growth
 
  During the past two fiscal years, the Company experienced significant
growth. In order to maintain and improve operating results during periods of
rapid expansion, the Company's management will be required to manage this
growth and the related expansion effectively. There is no assurance that the
Company will continue to expand as it has in recent years in order to improve
operating results. Future expansion may become more difficult to manage in
geographically dispersed operations. The Company's failure to effectively
manage growth could have a material adverse effect on its future operating
results.
 
 Volatility of Stock Price
 
  The market price of the Company's Common Stock has been volatile, with daily
market prices ranging from $17.38 to $60.50 per share during fiscal 1997. 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 15,
1997:
 
<TABLE>
<CAPTION>
     NAME                 AGE                POSITION OR OFFICE
     ----                 --- -------------------------------------------------
     <S>                  <C> <C>
     Craig D. Crisman....  56 Chairman of the Board and Chief Executive Officer
     Peter T. Altavilla..  44 Corporate Controller and Secretary
</TABLE>
 
  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.
 
  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.
 
                                      13
<PAGE>
 
ITEM 2. PROPERTIES
 
  Certain information concerning the Company's principal properties at
September 27, 1997 is set forth
below:
 
<TABLE>
<CAPTION>
                                                                                  SQUARE
LOCATION                            TYPE                    PRINCIPAL USE         FOOTAGE OWNERSHIP
--------                 --------------------------- ---------------------------- ------- ---------
<S>                      <C>                         <C>                          <C>     <C>
Goleta (Santa Barbara),
 California............. Headquarters, office, plant Marketing and manufacturing, 217,000   Owned
                          and warehouse               research and engineering
Goleta, California...... Office                      Administration                16,568  Leased
San Jose, California.... Office                      Customer support               1,300  Leased
Penang, Malaysia........ Office, plant & warehouse   Manufacturing                208,000   Owned*
Chung Ju, Korea......... Office, plant & warehouse   Manufacturing                293,000   Owned
Republic of Singapore... Office                      Customer Support               6,000  Leased
Beijing, China.......... Office, plant & warehouse   Manufacturing                 24,000  Leased
Dublin, Ireland......... Office, plant & warehouse   Manufacturing                 40,000   Owned
</TABLE>
---------------------
* Property held as collateral for Malaysian revolving credit facility. See
  Note 6 to the Notes to Consolidated Financial Statements under Item 8.
 
  The Company owns a building in Dassel, Minnesota which is leased by the
Company to the acquirer of a subsidiary which was previously sold by the
Company.
 
  One facility in Chung Ju, Korea, comprising 93,000 square feet, is being
offered for sale.
 
  The Company believes its existing manufacturing facilities are adequate to
support customer requirements during fiscal 1998.
 
ITEM 3. LEGAL PROCEEDINGS
 
  The Company is not a party, nor are its properties subject to, any material
pending legal proceedings other than ordinary routine litigation incidental to
the Company's business and the matters described above.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None
 
                                      14
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
  The Company's Common Stock is traded on the New York Stock Exchange under
the symbol "APM." The following table sets forth for the periods indicated the
high and low sale prices for the Common Stock.
 
<TABLE>
<CAPTION>
                                                                 HIGH     LOW
                                                                ------- -------
     <S>                                                        <C>     <C>
     Fiscal year ending September 28, 1996
      First Quarter............................................ $19     $12 1/8
      Second Quarter...........................................  19 1/8  13 3/4
      Third Quarter............................................  21 3/4   9 1/2
      Fourth Quarter...........................................  18 1/4   8 1/4
     Fiscal year ending September 27, 1997
      First Quarter............................................ $31 7/8 $17 3/8
      Second Quarter...........................................  60 1/2  27 3/8
      Third Quarter............................................  36 1/2  22 3/8
      Fourth Quarter...........................................  38 5/8  22 1/4
</TABLE>
 
  At December 15, 1997, there were approximately 1,738 record holders of the
Company's Common Stock.
 
  There were no cash dividends paid by the Company during the fiscal years
1997 or 1996. The Company currently intends to retain any earnings for use in
its business and does not anticipate paying cash dividends in the foreseeable
future.
 
                                      15
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
ITEM 6. SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE    1997     1996     1995      1994      1993
AND EMPLOYMENT AMOUNTS)          -------- -------- --------  --------  --------
<S>                              <C>      <C>      <C>       <C>       <C>
OPERATIONS
Net sales......................  $494,839 $344,754 $292,600  $275,927  $335,898
Net income (loss)..............    96,116   32,218    1,748   (52,670)  (43,728)
Net income (loss) per share:
 Primary.......................  $   3.88 $   1.35 $   0.08  $  (2.39) $  (2.17)
 Fully diluted.................  $   3.37 $   1.21 $   0.08  $  (2.39) $  (2.17)
Weighted average number of com-
 mon and common equivalent
 shares outstanding:
 Primary.......................    24,780   23,897   22,472    22,082    20,156
 Fully diluted.................    31,011   30,173   22,472    22,082    20,156
Order backlog..................  $137,508 $116,262 $107,466  $ 64,781  $ 77,126
Year-end employment............     8,431    6,401    5,478     5,531     7,259
BALANCE SHEET
Working capital (1)............  $161,164 $117,882 $ (5,963) $(36,443) $ 33,920
Total assets...................   477,988  359,450  246,817   220,556   278,516
Total debt.....................   166,731  163,917   69,629    67,151    57,183
Shareholders' investment.......   240,781  139,699  103,592    98,433   151,095
</TABLE>
---------------------
(1) This balance includes borrowings outstanding under loan facilities with
    Malaysian banks which are callable on demand and have no termination date.
    The balances for the years ended September 27, 1997 and September 28, 1996
    and the years ended September 30, 1995, 1994 and 1993 were $50.2 million,
    $45.8 million, $46.9 million, $46.1 million and $35.2 million,
    respectively.
 
                                      16
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
     RESULTS OF OPERATIONS
 
  Fiscal 1997 was a record year for Applied Magnetics. The Company posted a
net profit of $96.1 million for the year ended September 27, 1997, compared to
$32.2 million for the year ended September 28, 1996, and $1.7 million for the
year ended September 30, 1995. Net sales increased 43.5% in fiscal 1997 from
fiscal 1996 and 17.8% in fiscal 1996 from fiscal 1995.
 
  During fiscal 1997, the Company's continued revenue growth and profitability
compared to fiscal 1996 was attributed to strong customer demand for its
inductive thin film products which represented approximately 93.1% of total
net sales for fiscal 1997. During the first quarter of fiscal 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 thin film disk head technology using the picoslider ("30%") form
factor on 1.4 gigabytes and 1.7 gigabytes per 3.5 inch disk products. The
picoslider almost doubles the number of sliders that can be processed from one
wafer.
 
  The Company shipped magnetoresistive ("MR") disk heads during fiscal 1997,
with net sales representing approximately 4.9% of total net sales. However,
low yields on these programs coupled with an earlier than planned end of life
on one of its initial production programs limited the Company's ability to
achieve expected MR production volumes. As a result, revenue growth and
profitability were impacted. The Company is continuing its commitment to MR
product development with the addition of technical personnel and capacity
expansion of its MR wafer fab. The fab expansion is complete and will be fully
equipped by April 1998.
 
  Fiscal 1997 operating results included a charge of $4.2 million for customer
bankruptcy related to potentially uncollectible accounts receivable of
Micropolis (S) Pte Ltd. ("Micropolis"). On November 10, 1997, Singapore
Technologies announced plans to close its subsidiary, Micropolis, after review
of the company's financial position and market condition. At the time of the
shutdown, Applied Magnetics had no active production programs with Micropolis
and therefore no revenue impact is expected during fiscal 1998.
 
  The disk drive industry recently appears to be entering into an oversupply
condition, and as a result, head suppliers, including the Company, are
experiencing competitive pricing pressures for its inductive thin film heads.
In December 1997, Western Digital announced expected lower revenues and
profits for its December 1997 quarter, as a result of actions it is taking in
response to current disk drive oversupply in the industry's distribution
channel and increasing pricing pressures. The Company was then notified of
significant reductions to its order backlog due to Western Digital's plan to
transition from thin film to MR disk drive production substantially by the end
of its June 1998 quarter.
 
  In addition, the Company is evaluating manufacturing operations and plans to
take a pre-tax restructuring charge of approximately $8.0 million in its first
quarter of fiscal 1998 primarily in connection with planned realignment of
foreign operations.
 
  The Company's inductive thin film product at the 1.7 gigabyte per 3.5 inch
disk capacity point is planned for volume production through the first three
quarters of fiscal 1998. This is expected to be the final generation of
advanced inductive thin film products, making fiscal 1998 a significant
technology transition year for the Company. The product mix will evolve from
thin film to MR disk head technology and MR products are expected to represent
the majority of the Company's shipments by the third quarter of fiscal 1998.
Most of the new customer development programs for which the Company is
currently in qualification cycles utilize MR technology.
 
  Revenues, shipment volumes, operating and financial results for fiscal 1998
will be impacted by reduced advanced thin film production levels while the
Company seeks to achieve qualification status on new MR programs, execute
production ramps and improve MR processes and production yields on its new
programs. See "Products" under Item 1.
 
                                      17
<PAGE>
 
  During fiscal 1996, the Company's significant revenue growth and
profitability over fiscal 1995 was attributed to numerous factors, including
increased customer demand for its thin film products, continued timely
production ramps on qualified thin film programs during the first half of
fiscal 1996, successful transition to a new generation of advanced thin film
disk head products and achievement of profitable yields during the second half
of fiscal 1996.
 
  The Company had shifted from production of ferrite disk heads to thin film
disk heads during fiscal 1995, due to the superior performance characteristics
and competitive pricing of thin film disk heads over ferrite disk heads.
Technological development started in fiscal 1995 contributed to fiscal 1996
operational and financial improvements and included conversion from the thin
film ("70%") microslider to the nanoslider form factor, conversion from 3 inch
substrate ("wafer") to 6 inch wafer fabrication (which produces more thin film
disk heads per wafer) and conversion to fully etched air bearing ("FEAB") and
negative air pressure bearing surfaces that improved product performance.
 
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.
 
<TABLE>
<CAPTION>
                                      SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 27,
                                          1997          1996          1995
                                      ------------- ------------- -------------
<S>                                   <C>           <C>           <C>
Net sales............................     100.0%        100.0%        100.0 %
Cost of sales........................      66.1%         73.0%         86.4 %
Gross margin.........................      33.9%         27.0%         13.6 %
Operating expenses
  Research and development...........      10.6%         14.8%         11.5 %
  Selling, general and administra-
   tive..............................       1.7%          1.9%          2.5 %
  Provision for customer bankruptcy..       0.8%          --            --
  Terminated merger costs............       0.6%          --            --
  Total operating expenses...........      13.7%         16.7%         14.0 %
Income (loss) from operations........      20.2%         10.3%         (0.4)%
Interest income......................       1.7%          1.2%          0.7 %
Interest expense.....................       2.5%          2.6%          1.6 %
Other income, net....................       0.5%          0.6%          2.2 %
Income before taxes..................      19.9%          9.5%          0.8 %
Provision for income taxes...........       0.4%          0.2%          0.2 %
Net income...........................      19.4%          9.3%          0.6 %
</TABLE>
 
  NET SALES: 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 an
increase in shipments of head stack assemblies ("HSAs") as compared to head
gimbal assemblies ("HGAs"), increased capacity and continued high customer
demand. Thin film disk head net sales represented 93.1% of total net sales in
1997 compared to 76.0% in 1996. The Company continued volume production on MR
disk heads with net sales of $24.1 million 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 performs final
assembly of HSAs using thin film and MR disk heads purchased from other
manufacturers.
 
  Net sales of $344.8 million increased 17.8% in fiscal 1996 from net sales of
$292.6 million in fiscal 1995 primarily due to an increase in shipments of
inductive thin film products. Thin film disk head net sales increased to 76.0%
of total net sales in 1996 from 68.8% in 1995. Ferrite disk head net sales
represented 12.1% of total net sales in 1996 compared to 7.5% in 1995, as one
customer completed its program requirements. Substantially all ferrite
shipments were completed by the end of the fourth quarter of fiscal 1996. The
Company began initial volume production of MR technology products during the
fourth quarter of fiscal 1996. Total MR net sales were $6.0 million during
fiscal 1996, or 1.7% of total net sales. Other products represented 10.2% of
total net sales
 
                                      18
<PAGE>
 
and included tape head products and disk head products for which the Company
only performs final assembly of HSAs using thin film and MR disk heads
purchased from other manufacturers.
 
  GROSS MARGIN: The gross margin increased in fiscal 1997 to 33.9% as compared
to 27.0% in fiscal 1996. The increase was due to higher inductive thin film
disk head sales volumes, resulting in economies of scale, coupled with cost
controls.
 
  The gross margin increased in fiscal 1996 to 27.0% as compared to 13.6% in
fiscal 1995. The increase resulted from higher revenues and significant
improvements in production yields.
 
  RESEARCH AND DEVELOPMENT: Research and development expenses ("R&D") were
$52.5 million, $50.9 million, and $33.7 million for fiscal years 1997, 1996
and 1995, respectively. These expenses represented 10.6%, 14.8% and 11.5% of
net sales, respectively, for such periods.
 
  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.
 
  R&D expenses increased by $17.2 million in fiscal 1996 from 1995 as the
Company increased engineering resources on next generation inductive thin film
and MR technology and production process development.
 
  The Company continues to invest in advanced technology products and
processes and expects that expenditures generally will increase on an absolute
dollar basis during fiscal 1998 as MR and GMR technology and process
development efforts become critical to the future operational and financial
growth for the Company.
 
  SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Selling, general and
administrative ("SG&A") expenses in absolute dollars were $8.3 million, $6.5
million and $7.4 million in fiscal 1997, 1996 and 1995, respectively. These
expenses represented 1.7%, 1.9%, and 2.5% 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.
 
  VALUATION ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS: 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 announced plans to shut down its subsidiary,
Micropolis, one of the Company's customers. As a result, the Company recorded
the charge in the fourth quarter of fiscal 1997. The Company's allowance for
uncollectible accounts receivable at September 28, 1996 and September 30, 1995
was $0.8 million and $0.7 million, respectively.
 
  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 $8.3 million, $4.2 million
and $2.0 million in fiscal 1997, 1996 and 1995, respectively. Interest income
increased $4.1 million in fiscal 1997 from fiscal 1996 and increased $2.2
million in fiscal 1996 from 1995 due to investment of higher average cash
balances. Interest expense was $12.3 million, $9.1 million and $4.8 million in
fiscal 1997, 1996 and 1995, respectively. Interest expense increased $3.2
million in fiscal 1997 from 1996 and increased $4.3 million in fiscal 1996
from 1995, due to higher average debt outstanding. Increases in both
categories were primarily as a result of the Company's March 1996 issuance of
$115.0 million 7% Convertible Subordinated Debentures due in 2006.
 
  OTHER INCOME (EXPENSE): Other income was $2.4 million, $2.0 million and $6.3
million in fiscal 1997, 1996 and 1995, respectively. Other income in fiscal
1997 included $2.1 million in foreign exchange and
 
                                      19
<PAGE>
 
transaction net gains. 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 Technology Incorporated ("Seagate") and $0.5 million in foreign
exchange and transaction net gains. Other income in fiscal 1995 included $4.9
million in income recognized as the Company completed certain performance
milestones in connection with the sale to Seagate, $1.3 million related to
sale of tooling and excess assets and $0.2 million in foreign exchange and
transaction net losses.
 
  PROVISION FOR INCOME TAXES: The fiscal 1997 and 1996 provision for income
taxes included alternative minimum state and federal taxes and provision for
foreign income taxes. For fiscal year 1995 the most significant component of
the provision for income taxes was foreign taxes for which there were no
foreign tax credit offsets available.
 
  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, 1999. Currently, the Company is
exploring other tax incentives available in Malaysia after its tax holiday
expires. If the Company is unsuccessful in obtaining tax incentives or extend
the tax holiday, the foreign earnings would be taxed at Malaysian statutory
rates.
 
  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 September 27, 1997, the Company's cash and cash equivalents balance
increased to $162.3 million from $127.4 million at September 28, 1996. During
fiscal 1997, the Company generated $124.1 million from operating activities,
comprised primarily of the net effect of the following: i) $96.1 million from
net income, which included $38.5 million of depreciation and amortization
expense; ii) $4.2 million provision for customer bankruptcy; iii) net increase
in the accounts receivable balance of $13.7 million as a result of the
increase in net sales in September 1997 over September 1996; iv) increase in
inventories of $15.5 million and v) increase in the accounts payable balance
of $16.8 million. Higher production volumes in response to increased customer
orders for its disk head products resulted in higher inventories and accounts
payable as compared to fiscal 1996.
 
  During fiscal 1997, the Company expanded production facilities and purchased
manufacturing equipment in fiscal 1997 totaling $96.1 million. In addition,
the Company leased $35.1 million of production equipment through operating
leases, with terms of up to five years. The Company increased overall
production capacity and improved advanced thin film and MR production
processes. Also, during fiscal 1997, the Company's inductive thin film wafer
fab was converted to enable manufacturing of MR write heads and the Company
completed its first clean room expansion of the MR fab in Goleta, California.
This expansion was fully equipped during the first quarter of fiscal 1998. The
Company completed a second clean room expansion during the first quarter of
fiscal 1998, which is expected to be fully equipped by April 1998.
 
  During fiscal 1997, net cash of $7.4 million was generated from financing
activities, consisting primarily of increases in borrowings of $2.8 million
and net proceeds from stock option exercises of $4.6 million.
 
  During fiscal 1997, the Company also increased its Malaysian borrowings to
$50.2 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
 
                                      20
<PAGE>
 
certain covenants which preclude the Company from granting liens and security
interests in other assets in Malaysia. Credit facilities with five other
banks, established by the Company's Malaysian subsidiary during fiscal 1997
are unsecured. Unused borrowings available under all the facilities was
approximately $31.1 million at September 27, 1997. 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.
Also included in total debt is $115.0 of 7.0% Convertible Subordinated
Debentures, due 2006.
 
  The Company has a secured, asset-based revolving line of credit of $35.0
million 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. As of September 27, 1997, there were no borrowings outstanding.
The balance available under this line of credit was approximately $29.9
million at September 27, 1997 and the Company was in compliance with all
financial covenants. In December, 1997, the Company extended the line of
credit to January, 2001.
 
  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 1998, the Company plans approximately $170.0
million in capital expenditures, including equipment to be obtained through
operating leases, primarily to continue development and production of MR
technologies and products and increase overall production capacity.
 
  The Company's accounts receivable and inventory balances are heavily
concentrated with one customer, Western Digital. Sales to Western Digital
accounted for approximately 79.0% and 44.0% of the Company's sales in 1997 and
1996, respectively. The Company anticipates that Western Digital will continue
to represent its largest customer during fiscal 1998. 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 was a decrease of $0.6 million and $0.3 million in cash for fiscal
1997 and 1996, respectively.
 
  The Company uses software and related technologies throughout its operations
that will be affected by the date change in year 2000. An internal study was
completed in fiscal 1997 to determine the full scope and related costs to
ensure the Company's systems meet its internal needs. The Company has begun
implementation of a worldwide management information system that addresses the
year 2000 issue and also provides fully integrated manufacturing and financial
capabilities. The Company plans to continue implementation during fiscal 1998
and expects full conversion by the end of fiscal 1999. The cost of the
implementation will not have a material impact on the results of operations in
fiscal 1998.
 
  During fiscal 1998, the Company believes it will have sufficient cash flows
from existing cash balances, operations, existing credit facilities and
equipment lease financing alternatives to meet its operating and capital
expenditure requirements as the Company transitions from thin film disk head
production to MR disk head production. The Company continues to work with its
customers to qualify on MR disk head programs. In light of the recent reduced
demand from the Company's major customer for thin film products, management
believes that it will be able to reduce its funding requirements for planned,
but not committed, capital expenditures. Purchase commitments totaled $61.2
million at September 27, 1997. However, the Company's continued shipment and
revenue growth and profitability will depend on the Company's ability to
achieve "design-in"
 
                                      21
<PAGE>
 
status with its customers, achievement of satisfactory production yields and
successful execution of planned production ramps on MR disk head products.
While the Company is in the process of completing plant capacity expansion and
conversion of its existing fabs to enable manufacturing of MR write heads and
is devoting substantial engineering and manufacturing resources to these
efforts, there can be no assurances 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 and liquidity. This may require the Company to either obtain
additional capital from external sources or to curtail its capital, research
and development and working capital expenditures. Such curtailment could
adversely affect the Company's future years' operations and competitive
position.
 
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 will become effective for financial
statements of the Company in the first quarter of fiscal 1998. Management
believes that the adoption of SFAS 128 will not have a material impact on the
Company's EPS disclosure when it is adopted.
 
  In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS 130"). SFAS 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. SFAS 130 requires that
the Company (a) classify items of other comprehensive income by their nature
on the face of the financial statement in which comprehensive income is
reported or disclosed in the notes to the financial statements and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement
of financial position. This Statement will become effective for financial
statements of the Company in fiscal 1999.
 
  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.
 
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 disk head products with profitable
yields; (ii) the
 
                                      22
<PAGE>
 
relatively limited number of customers and customer changes in short range and
long range plans; iii) dependence on continued customer demand for the
Company's pico form factor inductive thin film products; (iv) timely
completion of capacity expansion of the Company's Goleta, California facility;
(v) competitive pricing pressures; (vi) the Company's ability to control
inventory levels; (vii) domestic and international competition in the
Company's product areas; (viii) risks related to international transactions;
and (ix) general economic risks and uncertainties.
 
                                      23
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
FINANCIAL STATEMENTS:
Report of Independent Public Accountants.................................. F-2
Consolidated Statements of Operations for the years ended September 27,
 1997, September 28, 1996 and September 30, 1995.......................... F-3
Consolidated Balance Sheets as of September 27, 1997 and September 28,
 1996..................................................................... F-4
Consolidated Statements of Cash Flows for the years ended September 27,
 1997, September 28, 1996 and September 30, 1995.......................... F-5
Consolidated Statements of Shareholders' Investment for the years ended
 September 27, 1997, September 28, 1996 and September 30, 1995............ F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
 
 
                                      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
September 27, 1997 and September 28, 1996, and the related consolidated
statements of operations, shareholders' investment and cash flows for each of
the three years in the period ended September 27, 1997. 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 September 27, 1997 and September
28, 1996, and the results of their operations and their cash flows for each of
the three years in the period ended September 27, 1997, in conformity with
generally accepted accounting principles.
 
                                          ARTHUR ANDERSEN LLP
 
Los Angeles, California
December 3, 1997
 
                                      F-2
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                FOR THE YEARS ENDED
                                     -----------------------------------------
                                     SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
                                         1997          1996          1995
                                     ------------- ------------- -------------
<S>                                  <C>           <C>           <C>
Net sales...........................   $494,839      $344,754      $292,600
Cost of sales.......................    326,990       251,503       252,684
                                       --------      --------      --------
  Gross profit......................    167,849        93,251        39,916
                                       --------      --------      --------
Research and development expenses...    (52,532)      (50,867)      (33,655)
Selling, general and administrative
 expenses...........................     (8,330)       (6,533)       (7,434)
Provision for customer bankruptcy...     (4,200)          --            --
Terminated merger costs.............     (2,906)          --            --
Interest income.....................      8,316         4,228         1,996
Interest expense....................    (12,346)       (9,056)       (4,826)
Other income, net...................      2,384         2,047         6,335
                                       --------      --------      --------
  Income before income taxes........     98,235        33,070         2,332
Provision for income taxes..........      2,119           852           584
                                       --------      --------      --------
  Net income........................   $ 96,116      $ 32,218      $  1,748
                                       ========      ========      ========
Net income per share:
  Primary...........................   $   3.88      $   1.35      $   0.08
                                       ========      ========      ========
  Fully diluted.....................   $   3.37      $   1.21      $   0.08
                                       ========      ========      ========
Weighted average number of common
 and common equivalent shares out-
 standing:
    Primary.........................     24,780        23,897        22,472
                                       ========      ========      ========
    Fully diluted...................     31,011        30,173        22,472
                                       ========      ========      ========
</TABLE>
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                     part of these consolidated statements.
 
                                      F-3
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
                          CONSOLIDATED BALANCE SHEETS
 
                (IN THOUSANDS, EXCEPT SHARE AND PAR VALUE DATA)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                            AS OF
                                                 ---------------------------
                                                 SEPTEMBER 27, SEPTEMBER 28,
                                                     1997          1996
                                                 ------------- -------------
<S>                                              <C>           <C>           <C>
Current assets:
 Cash and equivalents..........................    $ 162,302     $ 127,400
 Accounts receivable, less allowances of $4,942
  in 1997 and $766 in 1996.....................       52,924        43,403
 Inventories...................................       51,438        35,980
 Prepaid expenses and other....................       11,420        10,122
                                                   ---------     ---------
                                                     278,084       216,905
                                                   ---------     ---------
Property, plant and equipment, at cost:
 Land..........................................        2,556         2,556
 Buildings.....................................       92,962        72,284
 Manufacturing equipment.......................      193,217       155,696
 Other equipment and leasehold improvements....       32,433        28,268
 Construction in progress......................       50,056        30,052
                                                   ---------     ---------
                                                     371,224       288,856
 Less-accumulated depreciation and
  amortization.................................     (181,732)     (155,134)
                                                   ---------     ---------
                                                     189,492       133,722
                                                   ---------     ---------
Other assets...................................       10,412         8,823
                                                   ---------     ---------
                                                   $ 477,988     $ 359,450
                                                   =========     =========
                 LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current liabilities:
 Current portion of long-term debt.............    $     513     $   1,865
 Bank notes payable............................       50,188        45,789
 Accounts payable..............................       49,103        32,314
 Accrued payroll and benefits..................       11,287        11,001
 Other current liabilities.....................        5,829         8,054
                                                   ---------     ---------
                                                     116,920        99,023
                                                   ---------     ---------
Long-term debt, net............................      116,030       116,263
                                                   ---------     ---------
Other long-term liabilities....................        4,257         4,465
                                                   ---------     ---------
Shareholders' Investment:
 Preferred stock, $.10 par value, authorized
  5,000,000 shares, none issued and
  outstanding..................................       --            --
 Common stock, $.10 par value, authorized
  40,000,000 shares, issued 23,976,711 shares
  at September 27, 1997 and 23,283,047 shares
  at September 28, 1996........................        2,398         2,328
 Paid-in capital...............................      191,185       185,378
 Retained earnings (deficit)...................       49,303       (46,813)
                                                   ---------     ---------
                                                     242,886       140,893
Treasury stock, at cost (128,384 shares at Sep-
 tember 27, 1997 and 116,995 shares at Septem-
 ber 28, 1996).................................       (1,554)       (1,194)
Unearned restricted stock compensation.........         (551)          --
                                                   ---------     ---------
                                                     240,781       139,699
                                                   ---------     ---------
                                                   $ 477,988     $ 359,450
                                                   =========     =========
</TABLE>
  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 CASH FLOWS
 
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                 FOR THE YEARS ENDED
                                      -----------------------------------------
                                      SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
                                          1997          1996          1995
                                      ------------- ------------- -------------
<S>                                   <C>           <C>           <C>
Cash Flows from Operating Activi-
 ties:
Net income..........................    $  96,116     $  32,218     $   1,748
Adjustments to reconcile net income
 to net cash provided by operating
 activities:
 Depreciation and amortization......       38,506        28,891        27,600
 Provision for customer bankruptcy..        4,200        --            --
 Gain on sale of business and as-
  sets..............................       --            --            (6,109)
 Amortization of unearned restricted
  stock compensation, net...........          251        --               721
 Changes in assets and liabilities:
  Accounts receivable...............      (13,721)       (6,832)      (17,712)
  Inventories.......................      (15,458)       (3,253)       (3,772)
  Prepaid expenses and other........       (1,290)         (750)       (3,074)
  Accounts payable..................       16,789       (12,221)       23,168
  Accrued payroll and benefits......          396         1,705           181
  Other assets and liabilities......       (1,706)          (86)       (3,855)
                                        ---------     ---------     ---------
 Net cash flows provided by operat-
  ing activities....................      124,083        39,672        18,896
                                        ---------     ---------     ---------
Cash Flows from Investing Activi-
 ties:
Additions to property, plant and
 equipment..........................      (96,065)      (69,900)      (27,676)
Proceeds from sale of businesses and
 fixed assets, net..................       --            15,122        29,539
Notes receivable....................          106         1,803         2,048
                                        ---------     ---------     ---------
 Net cash flows provided by (used
  in) investing activities..........      (95,959)      (52,975)        3,911
                                        ---------     ---------     ---------
Cash Flows from Financing Activi-
 ties:
Proceeds from issuance of convert-
 ible subordinated debentures.......       --           115,000        --
Proceeds from issuance of debt......      239,200       144,214       160,868
Proceeds from issuance of capital
 lease obligations..................       --            --             5,142
Repayment of debt...................     (236,403)     (164,787)     (163,705)
Payment of debt issuance costs......       --            (4,274)       --
Proceeds from stock options exer-
 cised, net.........................        4,605         2,574         2,270
                                        ---------     ---------     ---------
 Net cash flows provided by financ-
  ing activities....................        7,402        92,727         4,575
                                        ---------     ---------     ---------
Effect of exchange rate changes on
 cash and equivalents...............         (624)         (260)           93
                                        ---------     ---------     ---------
Net increase in cash and equiva-
 lents..............................       34,902        79,164        27,475
Cash and equivalents at beginning of
 period.............................      127,400        48,236        20,761
                                        ---------     ---------     ---------
Cash and equivalents at end of peri-
 od.................................    $ 162,302     $ 127,400     $  48,236
                                        =========     =========     =========
Supplemental Cash Flow Data:
Interest paid.......................    $  12,346     $   8,698     $   4,827
                                        =========     =========     =========
Income taxes paid...................    $   2,239     $     541     $     494
                                        =========     =========     =========
</TABLE>
 
          The accompanying Notes to Consolidated Financial Statements
             are an integral part of these consolidated statements.
 
                                      F-5
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
              CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT
 
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                           COMMON STOCK                         TREASURY STOCK
                         -----------------                     -----------------    UNEARNED
                                                    RETAINED                       RESTRICTED
                           NUMBER          PAID-IN  EARNINGS    NUMBER               STOCK     SHAREHOLDERS'
                         OF SHARES  AMOUNT CAPITAL  (DEFICIT)  OF SHARES AMOUNT   COMPENSATION  INVESTMENT
                         ---------- ------ -------- ---------  --------- -------  ------------ -------------
<S>                      <C>        <C>    <C>      <C>        <C>       <C>      <C>          <C>
Balance, September 30,
 1994................... 22,161,460 $2,216 $178,481 $(80,779)    92,509  $  (812)    $(673)      $ 98,433
 Stock options exer-
  cised.................    399,773     40    2,668    --         --       --          --           2,708
 Purchase of treasury
  stock, net............     --       --      --       --         4,094      (18)      --             (18)
 Restricted stock issu-
  ance, net.............     57,972      6       42    --         --       --          (48)         --
 Amortization of
  unearned restricted
  stock compensation,
  net...................     --       --      --       --         --       --          721            721
 Net income.............     --       --      --       1,748      --       --          --           1,748
                         ---------- ------ -------- --------    -------  -------     -----       --------
Balance, September 30,
 1995................... 22,619,205  2,262  181,191  (79,031)    96,603     (830)      --         103,592
 Stock options exer-
  cised.................    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 exer-
  cised.................    668,296     67    5,008    --         --       --          --           5,075
 Purchase of treasury
  stock, net............     --       --      --       --        11,389     (360)      --            (360)
 Restricted stock issu-
  ance, 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
                         ========== ====== ======== ========    =======  =======     =====       ========
</TABLE>
 
  The accompanying Notes to Consolidated Financial Statements are an integral
                     part of these consolidated statements.
 
 
                                      F-6
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. NATURE OF THE BUSINESS
 
  Applied Magnetics Corporation (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.
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  The summary of significant accounting policies is presented to assist the
reader in understanding and evaluating the consolidated financial statements.
These policies are in conformity with generally accepted accounting
principles.
 
  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 1995 and 1996 accounts have been reclassified to conform with the 1997
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 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, net" in the Consolidated Statements of Operations. Foreign currency
gains of $2.1 million in 1997 and $0.5 million in 1996 and losses of $0.2
million in 1995 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 and equipment are accounted
for on a historical cost basis and are depreciated or amortized over their
estimated useful lives primarily using the straight-line method. Estimated
useful lives are as follows:
 
<TABLE>
<CAPTION>
                                                             AVERAGE USEFUL LIFE
                                                             -------------------
     <S>                                                     <C>
     Buildings..............................................      15-16 Years
     Manufacturing equipment................................        2-5 Years
     Other equipment........................................        1-5 Years
     Leasehold improvements.................................    Term of Lease
</TABLE>
 
  Depreciation and amortization expense from operations amounted to $38.5
million, $28.9 million and $27.6 million in 1997, 1996 and 1995, respectively.
 
                                      F-7
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (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 $10.2 million, $9.0 million and $6.4 million in 1997, 1996 and
1995, 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.
 
  The Company uses software and related technologies throughout its operations
that will be affected by the date change in year 2000. An internal study was
completed in fiscal 1997 to determine the full scope and related costs to
ensure the Company's systems meet its internal needs. The Company has begun
implementation of a worldwide management information system that addresses the
year 2000 issue and also provides fully integrated manufacturing and financial
capabilities. The Company plans to continue its implementation during fiscal
1998 and expects full conversion by the end of fiscal 1999.
 
  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 $154.1 million at
September 27, 1997 and $120.9 million at September 28, 1996.
 
  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):
 
<TABLE>
<CAPTION>
                                                    SEPTEMBER 27, SEPTEMBER 28,
                                                        1997          1996
                                                    ------------- -------------
     <S>                                            <C>           <C>
     Purchased parts and manufacturing supplies....    $24,187       $10,957
     Work in process...............................     25,434        21,601
     Finished goods................................      1,817         3,422
                                                       -------       -------
                                                       $51,438       $35,980
                                                       =======       =======
</TABLE>
 
  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.
 
  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 September 27, 1997
approximates its carrying value.
 
                                      F-8
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
  NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE: Net income per common and
common equivalent share is calculated using the treasury stock method, except
in those periods where the effect of including common equivalent shares is
anti-dilutive. Primary earnings per share is computed by dividing net income
by the weighted average number of shares of common stock and common stock
equivalents outstanding during the period. Common stock equivalents include
the Company's stock options. Fully diluted earnings per share is computed
based on weighted average number of shares of common stock and common stock
equivalents outstanding during the period and as if the Company's Convertible
Subordinate Debentures were converted, if dilutive, into common stock at the
beginning of the period after giving retroactive effect to the elimination of
interest expense, net of income tax effect, if any, applicable to the
Convertible Subordinate Debentures.
 
  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.
 
  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 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 will become effective for financial statements of the Company in the
first quarter of fiscal 1998. Management believes that the adoption of SFAS
128 will not have a material impact on the Company's EPS disclosure when it is
adopted.
 
  In June 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS 130"). SFAS 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and
losses) in a full set of general-purpose financial statements. SFAS 130
requires that the Company (a) classify items of other comprehensive income by
their nature on the face of the financial statement in which the comprehensive
income is reported or disclosed in the notes to the financial statements and
(b) display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
a statement of financial position. This Statement will become effective for
financial statements of the Company in fiscal 1999.
 
                                      F-9
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
  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. 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.
 
3. SEGMENTS OF BUSINESS
 
  The Company operates in one market, worldwide-components for the computer
peripheral industry. The Company's trade receivables are unsecured. Sales to
major customers are as follows:
 
<TABLE>
<CAPTION>
                                                 FOR THE YEARS ENDED
                                      -----------------------------------------
                                      SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
                                          1997          1996          1995
     (AS A PERCENTAGE OF SALES)       ------------- ------------- -------------
     <S>                              <C>           <C>           <C>
     Western Digital.................       79%           44%            9%
     NEC.............................        6%           20%            9%
     Seagate (Conner)................       --            13%           41%
     Quantum.........................        2%           10%            8%
     All Others......................       13%           13%           33%
                                           ---           ---           ---
     Total...........................      100%          100%          100%
                                           ===           ===           ===
</TABLE>
 
  Export sales are made by the United States operations to the following
geographic locations (in thousands):
 
<TABLE>
<CAPTION>
                                                  FOR THE YEARS ENDED
                                       -----------------------------------------
                                       SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 30,
                                           1997          1996          1995
                                       ------------- ------------- -------------
     <S>                               <C>           <C>           <C>
     Europe...........................   $    182      $    219      $    159
     Asia.............................    483,736       322,405       231,781
                                         --------      --------      --------
                                         $483,918      $322,624      $231,940
                                         ========      ========      ========
</TABLE>
 
  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-10
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
3. SEGMENTS OF BUSINESS (CONTINUED)
 
  Information regarding the Company's domestic and foreign operations is as
follows (in thousands):
 
<TABLE>
<CAPTION>
                                                    UNITED
                                                    STATES   FOREIGN   TOTAL
                                                   --------  -------- --------
     <S>                                           <C>       <C>      <C>
     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 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 income taxes..................                    $ 33,070
                                                                      ========
     Identifiable assets.......................... $246,067  $113,383 $359,450
                                                   ========  ======== ========
     1995
     Net sales.................................... $271,947  $ 20,653 $292,600
                                                   ========  ======== ========
     Intercompany sales........................... $138,230  $213,620 $   --
                                                   ========  ======== ========
     Operating profit............................. $ (3,608) $  8,770 $  5,162
     Interest expense, net........................                    $ (2,830)
                                                                      --------
      Income before income taxes..................                    $  2,332
                                                                      ========
     Identifiable assets.......................... $165,064  $ 81,753 $246,817
                                                   ========  ======== ========
</TABLE>
 
  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.
 
  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.
 
                                     F-11
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
4. INCOME TAXES
 
  The provision for income taxes for the following fiscal years consist of (in
thousands):
 
<TABLE>
<CAPTION>
                                                                 1997  1996 1995
                                                                ------ ---- ----
     <S>                                                        <C>    <C>  <C>
     Federal Income Taxes
      Current.................................................. $1,290 $527 $--
      Deferred.................................................    --   --   --
     State Income Taxes
      Current..................................................    780  181   92
      Deferred.................................................    --   --   --
     Foreign income taxes......................................     49  144  492
                                                                ------ ---- ----
                                                                $2,119 $852 $584
                                                                ====== ==== ====
</TABLE>
 
  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):
 
<TABLE>
<CAPTION>
                                                       1997     1996     1995
                                                     --------  -------  -------
<S>                                                  <C>       <C>      <C>
Income tax at the United States federal income tax
 rate..............................................  $ 34,382  $11,575  $   816
State income taxes, net of federal income tax bene-
 fit...............................................       507      118       59
Foreign income taxed at lower rate.................   (19,583)  (8,485)  (2,217)
Temporary differences/net operating losses (bene-
 fited) not benefited..............................   (13,187)  (2,356)   1,926
                                                     --------  -------  -------
                                                     $  2,119  $   852  $   584
                                                     ========  =======  =======
</TABLE>
 
  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 September 27, 1997 and September 28, 1996 were as follows
(in thousands):
 
<TABLE>
<CAPTION>
                                                               1997      1996
                                                             --------  --------
     <S>                                                     <C>       <C>
     Inventory reserves..................................... $  5,439  $  4,414
     Restructuring & other reserves.........................   10,404     7,984
     Net operating loss carryforwards.......................    3,035    23,005
     Foreign tax & general business credit carryforwards....    6,327     6,589
     Unrepatriated foreign earnings.........................   (3,500)   (4,550)
     Depreciation...........................................    2,750     1,703
     Other, net.............................................      475      (336)
                                                             --------  --------
      Subtotal..............................................   24,930    38,809
     Valuation allowance....................................  (24,930)  (38,809)
                                                             --------  --------
     Total net deferred tax asset (liability)............... $   --    $   --
                                                             ========  ========
</TABLE>
 
 
                                     F-12
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
4. INCOME TAXES (CONTINUED)
 
  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 September 27, 1997, the Company had total deferred tax liabilities of
$3.5 million and deferred tax assets of $28.4 million. The Company recorded a
valuation allowance in the amount of $24.9 million against the amount by which
deferred tax assets exceed deferred tax liabilities. The valuation reserve at
September 27, 1997 has been provided due to the uncertainty of the amount of
future domestic taxable income.
 
  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, 1999. Currently, the Company is
exploring other tax incentives available in Malaysia after its tax holiday
expires. If the Company is unsuccessful in obtaining tax incentives or
extending the tax holiday, the foreign earnings would be taxed at Malaysian
statutory rates.
 
  The Company had federal net operating loss carryforwards available for tax
purposes of approximately $8.7 million. To the extent not used, the net
operating loss carryforward expires in varying amounts beginning in 2006.
 
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 September 27, 1997, September 28, 1996 and September 30,
1995, there were exercisable options outstanding under the option plans to
purchase an aggregate of 490,509, 307,356 and 161,889 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 September 27, 1997, the Company
had reserved 10,000 shares of its $.10 par value Common Stock for future
issuance under this plan, options for 140,000 shares were outstanding at
prices from $3.00 to $43.13 per share, of which 26,660 shares were
exercisable. During fiscal 1997, no options were exercised or canceled under
this plan.
 
  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
 
                                     F-13
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
5. STOCK OPTIONS AND LONG-TERM INCENTIVE PLANS (CONTINUED)
 
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 1997, options for 84,286 shares were exercised.
 
  Stock option activity under the option plans is as follows:
 
<TABLE>
<CAPTION>
                                                        OPTIONS OUTSTANDING
                                                     ---------------------------
                                                      NUMBER    WEIGHTED AVERAGE
                                                     OF SHARES   EXERCISE PRICE
                                                     ---------  ----------------
<S>                                                  <C>        <C>
Balance October 1, 1994............................. 1,838,362       $ 6.09
 Granted............................................ 1,303,000       $ 5.07
 Exercised..........................................  (399,773)      $ 5.75
 Cancelled..........................................  (885,136)      $ 6.14
                                                     ---------
Balance September 30, 1995.......................... 1,856,453       $ 5.42
                                                     ---------
 Granted............................................ 1,059,000       $15.34
 Exercised..........................................  (582,772)      $ 5.19
 Cancelled..........................................   (62,861)      $ 5.90
                                                     ---------
Balance September 28, 1996.......................... 2,269,820       $10.09
                                                     ---------
 Granted............................................ 1,736,006       $35.26
 Exercised..........................................  (668,296)      $ 7.43
 Cancelled..........................................  (837,618)      $37.62
                                                     ---------
Balance September 27, 1997.......................... 2,499,912       $19.06
                                                     ---------
</TABLE>
 
  The following table summarizes information about the Company's stock options
outstanding and exercisable as of September 27, 1997:
 
<TABLE>
<CAPTION>
                        OPTIONS OUTSTANDING                             OPTIONS EXERCISABLE
-------------------------------------------------------------------- --------------------------
                                     WEIGHTED AVERAGE    WEIGHTED                   WEIGHTED
 RANGE OF                  NUMBER       REMAINING        AVERAGE       NUMBER       AVERAGE
EXERCISE PRICES          OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
---------------          ----------- ---------------- -------------- ----------- --------------
<S>                      <C>         <C>              <C>            <C>         <C>
$ 1.9048 - $15.2500.....  1,440,409        6.55          $10.7507      674,823      $ 7.0939
$15.5000 - $31.6250.....    916,003        8.72          $29.3841       16,246      $16.6393
$34.8750 - $43.1250.....    143,500        9.11          $36.5207         --        $   --
                          ---------        ----          --------      -------      --------
                          2,499,912        7.49          $19.0575      691,069      $ 7.3183
                          =========        ====          ========      =======      ========
</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 granted. 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.
 
                                     F-14
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
5. STOCK OPTIONS AND LONG-TERM INCENTIVE PLANS (CONTINUED)
 
  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:
 
<TABLE>
<CAPTION>
                                                                     1997  1996
                                                                     ----  ----
     <S>                                                             <C>   <C>
     Option life (in years)......................................... 2.83  3.18
     Risk-free interest rate........................................ 6.18% 5.23%
     Stock price volatility......................................... 0.57  0.56
</TABLE>
 
  The weighted-average fair value of stock options granted in 1997 and 1996
under the Company's stock option plans was $14.60 and $6.52, respectively.
 
  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:
 
<TABLE>
<CAPTION>
                                                     SEPTEMBER 27, SEPTEMBER 28,
                                                         1997          1996
                                                     ------------- -------------
     <S>                                             <C>           <C>
     Pro forma net income (in thousands)............    $88,963       $30,115
     Pro forma net income per share:
      Primary.......................................    $  3.59       $  1.26
      Fully diluted.................................    $  3.00       $  1.00
</TABLE>
 
  Pro forma net income and net income per share reflect only options granted
in the years ended September 27, 1997 and September 28, 1996. 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 September 27, 1997, no shares were available for future issuance
under the 1989 plan and 25,368 shares remain subject to restrictions. During
1997, 25,368 shares were issued, no shares were canceled and restrictions were
removed from 28,687 shares under the 1989 plan. Compensation expense recorded
under the 1989 plan during 1997 and 1995 was approximately $0.3 million and
$0.7 million, respectively. No compensation expense was recorded during 1996.
 
  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
September 27, 1997 or September 28, 1996. 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
$75.00. 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.
 
                                     F-15
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
6. NOTES PAYABLE AND LONG-TERM DEBT
 
  Notes payable and long-term debt consists of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                     SEPTEMBER 27, SEPTEMBER 28,
                                                         1997          1996
                                                     ------------- -------------
<S>                                                  <C>           <C>
7.00% Convertible Subordinated Debentures, due
 March 15, 2006....................................    $115,000      $115,000
Malaysian bank credit facilities, interest rates
 from 6.65% to 6.75% as of September 27, 1997......      50,188        45,789
Mortgage payable, interest rate of 8.50% as of Sep-
 tember 27, 1997...................................          86           106
Capital leases.....................................       1,457         3,022
                                                       --------      --------
                                                        166,731       163,917
Less--Current portion, including bank credit facil-
 ities.............................................      50,701        47,654
                                                       --------      --------
                                                       $116,030      $116,263
                                                       ========      ========
</TABLE>
 
  The aggregate principal payments of bank notes payable and long-term debt
for the years subsequent to September 27, 1997 are: 1998--$50.7 million,
1999--$0.5 million, 2000--$0.5 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 September 27, 1997, no borrowings
were outstanding. The balance available for borrowings under this line of
credit was approximately $29.9 million at September 27, 1997 and the Company
was in compliance with all financial covenants. In December 1997, the Company
extended the line of credit to January, 2001.
 
  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. During fiscal 1997, the Company's Malaysian subsidiary completed
credit facility agreements with five additional banks in Malaysia. The
borrowings under the new facilities are callable on demand, have no
termination date and are unsecured. The total amount available to borrow under
all the credit facilities was approximately $81.3 million of which $50.2
million was outstanding at September 27, 1997. The Company was in compliance
with all financial covenants under these facilities. The interest rates
outstanding on these loan facilities ranged from 6.65% to 6.75% at September
27, 1997 and had a weighted average interest of 6.70%. The Company intends to
continue its practice of repaying maturities with new borrowings under these
facilities.
 
                                     F-16
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
7. ACQUISITIONS
 
  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 a foreclosure procedure,
acquired the common stock of DBI for a $2.5 million reduction in debt owed 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. The Company has
engaged a third party consulting firm to operate and facilitate the sale of
DBI. It is management's intent to complete the sale of DBI during fiscal 1998.
DBI's financial position and results of operations are immaterial to the
Company's consolidated financial statements.
 
8. COMMITMENTS AND CONTINGENCIES
 
  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 September 27, 1997 are
as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                   LEASES
                                                              ------------------
                                                              CAPITAL  OPERATING
                                                              -------  ---------
     <S>                                                      <C>      <C>
     1998.................................................... $  545    $25,286
     1999....................................................    541     17,665
     2000....................................................    519     14,809
     2001....................................................    --      11,525
     Thereafter..............................................    --       6,079
                                                              ------    -------
     Total minimum payments..................................  1,605    $75,364
                                                              ======    =======
     Less imputed interest...................................   (148)
                                                              ------
     Present value of payments under capital leases..........  1,457
     Less current portion....................................   (492)
                                                              ------
     Long-term lease obligation.............................. $  965
                                                              ======
</TABLE>
 
  Manufacturing and other equipment at September 27, 1997 include assets under
capitalized leases of $1.5 million with related accumulated depreciation of
$0.1 million.
 
  Purchase commitments associated with capital expenditures were $61.2 million
at September 27, 1997.
 
  The Company entered into $1.4 million of capital leases during fiscal 1997.
 
  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 $20.9 million at September 27, 1997.
 
  Total rental expense, net of sublease rental income, for the years ended
September 27, 1997, September 28, 1996 and September 30, 1995, including items
on a month-to-month basis, was approximately $23.7 million, $15.2 million and
$10.2 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.
 
                                     F-17
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
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.
Compensation expense recorded under the cash profit sharing plan during 1997
and 1996 was approximately $4.5 million and $3.3 million, of which
approximately $0.6 million and $0.5 million was contributed to participating
employees' 401(k) accounts, respectively. There was no compensation expense
recorded and the Company made no 401(k) contributions during fiscal 1995.
 
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.
 
12. SUBSEQUENT EVENTS
 
  Subsequent to year end the Company's largest customer announced significant
changes reflecting current hard disk drive oversupply in the industry's
distribution channel which significantly reduces the Company's order backlog
existing at September 27, 1997. In addition, the Company announced plans to
take a one time pre-tax restructuring charge of approximately $8.0 million in
its first quarter of fiscal year 1998 primarily in connection with a planned
realignment of its offshore operations.
 
                                     F-18
<PAGE>
 
                         APPLIED MAGNETICS CORPORATION
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
13. SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                 THREE MONTHS ENDED
                                     ------------------------------------------
                                     DECEMBER 28 MARCH 29 JUNE 28  SEPTEMBER 27
                                     ----------- -------- -------- ------------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S>                                  <C>         <C>      <C>      <C>
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:
  Primary...........................  $   1.30   $   1.24 $   0.85   $   0.49
  Fully diluted.....................  $   1.10   $   1.06 $   0.75   $   0.46
Weighted average number of common
 and common equivalent shares
 outstanding:
  Primary...........................    24,532     24,992   24,723     24,872
  Fully diluted.....................    30,861     31,178   30,904     31,100
<CAPTION>
                                                 THREE MONTHS ENDED
                                     ------------------------------------------
                                     DECEMBER 30 MARCH 30 JUNE 29  SEPTEMBER 28
                                     ----------- -------- -------- ------------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S>                                  <C>         <C>      <C>      <C>
1996
Net sales...........................  $ 94,709   $ 86,706 $ 74,037   $ 89,302
Gross profit........................    23,514     25,297   17,882     26,558
Net income..........................     9,028      8,696    2,350     12,144
Net income per share:
  Primary...........................  $   0.38   $   0.36 $   0.10   $   0.51
  Fully diluted.....................  $   0.38   $   0.36 $   0.15   $   0.47
Weighted average number of common
 and common equivalent shares
 outstanding:
  Primary...........................    23,774     23,894   24,039     23,882
  Fully diluted.....................    23,774     24,845   30,215     30,345
</TABLE>
 
                                      F-19
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ACCOUNTING AND
     FINANCIAL DISCLOSURE
 
  None
 
                                   PART III
 
  Pursuant to Paragraph G(3) of the General Instructions to Form 10-K portions
of the information required by Part III of Form 10-K are incorporated by
reference from the Company's Proxy Statement to be filed with the Commission
in connection with the 1998 Annual Meeting of Stockholders ("the Proxy
Statement").
 
ITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT
 
  (a) Information concerning Directors of the Company appears in the Company's
Proxy Statement, under Item 1 "Election of Directors". This portion of the
Proxy Statement is incorporated herein by reference.
 
  (b) For information with respect to Executive Officers, see Part I of this
Form 10-K.
 
ITEM 11. EXECUTIVE COMPENSATION
 
  Information concerning executive compensation appears in the Company's Proxy
Statement, under the caption "Executive Compensation", and is incorporated
herein by reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  Information concerning the security ownership of certain beneficial owners
and management appears in the Company's Proxy Statement, under Item 1
"Election of Directors", and is incorporated herein by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  Information concerning certain relationships and related transactions
appears in the Company's Proxy Statement, under Item 1 "Election of
Directors", and is incorporated herein by reference.
 
                                      I-1
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
(a)(1)The following documents are filed as part of this Report:
      Financial Statements--See Index to Consolidated Financial Statements as
      Item 8 on F-1 of this Report.
 
   (2)Supplemental Schedule:
      Report of Arthur Andersen LLP
      Schedule II Valuation and Qualifying Accounts
 
  All other schedules have been omitted since the required information is not
  present in amounts sufficient to require submission of the schedule, or
  because the required information is included in the consolidated financial
  statements or notes thereto.
 
   (3)Exhibits:
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER  DESCRIPTION
 ------- -----------
 <C>     <S>
     3   Certificate of Incorporation and Bylaws (1) Amended and Restated
         Bylaws (2) Amendment to Bylaws dated June 14, 1989 (3) Certificate of
         Incorporation (as amended) (4)
     4   Instruments defining the rights of securities holders including
         indentures Rights Agreement, dated as of October 19, 1988, between
         Applied Magnetics Corporation and First Interstate Bank of California,
         as Rights Agent (2)
    10   (a)Applied Magnetics Corporation 1982 Long-Term Incentive Plan (5)
         (b)Applied Magnetics Corporation 1986 Long-Term Incentive Plan (6)
         (c)Applied Magnetics Corporation 1988 Stock Option Plan (7)
         (d)Applied Magnetics Corporation 1989 Long-Term Incentive Plan (8)
         (e)License and Technology Development Agreement dated as of September
              25, 1992, Between Applied Magnetics Corporation and Hitachi
              Metals, Ltd. (9)
         (f)Applied Magnetics Corporation 1992 Stock Option Plan (9)
         (g)Financing Agreement dated January 11, 1995 between the Company and
              CIT Group/Business Credit, Inc. (14)
         (h)Letter Agreement between Registrant and Hitachi Metals, Ltd. Dated
              May 30, 1995 extending maturity date of Letter of Credit to April
              12, 1996 (16)
         (i)Purchase Agreement between the Company and Delta Bravo, Inc., for
              the purchase of capital stock of Magnetic Data, Inc., a Delaware
              Corporation and Brumko Magnetic Corp., a Nebraska Corporation
              (10)
         (j)Cross License and Joint Research and Development Agreement
              effective as of November 5, 1993, between the Company and
              Hutchinson Technology Incorporated (11)
         (k)Applied Magnetics Corporation 1994 Employee Stock Option Plan (12)
         (l)Applied Magnetics Corporation 1994 Nonemployee Director's Stock
              Option Plan (12)
         (m)Letter Agreement dated as of November 14, 1994, between the Company
              and the CIT Group/Business Credit, Inc. (13)
         (n)Stock Purchase Agreement by and among the Company, Seagate
              Technology, Inc. and Applied Tape Technology, Inc. (13)
</TABLE>
 
                                      I-2
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER  DESCRIPTION
 ------- -----------
 <C>     <S>
         (o)Letter Agreement dated August 1, 1994, between the Company and
              Grisanti, Galef & Goldress, Inc. (13)
         (p)Offer letter dated April 19, 1995 between Maybank Banking Berhad
              and Applied Magnetics (M) Sdn Bhd. for extension of Credit
              Facility (16)
         (q)Corporate Guarantee of the Registrant dated June 8, 1995 in favor
              of Maybank Banking Berhad (16)
         (r)Employment Agreement between Craig D Crisman and the Company dated
              August 1, 1995 (17)
         (s)1995 Key Management Incentive Bonus Plan dated March 16, 1995 (17)
         (t)Worldwide Cash Profit Sharing Plan (18)
         (u)Form of Indemnification Agreement (19)
         (v)Form of Agreement (relating to termination benefits to key
              employees) (19)
         (w)Offer Letter dated July 18, 1996 between Arab-Malaysian Bank Berhad
              and Applied Magnetics (M) Sdn Bhd for credit facility (20)
         (x)General Agreement between Arab-Malaysian Bank Berhad and Applied
              Magnetics (M) Sdn Bhd for credit facility (20)
         (y)Corporate Guarantee of the Registrant dated August 14, 1996 in
              favor of Arab-Malaysian Bank Berhad (20)
         (z)Offer Letters dated August 6, 1996 and September 26, 1996 between
              BHL Bank and Applied Magnetics (M) Sdn Bhd for credit facility
              (20)
         (aa)Corporate Guarantee of the Registrant dated August 13, 1996 in
              favor if BHL Bank (20)
         (bb)Offer letter dated February 26, 1997 between United Overseas Bank
              (Malaysia) Bhd and Applied Magnetics (M) Sdn Bhd for credit
              facility (21)
         (cc)Corporate Guarantee of the Registrant dated March 11, 1997 in
              favor of United Overseeas Bank (Malaysia) Bhd (21)
         (dd)Offer letter dated October 23, 1996 between Bank Utama (Malaysia)
              Berhad and Applied Magnetics (M) Sdn Bhd for credit facility (21)
         (ee)Corporate Guarantee of the Registrant dated April 15, 1997 in
              favor of Bank Utama (Malaysia) Berhad (21)
         (ff)Offer letter dated December 10, 1996 between DCB Bank Berhad and
              Applied Magnetics (M) Sdn Bhd for credit facility (21)
         (gg)Corporate Guarantee of the Registrant dated February 26, 1997 in
              favor of DCB Bank Berhad (21)
         (hh)Employment Agreement Amendment No. 1 with Craig D. Crisman and the
              Company dated February 7, 1997 (21)
         (ii)Applied Magnetics Corporation 1989 Long-Term Incentive Plan
              Amendment dated May 9, 1997
    11   Statement re computation of per share earnings.
    13   Annual Report to Shareholders. Integrated with Form 10-K
    21   Subsidiaries of the registrant. Incorporated by reference to Form 10-K
         dated December 29, 1994
    22   Published report regarding matters submitted to vote of security
         holders. None
</TABLE>
 
 
                                      I-3
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER  DESCRIPTION
 ------- -----------
 <C>     <S>
    23   Consent of experts and counsel. Consent of Arthur Andersen LLP dated
         December 3, 1997.
    24   Power of Attorney. None
    27   Financial Data Schedule
    28   Information from reports furnished to state insurance regulatory
         authorities. None
    (1)  Filed an exhibit to the Company's Registration Statement on Form S-3
         (Registration No. 33-13653) filed on April 21, 1987, and incorporated
         herein by reference
    (2)  Filed as an exhibit to the Company's Current Report on Form 8-K dated
         October 19, 1988, and incorporated herein reference
    (3)  Filed as an exhibit to the Corporation's Annual Report on Form 10-K
         dated December 21, 1989 and incorporated hereby reference
    (4)  Filed as an exhibit to the Corporation's Quarterly Report on Form 10-Q
         dated May 4, 1989 and incorporated herein by reference
    (5)  Filed as an exhibit to the Company's definitive Proxy Statement filed
         pursuant to Regulation 14A on January 27, 1983, and incorporated
         herein by reference
    (6)  Filed as an exhibit to the Company's definitive Proxy Statement filed
         pursuant to Regulation 14A on December 23, 1985, and incorporated
         herein by reference
    (7)  Filed as an exhibit to the Company's definitive Proxy statement filed
         pursuant to Regulation 14A on January 7, 1988, and incorporated herein
         by reference
    (8)  Filed as an exhibit to the Company's definitive Proxy Statement filed
         pursuant to Regulation 14A on December 30, 1988 and incorporated
         herein by reference
    (9)  Filed as an exhibit to the Company's Annual Report on Form 10-K dated
         December 22, 1992, as amended by Form 8, filed February 12, 1993 and
         incorporated herein by reference
   (10)  Filed as an exhibit to the Company's Report on Form 10-Q dated May 14,
         1993 and incorporated herein by reference
   (11)  Filed as an exhibit to the Company's Current Report on Form 8-K dated
         December 2, 1993 and incorporated herein by reference
   (12)  Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q
         dated March 31, 1994, and incorporated herein by reference
   (13)  Filed as an exhibit to the Company's Annual Report on Form 10-K dated
         December 29, 1994
   (14)  Filed as an exhibit to the Company's Current Report on Form 8-K dated
         January 16, 1995 and incorporated by reference
   (15)  Filed as an exhibit to the Company's Report on Form 10-Q dated May 15,
         1995 and incorporated herein by reference
   (16)  Filed as an exhibit to the Company's Report on Form 10-Q dated August
         15, 1995 and incorporated herein by reference
   (17)  Filed as an exhibit to the Company's Annual Report on Form 10-K dated
         December 21, 1995, as amended by Form 10K/A, dated June 11, 1996 and
         incorporated herein by reference
   (18)  Filed as an exhibit to the Company's Report on Form 10Q/A dated March
         4, 1996 and incorporated herein by reference
</TABLE>
 
 
                                      I-4
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER  DESCRIPTION
 ------- -----------
 <C>     <S>
   (19)  Filed as an exhibit to the Company's Annual Report on Form 10-K dated
         December 20, 1996
   (20)  Filed as an exhibit to the Company's Report on Form 10-Q dated
         February 11, 1997 and incorporated herein by reference
   (21)  Filed as an exhibit to the Company's Report on Form 10-Q dated August
         8, 1997 and incorporated herein by reference
</TABLE>
 
  (b) Reports on Form-8K. Reports on 8-K dated February 24, 1997 and March 17,
1997 were filed by the Company with respect to the initiation of a proposed
business combination with Read-Rite Corporation and subsequent termination,
thereof, respectively.
 
  (c) Exhibits. The exhibits listed (a) (2) above are submitted as a separate
section of this report
 
  (d) The individual financial statements of the registrant have been omitted
since the registrant is primarily an operating company and all subsidiaries
are included in the consolidated financial statements
 
                                      I-5
<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.
 
                                          Applied Magnetics Corporation
 
Date: December 19, 1997                          /s/ Craig D. Crisman
                                          By: _________________________________
                                                    Craig D. Crisman
                                             Chairman of the Board and Chief
                                              Executive Officer (Principal
                                                   Financial Officer)
 
                                                 /s/ Peter T. Altavilla
Date: December 19, 1997                   By: _________________________________
                                                   Peter T. Altavilla
                                             Corporate Controller (Principal
                                                   Accounting Officer)
 
  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.
 
<TABLE>
<S>                                  <C>                           <C>
   /s/ Craig D. Crisman              Chairman of the Board and     December 19, 1997
____________________________________  Chief Executive Officer
   Craig D. Crisman


   /s/ Harold R. Frank               Director and Chairman         December 19, 1997
____________________________________  Emeritus
   Harold R. Frank


   /s/ R. C. Mercure, Jr.            Director                      December 19, 1997
____________________________________
   R. C. Mercure, Jr.


   /s/ Herbert M. Dwight, Jr.        Director                      December 19, 1997
____________________________________
   Herbert M. Dwight, Jr.


   /s/ Jerry E. Goldress             Director                      December 19, 1997
____________________________________
   Jerry E. Goldress
</TABLE>
 
                                      I-6
<PAGE>
          APPLIED MAGNETICS CORPORATION AND SUBSIDIARIES             SCHEDULE II
          SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                          (in thousands)
<TABLE> 
<CAPTION> 
                                                                                                   Balance
                                         Balance at                                                 at End
                                         Beginning                                                    of
Classification                           of Period    Additions (C)  Deductions (B)   Other (A)(B)  Period
--------------                           ---------    ------------   -------------    -----------   ------
<S>                                      <C>            <C>             <C>            <C>         <C>  
Year Ended September 30, 1995
Allowance for doubtful collection:
   Accounts Receivable                    $ 3,629         $   --       $   268       $ (3,245)      $   652
   Notes Receivable                        13,185          1,229            --          6,045        20,459


Year Ended September 28, 1996
Allowance for doubtful collection:
   Accounts Receivable                    $   652         $   --       $    --       $    114       $   766
   Notes Receivable                        20,459             --        (2,874)       (17,585)           --


Year Ended September 27, 1997
Allowance for doubtful collection:
   Accounts Receivable                    $   766         $4,200       $   (35)      $     11       $ 4,942
</TABLE> 

(A) In 1996 and 1997, the accounts receivable allowance amount represents
    recoveries of accounts previously written off.

    In 1996, the notes receivable allowance for doubtful collection represents
    the potential uncollectability of notes from Delta Bravo, Inc. ("DBI").

    In 1995 the Company determined that its allowance for doubtful trade
    receivables was in excess of the amount needed and it transferred this
    excess to its allowance for notes receivable where it was required. Also, in
    1995 the Company applied $2.8 million of excess 1993 restructure reserves to
    its allowance for notes receivable where it was required.

(B) In previous years, the Company fully reserved all DBI note balances. In July
    1996, the Company, acquired 100% of DBI (see Note 7). As such the related
    note receivable reserve was eliminated in consolidation.

(C) On November 10, 1997, Singapore Technologies announced plans to shut down
    its subsidiary, Micropolis (S) Pte Ltd., 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.

                                      S-1