UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

(Mark One)

[X]  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE
     ACT OF 1934
     For the fiscal year ended January 3, 1999

                                       OR

[ ]  TRANSITION  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE  SECURITIES
     EXCHANGE ACT OF 1934

     For the transition period from       to

                         Commission file number 0-16852

                               KOMAG, INCORPORATED
             (Exact name of registrant as specified in its charter)

            Delaware                                         94-2914864
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                               Identification No.)

               1704 Automation Parkway, San Jose, California 95131
          (Address of Principal Executive Offices, including Zip Code)

       Registrant's telephone number, including area code: (408) 576-2000

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

                                                           Name of each exchange
Title of each class                                         on which registered
-------------------                                         --------------------
      None                                                         None

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

                          Common Stock, $0.01 par value

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

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

                            [Cover page 1 of 2 pages]

<PAGE>

         The aggregate  market value of voting stock held by  non-affiliates  of
the Registrant as of February 28, 1999 was approximately $313,892,180 based upon
the closing sale price for shares of the  Registrant's  Common Stock as reported
by the Nasdaq  National  Market for the last  trading  date prior to that date).
Shares of Common Stock held by each  officer,  director and holder of 5% or more
of the  outstanding  Common Stock have been excluded in that such persons may be
deemed  to  be  affiliates.  This  determination  of  affiliate  status  is  not
necessarily a conclusive determination for other purposes.

         On  February  28,  1999,   approximately   53,920,660   shares  of  the
Registrant's Common Stock, $0.01 par value, were outstanding.

                       Documents Incorporated by Reference

         Designated  portions of the  following  document  are  incorporated  by
reference into this Report on Form 10-K where indicated:

         Komag,   Incorporated   Proxy  Statement  for  the  Annual  Meeting  of
Stockholders to be held on May 25, 1999, Part III.

                                       2

<PAGE>

<TABLE>
                              KOMAG, INCORPORATED

                 TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10K
<CAPTION>

                                                                                    Page
<S>                                                                                 <C>
Item 1.   Business ................................................................ 4-19
       
Item 2.   Properties ................................................................ 20
 
Item 3.   Legal  Proceedings ........................................................ 20
       
Item 4.   Submission  of Matters to Vote of  Security  Holders ...................... 21
       
Item 5.   Market for Registrant's Common Equity and Related Stockholder Matters ..... 24
       
Item 6.   Selected  Consolidated  Financial  Data ................................... 25
       
Item 7.   Management's Discussion and Analysis of Financial Condition
             Results of  Operations .............................................. 26-34
       
Item 7A.  Financial  Market  Risks .................................................. 35
       
Item 8.   Consolidated  Financial  Statements .................................... 37-63
       
Item 9.   Changes In and Disagreements with Accountants and Financial
             Disclosure ............................................................. 64
       
Item 10.  Directors and Executive  Officers ......................................... 64
       
Item 11.  Executive  Compensation ................................................... 64
       
Item 12.  Security Ownership of Certain Beneficial Owners and Management ............ 64
       
Item 13.  Certain  Relationships  and Related  Transactions ......................... 64
       
Item 14.  Exhibits, Financial Statement Schedules and Reports
             on Form 8-K ......................................................... 65-70
</TABLE>


                                       3
<PAGE>

                                     PART I


ITEM 1.  BUSINESS


     Komag,  Incorporated  ("Komag" or the "Company") designs,  manufactures and
markets  thin-film media ("disks"),  the primary storage medium for digital data
used in computer  hard disk  drives.  Komag  believes it is the world's  largest
independent  manufacturer  of  thin-film  media  and  is  well  positioned  as a
broad-based  strategic  supplier of choice for the industry's leading disk drive
manufacturers.  The Company's  business  strategy  relies on the  combination of
advanced technology and high-volume manufacturing. Komag's products are made for
the high-end desktop and  high-capacity/high-performance  enterprise segments of
the disk drive market and are used in products such as personal computers,  disk
arrays,  network  file  servers  and  engineering   workstations.   The  Company
manufactures  leading-edge  disk  products  primarily for 3 1/2-inch form factor
hard disk drives.  The Company was organized in 1983 and is  incorporated in the
State of Delaware.

     The Company's business is subject to risks and  uncertainties,  a number of
which are discussed under "Risk Factors."

     Increasing demand for digital storage and low-cost,  high-performance  hard
disk drives has resulted in strong unit demand for these products. International
Data Corporation  ("IDC")  forecasts that worldwide disk drive unit shipments in
1999  through  2002 will grow at a 15%  compound  annual  growth  rate.  Greater
processing power, more sophisticated operating systems and application software,
high-resolution graphics, larger databases and the emergence of the Internet are
among the  developments  that have  required ever higher  performance  from disk
drives. For example,  the first 5 1/4-inch hard disk drive,  introduced in 1980,
offered a capacity of five  megabytes  (one million bytes is a megabyte or "MB")
with an areal  density of less than two megabits (one million bits is a megabit;
eight bits is one byte) per square inch.  Current-generation  3 1/2-inch  drives
typically  have  capacities of four to twenty  gigabytes (one billion bytes is a
gigabyte or "GB") with areal densities of  approximately  three to four gigabits
(one billion bits is a gigabit) per square inch.  Today's areal  densities allow
for  approximately  4 GB of storage per 3 1/2-inch disk  platter.  By the end of
1999,  the Company  expects  that  increases in areal  densities  will allow for
approximately  6 GB of  storage  per 3  1/2-inch  disk.  Advances  in  component
technology have been critical to improving the performance and storage  capacity
of disk drives and lowering the cost per bit stored.

     The Company has  capitalized  on its  technological  strength in  thin-film
processes  and its  manufacturing  capabilities  to  achieve  and  maintain  its
position as the leading independent  supplier to the thin-film media market. The
Company's  technological  strength stems from the depth of its  understanding of
materials  science  and the  interplay  between  disks,  heads and  other  drive
components.  Komag's manufacturing  expertise in thin-film media is evidenced by
its  history  of   delivering   reliable   products  in  high  volume.   Current
manufacturing  operations  are conducted by the Company in the U.S. and Malaysia
as well as through  Asahi Komag Co., Ltd.  ("AKCL"),  a joint venture with Asahi
Glass  Co.,  Ltd.  ("Asahi  Glass")  and  Vacuum  Metallurgical  Company,  which
manufactures  thin-film  media in Japan and Thailand.  The Company  manufactures
disk  substrates  for  internal  use  through  its  subsidiary,  Komag  Material
Technology,  Inc.  ("KMT")  located in Santa Rosa,  California.  A 20%  minority
interest in KMT is held by Kobe Steel USA Holdings Inc.  ("Kobe USA"),  together
with Kobe Steel, Ltd. ("Kobe") and other affiliated companies.

                                       4
<PAGE>

Technology

     Komag  manufactures  and  sells  thin-film  magnetic  media on  rigid  disk
platters for use in hard disk drives.  These drives are used in computer systems
to record,  store and retrieve  digital  information.  Inside a disk drive,  the
media or disk  rotates at speeds of up to 10,000 rpm.  The head scans across the
disk as it spins,  magnetically  recording or reading  information.  The domains
where each bit of  magnetic  code is stored are  extremely  small and  precisely
placed. The tolerances of the disks and recording heads are extremely  demanding
and the interaction  between these components is one of the most critical design
aspects in an advanced disk drive.

     The primary factors governing the density of storage achievable on a disk's
surface are (1) the minimum distance at which read/write heads can reliably pass
over the  surface  of the disk to  detect a change  in  magnetic  polarity  when
reading from the disk,  defined as glide  height  (measured  in  microinches  or
millionths  of an inch);  (2) the  strength of the  magnetic  field  required to
change  the  polarity  of a bit of data on the  magnetic  layer  of a disk  when
writing, defined as coercivity (measured in oersteds--"Oe"), and (3) the ability
of  the  head  to   discriminate   a  signal   from   background   media   noise
(signal-to-noise  ratio). As glide height is reduced,  smaller bits can be read.
The higher the  coercivity  of the media,  the smaller the width of the bit that
can be stored. The signal-to-noise ratio is determined by the choice of magnetic
materials and the method for depositing  those  materials on the disk's surface.
The Company's plating,  polishing and texturing processes produce a uniform disk
surface with relatively few defects,  which permits the read/write  heads to fly
over the disk surface at glide heights of 0.8 to 1.0  microinches.  The magnetic
alloys  deposited on the  surfaces of Komag's  disks have high  coercivity,  low
noise and other  desirable  magnetic  characteristics.  The combination of these
factors results in more data stored in a given area on the disk surface.

     1998 was a year of tremendous transition for the Company and the disk drive
industry.  Disk drive programs utilizing newer, more advanced,  magnetoresistive
("MR") media and recording heads replaced older  generation  programs  utilizing
inductive media and heads. By the end of 1998 most disk drives were manufactured
with MR  components.  An MR disk is  optimized  for use with MR  heads  that use
separate read and write  elements.  The write element is made from  conventional
inductive materials, but the read element is made of a material whose electrical
resistance  changes when subjected to changes in a magnetic  field. MR heads are
more  sensitive to magnetic  fields  enabling them to read more  densely-packed,
smaller-sized  bits.  The  transition to MR disk drives has led to  significant,
unprecedented  increases in areal density.  The Company believes that the number
of  gigabits  per  square  inch  doubled  in  1998.   The  Company   began  1998
manufacturing both MR and inductive media. The Company had largely completed its
transition to MR products by the fourth  quarter of 1998 at which time MR media,
including more advanced  giant  magnetoresistive  ("GMR")  disks,  accounted for
approximately  97% of the Company's unit sales.  GMR disks  accounted for 12% of
unit sales in the fourth quarter of 1998.  The Company  believes that MR and GMR
disks will continue to be the predominant media for disk drives in 1999.

Products, Customers and Marketing

     Komag sells primarily MR media for 3 1/2-inch disk drives.  The Company has
also  historically  sold disks for 5  1/4-inch  drives and other disk drive form
factors.   Komag's  products  offer  a  range  of  coercivities,   glide  height
capabilities and other parameters to meet specific customer  requirements.  Unit
sales of 3  1/2-inch  disks  capable  of  storing  at least  3.2 GB per  platter
accounted  for  approximately  70% of the  Company's  unit  sales in the  fourth
quarter of 1998. The Company  anticipates that over 60% of its unit sales in the
first  quarter of 1999 will be 3 1/2-inch  disks capable of storing at least 4.3
GB  per  platter  and  the  Company  is in the  process  of  obtaining  customer
qualification  of 3  1/2-inch  products  capable  of  storing  up to  6.8 GB per
platter.

     Prior to  1997,  market  demand  for  advanced  thin-film  media  typically
exceeded  supply.  In  mid-1997,  the rate of growth in demand for media  slowed
abruptly due in large  measure to the rapid  advancement 

                                       5
<PAGE>

in  increased  storage  capacity  per  disk  achieved  through  the  use  of  MR
technology.  As a result,  drive designs  incorporated fewer disks and recording
heads to achieve the disk drive capacities  demanded by the market. In addition,
based upon historical supply shortages and forecasts for continued strong demand
growth rates,  the Company and its  competitors  (both  independent  and captive
suppliers) began adding significant media  manufacturing  capacity in 1996 which
for the most part became  operational  in 1997.  The  increased  supply of media
generated  by the  expanded  physical  capacity,  coupled  with  the  tremendous
improvement  in disk storage  capacity,  allowed the overall supply of thin-film
media to catch up to, and then exceed,  market demand.  Captive media  suppliers
(owned by vertically integrated disk drive customers) utilized their capacity at
the expense of independent  suppliers,  such as Komag,  during this period. As a
result, in 1997 and 1998, the market for disks produced by independent suppliers
decreased sharply and pricing pressures intensified.  In both 1997 and 1998, the
Company  idled  certain  equipment  and  facilities  to more  closely  align its
production capacity to demand for its products.  These restructuring  activities
resulted in significant restructuring and impairment charges.

     The Company  believes that there remains excess media  capacity  within the
industry. Certain media manufacturers have idled capacity and restructured their
operations.  StorMedia, Inc., an independent media supplier, declared bankruptcy
in late 1998. The Company believes that the longer-term success of the thin-film
media industry is dependent upon high growth in demand for storage  capacity and
further  consolidation  within  the media  industry.  Improvements  in  enabling
technologies,  such as  increased  bandwidth  capability  that will  speed  data
transfers  over the  Internet  and will  promote use of other  storage-intensive
applications  such as  multimedia,  are expected to drive the demand for storage
capacity.

      Komag  primarily  sells its media products to  independent  OEM disk drive
manufacturers  for  incorporation  into hard disk drives that are marketed under
the  manufacturers'  own labels.  The Company also currently  sells its disks to
computer system manufacturers who make disk drives for their own use or for sale
in the open market.  The Company works closely with customers as they design new
high-performance  disk drives and generally customizes its products according to
customer specifications.

      Three customers accounted for approximately 86% of the Company's net sales
in  1998.  Net  sales  to  major  customers  were as  follows:  Western  Digital
Corporation ("Western Digital")--43%;  Maxtor Corporation  ("Maxtor")--25%;  and
International Business Machines  ("IBM")--18%.  Sales are generally concentrated
in a small  number  of  customers  due to the high  volume  requirements  of the
dominant disk drive  manufacturers and their tendency to rely on a few suppliers
because  of the close  interrelationship  between  media and  other  disk  drive
components.  Given the relatively  small number of  high-performance  disk drive
manufacturers,  the Company  expects that it will  continue its  dependence on a
limited number of customers.

     Sales are made directly to disk drive manufacturers worldwide (except media
sales into Japan) from the  Company's  U.S. and Malaysian  operations.  Sales of
media for assembly into disk drives  within Japan are made solely  through AKCL.
On a selective  basis,  the Company has used AKCL to  distribute  the  Company's
products to Japanese drive  manufacturers for assembly outside of Japan.  During
1998, the Company sold product to  Matsushita-Kotobuki  Electronics  Industries,
Ltd.  ("MKE") in Japan and to MKE's  Singapore  manufacturing  facility  through
AKCL.  Media  sales  to the Far East  from  the  Company's  U.S.  and  Malaysian
operations  represented  83%, 96% and 88% of Komag's net sales in 1998, 1997 and
1996,  respectively.  The Company's  customers assemble a substantial portion of
their  disk  drives  in the  Far  East  and  subsequently  sell  these  products
throughout the world.  Therefore,  the Company's high  concentration of Far East
sales does not  accurately  reflect the  eventual  point of  consumption  of the
assembled disk drives.  All foreign sales are subject to certain risks common to
all export activities,  such as government regulation and the risk of imposition
of tariffs or other trade  barriers.  Foreign sales must also be licensed by the
Office of Export Administration of the U.S. Department of Commerce.

                                       6
<PAGE>

     The Company's  sales are generally made pursuant to purchase  orders rather
than long-term contracts.  At January 3, 1999, the Company's backlog of purchase
orders scheduled for delivery within 90 days totaled approximately $69.6 million
compared to $23.7  million at December 28, 1997.  These  purchase  orders may be
changed or canceled by customers on short notice  without  significant  penalty.
Accordingly,  the backlog  should not be relied upon as  indicative of sales for
any future period.

Manufacturing

     Komag's  manufacturing  expertise  in  thin-film  media is evidenced by its
history of delivering reliable products in high volume.  Through the utilization
of  proprietary  processes  and  techniques,  the Company has the  capability to
produce  advanced disk  products  that  generally  exhibit  uniform  performance
characteristics.   Such   uniform   performance   characteristics   enhance  the
reliability of the drive products  manufactured by the Company's  customers.  In
addition,  these  characteristics  raise  production  yields  on the  customers'
manufacturing  lines,  which is an important  cost  consideration  especially in
high-performance  disk drives with large component counts.  Manufacturing  costs
are highly  dependent  upon the  Company's  ability to  effectively  utilize its
installed  physical  capacity to produce large volumes of products at acceptable
yields.  To improve  yields and capacity  utilization,  Komag has adopted formal
continuous improvement programs at all of its worldwide operations.  The process
technologies employed by the Company require substantial capital investment.  In
addition,  long lead  times to  install  new  increments  of  physical  capacity
complicate capacity planning.

      The manufacture of the Company's  thin-film  sputtered disks is a complex,
multistep process that converts  aluminum  substrates into finished data storage
media ready for use in a hard disk drive. The process requires the deposition of
extremely  thin,  uniform  layers of  metallic  film onto a disk  substrate.  To
achieve  this,  the Company  uses a vacuum  deposition,  or  sputtering,  method
similar to that used to coat semiconductor wafers. The basic process consists of
many interrelated steps that can be grouped into five major categories:

     1. Sizing and Grinding of the Substrate:  A raw aluminum blank substrate is
sized by  precisely  cutting  the inner  and  outer  diameter  of the  blank.  A
mechanical  grinding  process  is then  utilized  to provide a  relatively  flat
surface on the substrate prior to nickel alloy plating.

     2. Nickel Alloy Plating and Polishing of the Substrate: Through a series of
chemical baths aluminum  substrates are plated with a uniform nickel  phosphorus
layer in order to provide  support for the magnetic  layer.  Next, this layer is
polished to achieve the required flatness.

     3. Fine  Polishing,  Texturing  and Cleaning:  During these process  steps,
disks are smoothed and cleaned to remove surface defects to allow the read/write
heads of the disk drives to fly at low and constant levels over the disks.

     4.  Sputtering  and Lube:  By a  technically  demanding  vacuum  deposition
process,  magnetic  layers  are  successively  deposited  on the disk and a hard
protective  overcoat  is  applied.  After  sputtering,  a  microscopic  layer of
lubrication is applied to the disk's  surfaces to improve  durability and reduce
surface friction.

     5. Glide Test and  Certification:  In  robotically  controlled  test cells,
disks are first tested for surface defects optically, then for a specified glide
height  and  finally  certified  for  magnetic  properties.  Based on these test
results, disks are graded against customers' specific performance requirements.

     Most of the  critical  process  steps are  conducted in Class 100 or better
environments.   Throughout   the  process,   disks  are  generally   handled  by
custom-designed and, in many cases,  Company-built automated equipment to reduce
contamination  and enhance process  precision.  Minute  impurities in materials,
particulate  contamination  or other production  problems can reduce  production
yields and, in extreme cases, result in the prolonged  suspension of production.
Although no  contamination  problems have 

                                       7
<PAGE>

required prolonged  suspension of the Company's production to date, no assurance
can be given that the Company will not  experience  manufacturing  problems from
contamination or other causes in the future.

     As areal density increases,  recording heads are required to read and write
smaller  data bits packed more tightly  together on the surface of the disk.  To
accomplish  this, the read/write  head must fly closer to the disks' surfaces in
order to discriminate  smaller,  weaker magnetic  signals.  In 1998, the Company
completed a number of changes in its manufacturing processes designed to improve
disk  characteristics.  These new  processes  produce disk  substrates  that are
smoother and flatter, with fewer, smaller defects. Additionally,  disks produced
with these modified processes  facilitate increased density through more uniform
crystal  growth and  improved  magnetic  orientation  on the disk  surface.  The
Company modified its sputtering  process from the deposition of a magnetic layer
over an amorphous  underlayer  to epitaxial  deposition  of the active  magnetic
layer upon a crystalline underlayer.  Since epitaxial deposition requires higher
temperatures  and dryer  process  chambers  than the former  processes,  several
significant  process  changes were  implemented  in 1998.  First,  the processes
related to producing substrates, prior to sputtering, were changed by adding new
annealing  steps to  accommodate  higher  process  temperatures.  Next,  to make
substrates   smoother   and  reduce   defects  a  new  polish  step  was  added.
Additionally,  the Company upgraded a portion of its in-line sputtering lines to
increase process temperatures and provide higher vacuum capability.

Facilities and Production Capacity

     Based on analysis of the Company's production capacity and its expectations
of media market demand, the Company  implemented  restructuring plans during the
third  quarter  of  1997  and  the  second  quarter  of  1998.  Under  the  1997
restructuring plan, the Company consolidated its U.S.  manufacturing  operations
onto its new campus in San Jose,  California  by closing two older  factories in
Milpitas, California. The first of the two Milpitas facilities was closed at the
end of the third  quarter of 1997 and the second  facility was closed in January
1998.  Under its 1998  restructuring  plan,  the  Company  ceased  its  back-end
operations in its oldest San Jose,  California facility in the fourth quarter of
1998.  The Company,  however,  continues to use this  facility for its front-end
operations for both production and new process  development.  Additionally,  the
Company may periodically  utilize back-end  operations in this facility based on
media demand.  At January 3, 1999, the Company and its joint venture,  AKCL, had
facilities in the U.S., Malaysia, Japan and Thailand.

     The Company  occupies  three  production  factories in the U.S.  comprising
approximately   372,000   square  feet  of   floorspace,   an  R&D  facility  of
approximately  188,000 square feet and warehouse and  administrative  facilities
with  approximately  130,000 square feet. Two factories are located in San Jose,
California. The third factory, the Company's majority-owned subsidiary (KMT), is
located in Santa Rosa,  California.  The factories in San Jose primarily perform
the process steps from plate through test, whereas the KMT facility manufactures
aluminum substrates.

     The Company owns three  production  facilities  in Malaysia,  two in Penang
totaling  approximately  615,000 square feet and one in Sarawak of approximately
275,000 square feet. One of the Penang  factories  performs all of the Company's
process steps except aluminum substrate preparation and the other is equipped to
perform the fine polish  through  test steps.  The Sarawak  factory is primarily
dedicated  to  substrate,  plating  and  polishing  operations.  The Company has
strategically  located a large  portion  of its total  worldwide  front-end  and
back-end manufacturing capacity in Malaysia.  These facilities are closer to the
customers'  disk drive assembly  plants in Southeast Asia and enjoy certain cost
and tax advantages.

     AKCL occupies  approximately  495,000 square feet of building space. AKCL's
Japanese  facilities are primarily dedicated to fine polish through test and its
Thailand facility is designed for plating and polishing.

                                       8
<PAGE>

Recent Development

     In February 1999, the Company and Western Digital  announced the signing of
a letter of intent under which the Company will acquire  Western  Digital's disk
media  business  for  approximately  $80 million of the  Company's  Common Stock
(based on the market value of the Company's  Common Stock at the time the letter
of intent was signed). In addition, the Company will assume certain liabilities,
mainly lease obligations related to production  equipment and facilities.  Terms
of the strategic  relationship  include a three-year  volume purchase  agreement
under which Western Digital will buy a substantial portion of its media from the
Company.  The Company plans to combine  Western  Digital's  media group with its
manufacturing  operations  over the next 18 months.  Such action will relocate a
portion of Western  Digital's  production  equipment to the  Company's  offshore
locations,   thus  more  fully  utilizing  the  Company's  lower-cost  Malaysian
operations.  At the time of this filing the Company  and  Western  Digital  were
continuing to negotiate terms of the acquisition.

Research, Development and Engineering

     Since its  founding,  Komag has  focused  on the  development  of  advanced
thin-film disk designs as well as the process technologies  necessary to produce
these designs.  The Company's  spending and capital investment for R&D are aimed
at the  investigation,  design,  development  and  testing of new  products  and
processes  as well as the  development  of more  efficient  and  cost  effective
processes that can be integrated  into  manufacturing  in a commercially  viable
manner.  Historically,  the Company has utilized a full-scale in-line sputtering
line for both  development and pilot  production.  The Company's R&D facility is
equipped with two in-line  sputtering lines and two static  sputtering  systems.
The Company believes this additional  capacity will allow more rapid development
of new products as well as expanded prototype and pilot production capability.

     The  Company's   expenditures   (and  percentage  of  sales)  on  research,
development  and  engineering  activities,  were $61.6 million (18.7%) in fiscal
1998,  $51.4 million  (8.1%) in fiscal 1997 and $29.4  million  (5.1%) in fiscal
1996.

Strategic Alliances

     The Company has established joint ventures with Asahi Glass and Kobe. Komag
believes  these  alliances have enhanced the Company's  competitive  position by
providing research,  development,  engineering and manufacturing  expertise that
reduce costs and technical risks and shorten product development cycles.

     Asahi Komag Co., Ltd. ("AKCL")

     In 1987, the Company formed a partnership (Komag Technology  Partners) with
the  U.S.  subsidiaries  of two  Japanese  companies,  Asahi  Glass  and  Vacuum
Metallurgical  Company.  The  partners  simultaneously  formed  a  wholly  owned
subsidiary,  AKCL, to manufacture  and distribute  thin-film  disks in Yonezawa,
Japan. Under the joint venture  agreement,  the Company  contributed  technology
developed prior to January 1987 and licensed technology  developed after January
1987, to the extent such  technology  relates to sputtered  thin-film  hard disk
media, for a 50% interest in the partnership.  The Japanese partners contributed
equity capital  aggregating  1.5 billion yen  (equivalent to  approximately  $11
million at that time). AKCL began commercial production in 1988.

     The terms of the joint  venture  agreement  provide that AKCL may only sell
disks for  incorporation  into disk drives that are assembled in Japan,  with no
limitation  on the territory in which AKCL's  customers can sell such  assembled
disk drive products. During the term of the joint venture agreement and for five
years thereafter,  the Japanese partners and their affiliates have agreed not to
develop,  manufacture or sell  sputtered  media anywhere in the world other than
through the joint venture, and the Company and its affiliates have agreed not to
develop,  manufacture  or sell  such  media in Japan  except 

                                       9
<PAGE>

through the joint venture. The Company has, however, periodically granted AKCL a
limited right to sell its disks  outside of Japan and has received  royalties on
such sales. Upon the occurrence of certain terminating events and the subsequent
acquisition  of  AKCL  by one  or  more  of  the  joint  venture  partners,  the
restrictions  related to activities of the  acquiring  joint venture  partner(s)
within Japan may lapse.

     Disk  sales  to AKCL  represented  3% of the  Company's  net  sales in 1998
compared to 14% in 1997 and less than 6% in 1996.  The Company  purchased  1% of
AKCL's unit output during 1998 compared to approximately  11% and 3% in 1997 and
1996,   respectively.   The  Company  anticipates  that  distribution  sales  of
AKCL-produced  disks to U.S.  customers in 1999 will remain a  relatively  small
percentage of the Company's net sales.

     Substantially   lower  average  selling  prices,   coupled  with  equipment
writedowns and lower manufacturing  yields,  adversely affected AKCL's financial
results for 1998.  AKCL  completed a transition to static  sputter  equipment in
early 1998. As a result,  AKCL idled its remaining in-line sputtering  equipment
and wrotedown  the remaining  book value of these  permanently  impaired  assets
during 1998.  AKCL  believes that the products  produced by a static  sputtering
process  are  technically  similar to those  produced  by other  Japanese  media
suppliers,  thus  improving  AKCL's  ability to meet  specific  requirements  of
certain Japanese customers on a timely basis.

     AKCL  incurred  substantial  losses in 1998. In the first half of 1998 AKCL
incurred low yields and operated  significantly  under  capacity.  In the second
half of 1998 unit  volume and  manufacturing  yields  increased  but the overall
average  selling price for AKCL's  products  decreased  sharply.  AKCL's current
financing  arrangements  may not be sufficient if losses continue at AKCL. There
can be no assurance that additional financing will be available to AKCL. Failure
to secure  additional  financing could have a material  adverse affect on AKCL's
business and  financial  results.  The Company has no  obligation  to provide or
guarantee  financing to AKCL. Further writedowns of the Company's  investment in
AKCL  are  limited  to the  book  value  of  the  investment  on  the  Company's
consolidated balance sheet ($1.4 million at January 3, 1999).

     Komag Material Technology, Inc. ("KMT")

     In  1988,  Komag  formed a wholly  owned  subsidiary,  KMT,  to  secure  an
additional stable supply of aluminum substrates of satisfactory  quality for the
Company's  products.  In 1989,  Kobe,  a  leading  worldwide  supplier  of blank
aluminum  substrates,  purchased  a 45%  interest  in KMT for $1.4  million.  In
December 1995, the Company reacquired 25% of the outstanding Common Stock of KMT
by purchasing shares from Kobe for $6.75 million.  The Company's purchase raised
its total  ownership  percentage  of KMT to 80%.  Kobe retains one seat on KMT's
Board of Directors.

     Under agreements between Kobe and the Company, Kobe will continue to supply
substrate blanks to KMT while the Company will continue to purchase KMT's entire
output of finished  substrates.  In  combination,  KMT,  Kobe, and the Company's
Sarawak   facility  supply   substantially   all  of  the  Company's   substrate
requirements.

     Equity Positions Held by Asahi Glass and Kobe in Komag

     Asahi  Glass and Kobe each  purchased  two million  shares of newly  issued
Common  Stock from the Company  for $20 million in January  1989 and March 1990,
respectively. In 1992, Asahi Glass transferred ownership of its shares to a U.S.
subsidiary of Asahi Glass.  Under their  respective  stock purchase  agreements,
Asahi  Glass and Kobe each have the right to purchase  additional  shares of the
Company's  Common Stock on the open market to increase their  respective  equity
interests in the Company to 20%, to maintain  their  percentage  interest in the
Company by  purchasing  their pro rata shares of any new equity  issuance by the
Company and to require the Company to register  their shares for resale,  either
on a demand  basis or  concurrent  with an offering by the  Company.  Each stock
purchase  agreement further provides that the Company shall use its best efforts
to elect a  representative  of each 

                                       10
<PAGE>

investor to the Company's Board of Directors and to include such representatives
on the  Nominating  Committee of the Board.  There were no purchases or sales of
the  Company's  stock  by  Asahi  Glass  or Kobe in 1998  and  according  to the
Company's  stock  records at  February  28,  1999,  Asahi  America and Kobe held
2,000,000  and  2,000,002  shares  of  Common  Stock,  respectively.   Sales  of
significant  amounts of the security  holdings of Asahi Glass and/or Kobe in the
future could  adversely  affect the market price of the Company's  Common Stock.
Any sales by either party, however,  would relieve the Company of its obligation
to nominate that party's representative for election to the Board of Directors.

Competition

     Current thin-film disk competitors fall into three groups: U.S. independent
manufacturers,  U.S. captive  manufacturers,  and Japanese/Asian  manufacturers.
Based upon  research  conducted by an  independent  market  research  firm,  the
Company believes it is the leading independent supplier of thin-film disks. U.S.
independent   thin-film  disk   competitors  in  1998  included  HMT  Technology
Corporation and StorMedia Inc.  ("StorMedia").  StorMedia ceased  operations and
declared  bankruptcy in the third quarter of 1998.  Japan-based  thin-film  disk
competitors include Fuji Electric Company,  Ltd.;  Mitsubishi Kasei Corp.; Showa
Denko K.K.; and HOYA Corporation. The U.S. captive manufacturers include IBM and
OEM disk drive manufacturers,  such as Seagate Technology,  Inc. ("Seagate") and
Western Digital, which manufacture disks as a part of their vertical integration
programs. In addition,  Maxtor received a portion of its disks requirements from
MaxMedia,  a subsidiary  of Hyundai  Electronics  America.  Hyundai  Electronics
America is a major  shareholder of Maxtor. To date, IBM and other OEM disk drive
manufacturers have sold nominal quantities of disks in the open market.

     Prior  to  1997,  the  U.S.   independent   manufacturers,   U.S.   captive
manufacturers,  and  Japanese/Asian  manufacturers  each supplied  approximately
one-third of the worldwide thin-film disk unit output. The Company believes that
the captive manufacturers  increased their market share to approximately 40% and
50% in 1997 and 1998,  respectively.  The increased market share for the captive
suppliers heightened price competition among the independent media suppliers for
the remaining  available  market.  This significant  pricing pressure  adversely
affected the financial  results of  independent  suppliers,  including  those of
Komag. See "Risk Factors--Competition."

Environmental Regulation

     The Company is subject to a variety of environmental  and other regulations
in  connection  with  its  operations  and  believes  that it has  obtained  all
necessary  permits for its  operations.  The  Company  uses  various  industrial
hazardous  materials,  including metal plating  solutions,  in its manufacturing
processes.  Wastes from the Company's  manufacturing processes are either stored
in areas  with  secondary  containment  before  removal  to a  disposal  site or
processed on site and discharged to the industrial sewer system.

     The Company has made  investments  in upgrading its  waste-water  treatment
facilities  to  improve  the  performance  and  consistency  of its  waste-water
processing. Nonetheless, industrial waste-water discharges from the Company may,
in the future, be subject to more stringent regulations.  Failure to comply with
present or future  regulations  could result in the  suspension  or cessation of
part or all of the Company's  operations.  Such  regulations  could restrict the
Company's  ability  to expand at its  present  locations  or could  require  the
Company to acquire costly equipment or incur other significant expenses.

Patents and Proprietary Information

     Komag holds and has applied  for U.S.  and foreign  patents and has entered
into cross-licenses  with certain of its customers.  While possession of patents
could present  obstacles to the  introduction of new products by competitors and
possibly  result in  royalty-bearing  licenses from third  parties,  the Company
believes  that its  success  does not depend on the  ownership  of  intellectual
property rights but rather on its

                                       11
<PAGE>

innovative skills,  technical competence and marketing  abilities.  Accordingly,
the patents  held and  applied  for will not  constitute  any  assurance  of the
Company's future success.

     The Company  regards  elements of its  equipment  designs and  processes as
proprietary and confidential  and relies upon employee and vendor  nondisclosure
agreements  and a system of internal  safeguards for  protection.  Despite these
steps for protecting proprietary and confidential  information,  there is a risk
that competitors may obtain and use such information.  Furthermore,  the laws of
certain  foreign  countries  in which the Company  does  business  may provide a
lesser  degree of  protection  to the  Company's  proprietary  and  confidential
information than provided by the laws of the U.S. In addition,  the Company from
time to time receives  proprietary and  confidential  information  from vendors,
customers  and  partners,  the use and  disclosure  of  which  are  governed  by
nondisclosure  agreements.  Through internal communication and the monitoring of
use  and  disclosure  of  such  information,   the  Company  complies  with  its
obligations  regarding use and  nondisclosure.  However,  despite these efforts,
there is a risk that such  information  may be used or disclosed in violation of
the Company's obligations of nondisclosure.

     The  Company  has  occasionally  received,  and may  receive in the future,
communications  from third parties  asserting  violation of intellectual  rights
alleged to cover certain of the Company's products or manufacturing processes or
equipment. In such cases, the Company evaluates whether it would be necessary to
defend against the claims or to seek licenses to the rights  referred to in such
communications.  No  assurance  can be given  that the  Company  will be able to
negotiate  necessary  licenses  on terms that would not have a material  adverse
effect on the Company or that any  litigation  resulting  from such claims would
not have a material  adverse  effect on the  Company's  business  and  financial
results.

Employees

     As of January 3, 1999, the Company and its  consolidated  subsidiaries  had
4,086  employees  (4,012 of which are  regular  employees  and 74 of which  were
employed  on a  temporary  basis),  including  3,665  in  manufacturing,  269 in
research,  development  and  engineering  and 152 in sales,  administrative  and
management positions. Of the total, 2,611 are employed at offshore facilities.

     The Company believes that its future success will depend in large part upon
its  ability to  continue to attract,  retain and  motivate  highly  skilled and
dedicated  employees.  None of the Company's employees is represented by a labor
union and the Company has never experienced a work stoppage.

Risk Factors

     The  following  discussion  of  risks  and  uncertainties  facing  Komag is
presented in accordance with the SEC's Plain English requirements.

     Our business is subject to a number of risks and uncertainties.  While this
discussion represents our current judgment on the risks facing us and the future
direction  of our  business,  such risks and  uncertainties  could cause  actual
results to differ materially from any future  performance  suggested herein. The
discussion contained in Item 1--"Business" and Item 7--"Management's  Discussion
and  Analysis  of  Financial  Condition  and  Results  of  Operations"  contains
predictions,  estimates  and other  forward-looking  statements  that  involve a
number of risks and  uncertainties.  Among the factors  that could cause  actual
results  to differ are the  following.  We sell a single  product  into a market
characterized  by rapid  technological  change and sudden  shifts in the balance
between  supply and demand.  Further,  we are  dependent on a limited  number of
customers,  some of whom  also  manufacture  some or  most of  their  own  disks
internally.  Competition in the market, defined by both technology offerings and
pricing,  can be fierce,  especially during times of excess available  capacity.
Such conditions were prevalent in 1998. We have a high fixed-cost structure that
can cause operating  results to vary dramatically with changes in product yields
and  utilization  of our  equipment  and  factories.  In addition,  our business
requires 

                                       12
<PAGE>

substantial investments for research and development activities and for physical
assets such as  equipment  and  facilities  that are  dependent on our access to
financial  resources.  These and other risks are discussed more fully below.  We
undertake no obligation to publicly release the result of any revisions to these
forward-looking  statements that may be made to reflect events or  circumstances
after the date hereof or to reflect the occurrence of unanticipated events.

Our Business Depends on the Success of the Hard Disk Drive Industry

     The demand for our  high-performance  thin-film disks depends on the demand
for hard disk  drives  and our  ability  to provide  high  quality,  technically
superior  products  at  competitive  prices.  The  hard  disk  drive  market  is
characterized by short product life cycles and rapid  technological  change. The
market is also  characterized  by  changes  in the  balance  between  supply and
demand. During periods of excess supply, prices can drop rapidly, causing abrupt
changes in our financial performance.

     Demand for disk drives grew rapidly for years,  including a 22% increase in
1996 unit shipments over 1995, and industry  forecasts were for continued strong
growth.  Komag  and  a  majority  of  our  competitors  (both  independent  disk
manufacturers and captive disk manufacturers owned by vertically integrated disk
drive  customers)  committed  to  expansion  programs in 1996 and  substantially
increased their media manufacturing capacity in 1997. In 1997 the rate of growth
in  demand  for disk  drives  fell  sharply  to  approximately  8%.  Disk  drive
manufacturers  abruptly reduced orders for media from independent  suppliers and
relied more heavily on internal  capacity to supply a larger proportion of their
media requirements.  The media industry's  capacity expansion,  coupled with the
decrease  in the rate of demand  growth,  resulted  in excess  media  production
capacity in the last half of 1997 and continuing through 1998. This excess media
production  capacity  caused sharp  declines in average  selling prices for disk
products as independent  suppliers struggled to utilize their capacity.  Pricing
pressure on component  suppliers was further  compounded by high consumer demand
for sub-$1,000 personal computers.

     Recently,  the disk drive  industry has migrated from  qualifying  specific
vendors to qualifying  specific  vendor plant sites for given product  programs.
This  practice  reduces  the disk drive  manufacturer's  cost to qualify a given
product  and,  in some  cases,  is a  requirement  imposed  upon the disk  drive
manufacturer  by computer  systems  manufacturers.  Qualification  by plant site
limits our  ability to more  quickly  balance  production  levels at our various
plants and, in periods of excess  capacity,  may require us to staff and operate
multiple plants inefficiently.  Furthermore, our failure to qualify new products
and/or  successfully  achieve volume production of such products could adversely
affect our results of operations.

     In general,  our customers have been moving  towards  fewer,  larger-volume
disk drive programs, characterized by shorter product life cycles. Additionally,
media must be more  customized  to each disk  drive  program  and  supply  chain
management,  including  just-in-time  delivery,  is rapidly  becoming a standard
industry  practice.  Timely  development of new products and  technologies  that
assist  customers in reducing their  time-to-market  performance and operational
excellence  that supports  high-volume  manufacturing  ramps and tight inventory
management  throughout the supply chain will be keys to both the  maintenance of
constructive customer relationships and our profitability.  We cannot assure you
that we will be able to respond to this rapidly changing environment in a manner
that will maximize  utilization  of our  production  facilities and minimize our
inventory losses.

We are in  Default  under  Financial  Covenants  Contained  in Our  Bank  Credit
Facilities

         The size of our  second  quarter  1998 net loss  resulted  in a default
under certain financial  covenants  contained in our bank credit facilities.  We
are not in payment default under these credit facilities as we have continued to
pay all interest  charges and fees  associated  with these  facilities  on their
scheduled due dates. At the time of the covenant  default we had $260 million of
debt  outstanding  against a total borrowing  capacity of $345 million under our
various senior unsecured credit facilities. As a result of the covenant default,
our lenders withdrew the $85 million in unused borrowing capacity.  

                                       13
<PAGE>

To date,  our lenders have not  accelerated  any  principal  payments  under our
credit facilities.  As a result of the technical default and reclassification of
our bank debt to current liabilities, our auditors have included a going concern
paragraph in their audit opinion to highlight  our need to amend or  restructure
our debt obligations.

We are  currently  negotiating  with our lenders for  amendments to our existing
credit facilities. If we successfully amend or restructure our credit facilities
we will  seek to have our  auditors  reissue  their  opinion  without  the going
concern  paragraph.  We cannot  assure  you that we will be able to obtain  such
amendments to our credit  facilities on commercially  reasonable terms. If we do
not  successfully  amend these credit  facilities,  we would remain in technical
default of our bank loans and the lenders would retain their rights and remedies
under the  existing  credit  agreements.  As long as the  lenders  choose not to
accelerate any principal  payments,  we would continue to operate in default for
the  near  term.  However,  we will  likely  need to raise  additional  funds to
restructure our debt obligations and to operate our business for the long term.

         Over the  next  several  years we will  need  financial  resources  for
capital expenditures,  working capital and research and development. During 1997
and 1998, we spent approximately $199 million and $89 million,  respectively, on
property,  plant and  equipment.  In 1999,  we plan to spend  approximately  $40
million on property,  plant and  equipment,  primarily for projects  designed to
improve  yield  and  productivity.  We  believe  that in  order to  achieve  our
long-term growth  objectives and maintain and enhance our competitive  position,
such additional financial resources will be required.  We cannot assure you that
we will be able to secure such financial  resources on  commercially  reasonable
terms.  If we are unable to obtain adequate  financing,  we could be required to
significantly reduce or possibly suspend our operations,  and/or sell additional
securities on terms that would be highly dilutive to our current stockholders.

We are Dependent on a Small Number of Customers for Most of our Business

     Our  sales  are   concentrated  in  a  small  number  of  customers.   This
concentration is due to the high-volume  requirements of the dominant disk drive
manufacturers and their tendency to rely on a few suppliers because of the close
interrelationship  between media  performance and disk drive performance and the
complexity of integrating components from a variety of suppliers.  Our net sales
to major customers in 1998 were as follows:

    o    Western Digital Corporation ("Western Digital")--43%;
    
    o    Maxtor Corporation, ("Maxtor")--25%; and
    
    o    International Business Machines ("IBM")--18%.

Given the relatively small number of disk drive manufacturers, we expect that we
will continue to depend on a very limited number of customers.

     Our sales are generally  made pursuant to purchase  orders that are subject
to cancellation,  modification or rescheduling without significant penalties. We
cannot assure you that our current  customers will continue to place orders with
us,  that  orders by existing  customers  will  recover to the levels of earlier
periods or that we will be able to obtain orders from new customers.

     In addition,  given our  dependence on a few customers and a limited number
of  product  programs  for each  customer,  we must make  significant  inventory
commitments to support our customers' programs.  We have limited remedies in the
event of program cancellations.  If a customer cancels or materially reduces one
or more product  programs,  or  experiences  financial  difficulties,  we may be
required to take significant inventory charges, which, in turn, could materially
and  adversely  affect our results of  

                                       14
<PAGE>

operations.  While we have taken certain charges including inventory write-downs
to address  known  issues,  we cannot assure you that we will not be required to
take additional  inventory  writedowns due to our inability to obtain  necessary
product qualifications or due to further order cancellations by customers.

The Hard Disk Drive Industry is Very Competitive

     Our thin-film disk products  primarily serve the 3 1/2-inch hard disk drive
market,  where product  performance,  consistent quality and availability are of
great competitive  importance.  To succeed in an industry characterized by rapid
technological   developments,   we  must  continuously   advance  our  thin-film
technology at a pace consistent with or faster than our  competitors.  If we are
unable to keep pace  with  rapid  advances,  we may lose  market  share and face
increased price  competition from other  manufacturers.  Such competition  could
materially adversely affect our results of operations.

     In response to higher  historical  and projected  growth rates for the disk
drive market,  Komag and a majority of our competitors  (both  independent  disk
manufacturers and captive disk manufacturers owned by vertically integrated disk
drive customers)  substantially increased disk manufacturing capacity in 1997 to
satisfy the anticipated demand for disk products.  These significant investments
in capable new disk production  capacity,  combined with the slowdown in demand,
have  resulted in excess disk media  capacity  in the  merchant  market as drive
manufacturers  sourced a higher  portion of their disk  requirements  from their
captive media operations. This excess supply over demand condition has increased
competition    for   the   remaining    merchant   market   and   has   led   to
higher-than-historical   price  erosion  and  lower  factory  utilization  among
independent  media suppliers.  These market  conditions  adversely  affected our
results  of  operations  beginning  in the  last  half  of  1997  and  continued
throughout  1998.  Our  operating  results  for the last  half of 1998  improved
relative to results  for the first half of 1998 due to the lower cost  structure
associated with our restructuring activities, variable cost reductions, improved
manufacturing  yields,  and higher  factory  utilization.  We  believe  that our
manufacturing  operations  in  Penang  and  Sarawak,   Malaysia  can  provide  a
competitive cost advantage  relative to most other thin-film disk  manufacturers
that operate exclusively or primarily in the U.S. and Japan.

     We also compete  against media  operations  owned directly by or affiliated
with  many of our  customers  for the  supply  of the  thin-film  disks.  Of our
customers,  IBM,  Seagate and Western  Digital produce  significant  portions of
their media demand through their  directly-owned  media operations.  During 1998
IBM and Seagate  produced  more than 80% of their media demand  internally,  and
Western  Digital  produced  more than 60% of its media  requirement  internally.
During 1998,  MaxMedia supplied  approximately  40% of Maxtor's  requirement for
media. Hyundai Electronics America owns MaxMedia and is also a major shareholder
in Maxtor.  To date,  MaxMedia and the captive media operations of IBM, Seagate,
and  Western  Digital  have sold  nominal  quantities  of disks in the  merchant
market.

Our Operating results are Subject to Quarterly Fluctuations

     We believe that our future operating results will continue to be subject to
quarterly variations based upon a wide variety of factors, including:

    o    the cyclical nature of the hard disk drive industry;
    
    o    our  ability  to  develop  and  implement  new  manufacturing   process
         technologies;
    
    o    increases in our  production  and  engineering  costs  associated  with
         initial design and production of new product programs;
    
    o    the  extensibility  of our  process  equipment  to meet more  stringent
         future product requirements;

                                       15
<PAGE>

    o    our ability to  introduce  new products  that  achieve  cost-effective,
         high-volume production in a timely manner;
    
    o    changes in our product mix and average selling prices;
    
    o    the  availability  and the  extent  of  utilization  of our  production
         capacity;
    
    o    changes in our manufacturing efficiencies, in particular product yields
         and input  costs for direct  materials,  operating  supplies  and other
         running costs;
    
    o    prolonged  disruptions  of operations at any of our  facilities for any
         reason;
    
    o    changes in the cost of or limitations on availability of labor; and
    
    o    structural   changes   within  the  disk  media   industry,   including
         combinations, failures, and joint venture arrangements.

     Because thin-film disk manufacturing  requires a high level of fixed costs,
our gross margins are also extremely sensitive to changes in volume. At constant
average  selling  prices,  reductions  in  our  manufacturing  efficiency  cause
declines in our gross margins.  Additionally,  decreasing  market demand for our
products generally results in reduced average selling prices and/or low capacity
utilization that, in turn, adversely affect gross margins and operating results.
We incurred  substantial  negative  gross  margins of 41.5% and 45.2% during the
first and second quarters of 1998, respectively,  as a result of the combination
of the lower  overall  average  selling price and higher unit  production  costs
related to  underutilized  capacity.  Our gross margin improved in the third and
fourth  quarters  of 1998 to  negative  3.4% and  positive  7.9%,  respectively,
primarily due to:

    o    increased unit volume;
    
    o    higher manufacturing yields;
    
    o    reduced material input costs; and
    
    o    the lower  fixed cost  structure  of our  business  resulting  from our
         implementation of restructuring plans.

     Industry consolidation,  including mergers,  alliances or failures,  within
the hard disk drive  industry can cause sudden market  changes  making  capacity
planning difficult and causing dramatic  fluctuations in operating  results.  In
1998,  disk drive  makers  JTS  Corporation  and  Micropolis  (USA) Inc.  ceased
operations.  StorMedia Inc., one of our thin-film media competitors, also ceased
operations in 1998. While we believe that further consolidation within hard disk
drive  manufacturers  and media  manufacturers  will likely be beneficial to the
industry for the long-term,  we cannot assure you that such consolidation  would
not have an adverse affect on our results of operations.

The  Thin-film  Disk  Industry  has  been   Characterized  by  Rapid  Technology
Developments, Increasingly Shorter Product Life Cycles and Price Erosion

     We believe  that our  future  success  depends,  in large  measure,  on our
ability to develop and implement new process technologies in a timely manner and
to continually improve these technologies. New process technologies must support
cost-effective,   high-volume  production  of  thin-film  disks  that  meet  the
ever-advancing   customer   requirements   for   enhanced   magnetic   recording
performance.

                                       16
<PAGE>

     In this regard,  in 1998, we modified our plating and polishing process for
aluminum  substrates and our  sputtering  process for  applications  of magnetic
layers to the surface of a disk. Both changes required  substantial  process and
equipment modifications. In the fourth quarter of 1998, more than three-quarters
of our unit sales were manufactured using these new processes.

     Advances  in hard disk drive  technology  demands  continually  lower glide
heights and higher areal densities  requiring  substantial  on-going process and
technology  development.   Additionally,  the  development  of  alternatives  to
aluminum-based   substrates,   such  as  glass-based  substrates,   may  require
substantial investments in new process technologies and capital expenditures. We
expect that  manufacturers  will migrate their  programs to glass as the cost of
glass-based  media  technologies   decreases  and/or  demands  for  increasingly
higher-density  products require the technological  advantages offered by glass.
We have devoted a portion of our research and development efforts to glass-based
technologies.  However,  we cannot  assure  you that we will be able to  develop
cost-efficient processes to compete in the glass-based thin-film media market.

     Although we have a significant,  ongoing research and development effort to
advance our process  technologies and the resulting  products,  we cannot assure
you that we will be able to develop and implement such  technologies in a timely
manner in order to compete  effectively  against  competitors'  products  and/or
entirely  new data  storage  technologies.  Our results of  operations  would be
materially adversely affected if our efforts to advance our process technologies
are not  successful  or if the  technologies  that we have chosen not to develop
proved to be viable competitive alternatives.

Our Foreign  Operations  and Joint  Ventures  Entail  Risks to Our  Business and
Operations

     In 1998,  our sales to  customers  in the Far East,  including  the foreign
subsidiaries of domestic disk drive companies,  accounted for  approximately 83%
of our net sales from our U.S. and Malaysian facilities.  Our customers assemble
a substantial portion of their disk drives in the Far East and subsequently sell
these products  throughout the world.  Therefore,  our high concentration of Far
East sales does not accurately  reflect the eventual point of consumption of the
assembled disk drives. We anticipate that  international  sales will continue to
represent the majority of our net sales.  All of our sales are currently  priced
in U.S.  dollars  worldwide.  Certain  costs at our  foreign  manufacturing  and
marketing  operations  are  incurred  in the local  currency.  We also  purchase
certain operating  supplies and production  equipment from Japanese suppliers in
yen-denominated transactions.  Accordingly, our operating results are subject to
the risks inherent with international operations, including, but not limited to:

    o    compliance  with or changes in the law and regulatory  requirements  of
         foreign jurisdictions;
    
    o    fluctuations in exchange rates, tariffs or other barriers;
    
    o    difficulties in staffing and managing foreign operations;
    
    o    exposure to taxes in multiple jurisdictions; and
    
    o    transportation delays and interruptions.

     Our Malaysian  operations  accounted for a significant  portion of our 1998
consolidated net sales.  Prolonged  disruption of operations in Malaysia for any
reason  would  cause  delays  in  shipments  of our  products,  thus  materially
adversely  affecting  our results of  operations.  Changes in relative  currency
values  can be swift  and  unpredictable.  In 1998,  economic  difficulties  and
political  unrest  throughout   Southeast  Asia  created  substantial   currency
devaluations in the region. In mid-1998,  the Malaysian  government devalued the
Malaysian ringgit ("MR") to a fixed exchange rate of 3.8 MR to $1 U.S. While the
effect of a devaluation in the MR reduces the U.S. dollar equivalent of MR-based
operating 

                                       17
<PAGE>

expenses,  future  fluctuations  could also have the opposite effect.  While the
political and economic issues in Southeast Asia have not had a material  adverse
affect on our  Malaysian  operations,  we cannot  assure you that future  events
would not cause a disruption in our operations.  Extended disruptions would have
a material adverse affect on our results of operations.

     Fluctuations in the financial results of AKCL, our unconsolidated  Japanese
disk manufacturing  joint venture,  also impact our financial  performance.  Our
equity in the net loss of AKCL increased our 1998 consolidated net loss by $27.0
million.  Equipment  writedowns  for  permanent  impairment  on  AKCL's  in-line
sputtering  equipment,  coupled with low sales volumes in the first half of 1998
and  substantially  lower  average  selling  prices  and  manufacturing  yields,
adversely  affected AKCL's financial results for 1998. Further writedowns of our
investment  in AKCL are  limited  to the book  value  of the  investment  on our
consolidated  balance  sheet  ($1.4  million at January  3, 1999)  assuming  the
Japanese yen to U.S. dollar exchange rate remains stable. Our investment in AKCL
is adjusted for changes in the prevailing  rate of exchange  between the yen and
dollar. A strengthening yen increases the dollar-based  investment balance. AKCL
is subject to many of the same risks  that we face,  including  dependence  on a
limited  customer base.  Additionally,  AKCL is subject to risks associated with
fluctuations  in the relative  strength of the Japanese Yen to the U.S.  dollar.
AKCL,  which  bases the  pricing  for a large  portion of its  products  in U.S.
dollars, incurs most of its costs in Japanese Yen.


The Market Price of Our Common Stock has been Volatile

     The market  price of our common  stock has been  volatile  in  response  to
actual and anticipated quarterly variations in:

    o    our operating results;
    
    o    perceptions of the disk drive industry's relative strength or weakness;
    
    o    developments in our relationships with our customers and/or suppliers;
    
    o    announcements  of  alliances,  mergers  or  other  relationships  by or
         between our competitors and/or customers;
    
    o    announcements of technological innovations or new products by us or our
         competitors;
    
    o    the success or failure of new product qualifications;
    
    o    developments related to patents or other intellectual  property rights;
         and
    
    o    other events or factors.

     We expect this  volatility  to continue in the  future.  In  addition,  any
shortfall or changes in our revenue, gross margins,  earnings or other financial
results from analysts' expectations could cause the price of our Common Stock to
fluctuate  significantly.  In recent  years,  the stock  market in  general  has
experienced  extreme  price and  volume  fluctuations  which  have  particularly
affected the market price of many technology companies and which have often been
unrelated to the operating  performance of those  companies.  These broad market
fluctuations  may  adversely  affect  the  market  price  of our  Common  Stock.
Volatility  in the price of stocks of companies in the hard disk drive  industry
has been particularly high,  especially during 1997 and 1998. During this period
the price of our stock fell to a low of $2 5/8 during the third  quarter of 1998
from a high of $35 1/8 during the second  quarter of 1997.  See "Price  Range of
Common Stock."

                                       18
<PAGE>

Our  Business  Depends on Our Ability to Protect  Our  Patents  and  Proprietary
Information Rights

     Protection of technology  through  patents and other forms of  intellectual
property rights in technically sophisticated fields is commonplace.  In the disk
drive  industry,  it is not uncommon for companies and  individuals  to initiate
actions against others in the industry to enforce intellectual  property rights.
We cannot  assure  you that  others  have not or will not  perfect  intellectual
property rights and either enforce those rights to prevent us from using certain
technologies  or  demand  royalty  payments  from us in return  for using  those
technologies,  either of which may have a material adverse affect on our results
of operations.  As a measure of protection,  we have entered into  cross-license
agreements with certain customers.  In addition,  we review, on a routine basis,
patent  issuances  in the U.S.  and patent  applications  that are  published in
Japan.  Through these reviews,  we occasionally  become aware of a patent, or an
application  that may mature into a patent,  which could give rise to a claim of
infringement.  When such patents are identified, we investigate the validity and
possibility  of  actual  infringement.  We are  presently  involved  in  such an
investigation of several recently issued patents.  However, we cannot assure you
that we will  anticipate  claims that we infringe  the  technology  of others or
successfully defend ourselves against such claims.  Similarly,  we cannot assure
you  that  we will  discover  significant  infringements  of our  technology  or
successfully  enforce our rights to our  technology  if we  discover  infringing
uses.

We Rely on a Limited Number of Suppliers for Materials and Equipment Used in Our
Manufacturing Processes

     We  rely  on a  limited  number  of  suppliers,  and in  some  cases a sole
supplier,  for some of the  materials and  equipment  used in our  manufacturing
processes including aluminum substrates, nickel plating solutions, polishing and
texturing supplies, and sputtering target materials. As a result, our production
capacity  would be  limited  if one or more of these  materials  were to  become
unavailable  or  available  in  reduced  quantities.   If  such  materials  were
unavailable for a significant period of time, our results of operations would be
adversely affected.

Earthquakes or Other Natural or Man-made Disasters Could Disrupt Our Operations

     Our California manufacturing facilities, our Japanese joint venture (AKCL),
our  Japanese  supplier  of  aluminum  blanks for  substrate  production,  other
Japanese  suppliers of key  manufacturing  supplies and our Japanese supplier of
sputtering  machines  are each  located  in areas  with  seismic  activity.  Our
Malaysian operations have been subject to temporary production interruptions due
to localized flooding,  disruptions in the delivery of electrical power, and, on
one  occasion  in  1997,  by  smoke  generated  by  large,  widespread  fires in
Indonesia.  These events have in the past  disrupted  production and prevented a
portion of our workforce  from reaching the facility.  We cannot assure you that
natural or  man-made  disasters  will not result in a  prolonged  disruption  of
production in the future.  If any natural or man-made  disasters do occur,  they
could have a material adverse effect on our results of operations.


                                       19
<PAGE>

ITEM 2. PROPERTIES

     Worldwide  (excluding  AKCL),  the Company  currently  occupies  facilities
totaling   approximately  1.6  million  square  feet.  The  Company  owns  three
manufacturing  facilities  in  Malaysia,  two in Penang and one in Sarawak.  The
square  footage of each of these  facilities  and  acreage of the  related  land
parcels are 340,000 square feet and 13 acres,  275,000 square feet and 18 acres,
and 275,000  square feet and 89 acres.  The  Company  leases four  manufacturing
facilities in San Jose and Santa Rosa,  California.  These facilities are leased
for the following terms:


     Facility Size              Current Lease
     (square feet)              Term Expires                   Extension Options
     -------------              -------------                  -----------------
        225,000                 September 2006                    20 years
        188,000                   January 2007                    20 years
        103,000                      July 1999                    10 years
         97,000(1)               February 2001                    10 years
         82,000                  February 2007                    20 years
         48,000                  December 1999                          --
         44,000                     April 1999                    10 years


     In addition to the  facilities  listed  above,  the  Company  leases  other
smaller facilities in California and Singapore.  The Company owned approximately
6 acres of undeveloped land adjacent to its Milpitas manufacturing complex which
was sold in March 1998.

(1) This  facility  was  vacated  in the  third  quarter  of 1997 as part of the
Company's restructuring plan and subleased in December 1997.



ITEM 3. LEGAL PROCEEDINGS

     There are no material legal  proceedings to which either the Company or its
subsidiaries is a party or to which any of its property is subject.

                                       20
<PAGE>

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

     No matters were  submitted to the  stockholders  of the Company  during the
Company's fourth quarter of 1998.

Executive Officers of the Registrant
<TABLE>
     As of  February  23,  1999,  the  executive  officers of the Company are as
follows:
<CAPTION>

Name                               Age      Position
----                               ---      --------
<S>                                 <C>     <C>
Tu Chen.............................63      Chairman of the Board of Directors
Stephen C. Johnson..................56      President, Chief Executive Officer and Director
Christopher H. Bajorek..............55      Senior Vice President--Chief Technical Officer
Ray Martin..........................55      Senior Vice President--Customer Sales and Service
William L. Potts, Jr................52      Senior Vice President, Chief Financial Officer
                                               and Secretary
Thian Hoo Tan.......................50      Senior Vice President--Operations
Ronald Allen........................50      Vice President--Manufacturing Technologies
Richard Austin......................43      Vice President--Worldwide Substrate
                                               Manufacturing and Support Services
Tim Gallagher.......................46      Vice President--Product Development
Elizabeth A. Lamb...................47      Vice President--Human Resources
Thiam Seng Tan......................42      Vice President--Penang Operations
Eric Tu.............................45      Vice President--U.S. Media Operations
Tsutomu T. Yamashita................44      Vice President--Research and Process
                                               Development
</TABLE>

     Dr.  Chen is a founder of the  Company  and has served as  Chairman  of the
Board from its inception in June 1983.  From 1971 to June 1983, he was a Member,
Research  Staff,  and  Principal  Scientist  at Xerox  Corporation's  Palo  Alto
Research  Center.  From  1968 to 1971,  Dr.  Chen  was  employed  as a  research
scientist for Northrop  Corp.  Dr. Chen received his Ph.D.  and M.S.  degrees in
Metallurgical  Engineering  from the  University  of Minnesota  and holds a B.S.
degree in Metallurgical  Engineering  from Cheng Kung University in Taiwan.  Dr.
Chen is a director of Headway Technologies, Inc.

     Mr.  Johnson has served as  President  and Chief  Executive  Officer of the
Company since  September  1983. From 1977 to 1983, Mr. Johnson was an officer of
Boschert Incorporated,  a manufacturer of switching power supplies, initially as
Vice  President,  Marketing and  subsequently  as President and Chief  Executive
Officer.  Mr.  Johnson  holds  a  B.S.  degree  in  Engineering  from  Princeton
University,  a M.S. degree in Electrical  Engineering from the University of New
Mexico and an M.B.A.  degree from the Harvard  Graduate School of Business.  Mr.
Johnson is a director of Exabyte Corporation and Uniphase Corporation.

     Dr.  Bajorek  joined  the  Company  and was  elected  to the newly  created
position of Senior Vice President-Chief Technical Officer in June 1996. Prior to
joining  Komag,  Dr.  Bajorek was Vice  President,  Technology  Development  and
Manufacturing,  for the Storage Systems Division of IBM in San Jose, California.
During his 25-year  career with IBM,  Dr.  Bajorek  held  various  positions  in
research  and  management  related to magnetic  recording,  magnetic  bubble and
optical storage applications.  He holds a Ph.D. degree in Electrical Engineering
and Business Economics from the California Institute of Technology.  Dr. Bajorek
is  a  director  of  the  International   Disk  Drive  Equipment  and  Materials
Association (IDEMA), an industry trade association.

                                       21
<PAGE>

     Mr.  Martin  joined  the  Company  in  October  1997  and  served  as  Vice
President--Product Assurance and Product Test until his promotion to Senior Vice
President--Customer Sales and Service in June 1998. From 1990 to 1997, he headed
product  engineering  and  head/media  development  as  Director  of Process and
Technology at Quantum Corporation.  Prior to working at Quantum, Mr. Martin held
a number of management and  engineering  positions at several leading disk drive
manufacturers,  including Western Digital,  Seagate, and IBM. Mr. Martin holds a
B.S. degree in Mechanical Engineering from Kansas State University.

     Mr. Potts joined the Company in 1987 and served as Vice President and Chief
Financial Officer from January 1991 until his promotion to Senior Vice President
and Chief  Financial  Officer in January 1996. In addition,  Mr. Potts serves as
Secretary. Prior to joining Komag, Mr. Potts held financial management positions
at several  high-technology  manufacturing  concerns.  He has also served on the
consulting  staff of Arthur  Andersen & Co.  Mr.  Potts  holds a B.S.  degree in
Industrial  Engineering  from Lehigh  University  and an M.B.A.  degree from the
Stanford Graduate School of Business.

     Mr.  Thian  Hoo  Tan was  appointed  Vice  President  of  Manufacturing  in
September 1993 and was promoted to Senior Vice President--Operations in February
1998. He previously served as Vice President--Manufacturing--Asia  Operations in
charge of the  Company's  operations  in Penang and Sarawak,  Malaysia.  Mr. Tan
joined Komag in 1989 and was in charge of operations at the Company's  first San
Jose, California  manufacturing facility.  Before joining Komag in 1989, Mr. Tan
was Vice President of Operations at HMT Technology.  Mr. Tan holds a M.S. degree
in Physics from the University of Malaya at Kuala Lumpur.

     Mr. Allen was  promoted to Vice  President--Manufacturing  Technologies  in
January  1997.  Mr. Allen  joined the Company in October  1983 to establish  the
Company's automation  manufacturing program that he has since directed. Prior to
joining Komag,  Mr. Allen was employed with Xerox's Palo Alto Research Center as
a member of the research staff.  Mr. Allen also worked at General  Electric,  in
the Schenectady  Research Center. Mr. Allen holds a B.S. degree in Physics and a
minor in Chemistry from Dillard University.

     Mr. Austin  joined the Company in October 1988 as Facilities  and Equipment
Maintenance  Manager.  Prior  to his  appointment  as Vice  President--Worldwide
Substrate  Manufacturing  and Support  Services in June 1998,  Mr. Austin served
Komag as Vice President--U.S.  Manufacturing. Prior to joining Komag, Mr. Austin
was an Equipment  Maintenance and Facilities Manager at VLSI Technology Inc. Mr.
Austin also worked at National  Semiconductor and Rockwell International between
1975 and 1983.

     Dr.  Gallagher  joined the  Company  in May 1996 as  Director  of  Advanced
Product  Integration  and served in that  capacity  until his  promotion to Vice
President--Product  Development  in July  1998.  Prior  to  joining  Komag,  Dr.
Gallagher  held  positions  as  Director  of New  Products at Seagate and Senior
Technical Staff Member at IBM, working  primarily on advanced disk and recording
head  development.  He holds a PhD degree in Applied Physics from the California
Institute of Technology.

     Ms. Lamb joined the Company as Vice  President--Human  Resources in October
1996.  From 1995 to 1996 she was  Director of  Worldwide  Staffing  and Employee
Relations  at Adaptec.  Prior to that,  Ms. Lamb was  Director of  Compensation,
Benefits  and  Executive  programs at Tandem.  Ms.  Lamb holds a B.A.  degree in
Communications from San Jose State University.

     Mr.  Thiam Seng Tan joined the  Company in  December  1993 as  Director  of
Quality Assurance. He was appointed Vice President--Penang Operations in October
1998.  Prior to joining the Company,  Mr. Tan held  positions in  manufacturing,
engineering,  customer service and materials  management at Hewlett Packard Sdn.
Bhd. from 1979 to 1993. Mr. Tan holds a B.Sc.  degree in Mechanical  Engineering
from the University of London.

                                       22
<PAGE>

     Mr. Tu rejoined the Company as Vice  President--U.S.  Media  Operations  in
July 1998. He previously  worked for Komag from 1988 to 1993. Prior to rejoining
the Company,  Mr. Tu held senior  manufacturing  positions with Kobe  Precision,
Inc., a manufacturer  of aluminum  substrates and Fuji Electric  (Malaysia) Sdn.
Bhd.,  a  computer  hard  disk  maker in  Malaysia.  Mr. Tu holds a MS degree in
Mechanical Engineering from University of Missouri.

     Mr.  Yamashita  joined  the  Company  in 1984 and was  Senior  Director  of
Research prior to his promotion to Vice  President--Research  and Development in
January 1995. Mr.  Yamashita  currently serves as Vice  President--Research  and
Process Development.  Prior to joining the Company, Mr. Yamashita was a graduate
research  assistant in the  Department of Material  Science and  Engineering  at
Stanford University.  Mr. Yamashita holds a B.S. degree in Chemistry and an M.S.
degree in Materials Science from Stanford University.

                                       23
<PAGE>

PART II

ITEMS 5, 6, 7 and 8.

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


     The Company's  Common Stock is traded on the Nasdaq  National  Market under
the  symbol  KMAG.  The  following  table  sets  forth the range of high and low
closing sales prices,  as reported on the Nasdaq  National  Market.  At March 1,
1999 the Company had approximately 476 holders of record of its Common Stock and
53,923,044 shares outstanding.

                                                           Price Range of
                                                           Common Stock
                                                           ------------
                                                         High          Low
                                                         ----          ---
   1997
       First Quarter                                     32 7/8        25 13/32
       Second Quarter                                    35 1/8        16 7/16
       Third Quarter                                     22 7/16       16 1/8
       Fourth Quarter                                    21 3/8        14 1/2

   1998
       First Quarter                                     15 5/8        12 1/16
       Second Quarter                                    15 1/2         5 5/8
       Third Quarter                                      6 1/8         2 5/8
       Fourth Quarter                                    11             2 1/8

   1999
       First Quarter (through March 30, 1999)            15 1/4         4 13/16

     DIVIDEND POLICY
         The  Company has never paid cash  dividends  on its Common  Stock.  The
Company  presently  intends  to  retain  all cash for use in the  operation  and
expansion  of the  Company's  business and does not  anticipate  paying any cash
dividends in the near future.  Komag's debt  agreements  prohibit the payment of
dividends without the lenders' consent.

                                       24
<PAGE>

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
         The following table sets forth selected consolidated financial data and
other  operating  information  of Komag,  Incorporated.  The financial  data and
operating  information is derived from the consolidated  financial statements of
Komag,  Incorporated  and should be read in  conjunction  with the  consolidated
financial  statements,  related notes and other financial  information  included
herein.
<CAPTION>
                                                                                         Fiscal Year Ended
                                                  -------------------------------------------------------------------------------
                                                     1998 (1)          1997 (2)          1996           1995           1994
                                                  ---------------- ----------------- -------------- -------------- --------------
                                                         (in thousands, except per share amounts and number of employees)
<S>                                                  <C>              <C>              <C>            <C>            <C>
Consolidated Statements of
    Operations Data:
Net Sales                                            $ 328,883        $  631,082       $577,791       $512,248       $392,391
Gross Profit (Loss)                                    (62,752)           93,546        175,567        197,486        125,386
Restructuring Charge                                   187,768            52,157              -              -              -
Income (Loss) Before
    Minority Interest and Equity
    in Joint Venture Income (Loss)                    (338,789)          (16,838)       100,553        101,410         54,156
Minority Interest in Net Income
    of Consolidated Subsidiary                             544               400            695          1,957          1,091
Equity in Net Income (Loss) of
    Unconsolidated Joint Venture                       (27,003)           (4,865)        10,116          7,362          5,457
Net Income (Loss)                                    $(366,336)       $  (22,103)      $109,974       $106,815       $ 58,522

Basic Net Income (Loss) Per Share                       $(6.89)           $(0.42)         $2.15          $2.24          $1.31
Diluted Net Income (Loss) Per Share                     $(6.89)           $(0.42)         $2.07          $2.14          $1.27

Consolidated Balance Sheet Data:
Working Capital                                      $ (92,844)       $  296,099       $142,142       $252,218       $118,230
Net Property, Plant & Equipment                        470,017           678,596        643,706        329,174        228,883
Long-term Debt (less current portion)                        -           245,000         70,000              -         16,250
Stockholders' Equity                                   323,807           686,184        697,940        574,564        331,215
Total Assets                                         $ 694,095        $1,084,664       $938,357       $686,315       $424,095

Number of Employees at Year-end                          4,086             4,738          4,101          2,915          2,635
<FN>
(1)  Results of  operations  for 1998  included a $187.8  million  restructuring
     charge  that  primarily  related  to an  asset  impairment  charge  of $175
     million.  The asset impairment charge effectively  reduced asset valuations
     to reflect the economic effect of industry price erosion for disk media and
     projected  underutilization  of  the  Company's  production  equipment  and
     facilities.  Based on analysis of the Company's production capacity and its
     expectations  of the media market over the remaining  life of the Company's
     fixed assets,  the Company  concluded  that it would not be able to recover
     the book value of those assets.
(2)  Results  of  operations  for 1997  included a $52.2  million  restructuring
     charge related to the  consolidation  of the Company's  U.S.  manufacturing
     operations.
(3) The Company paid no cash dividends during the five-year period.
</FN>
</TABLE>

                                       25
<PAGE>

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

Results of Operations

Overview

         The Company's  business is both capital intensive and volume sensitive,
making  capacity  planning  and  efficient  capacity  use  imperative.  Physical
capacity,  utilization of this physical capacity,  yields and average unit sales
price constitute the key determinants of the Company's  profitability.  Of these
key  determinants,  price and  utilization  are the most sensitive to changes in
product  demand.  If capacity  and product  price are fixed at a given level and
demand is sufficient to support a higher level of output,  then increased output
attained through improved utilization rates and higher manufacturing yields will
translate   directly  into   increased   sales  and  improved   gross   margins.
Alternatively,  if demand for the Company's products decreases,  falling average
selling prices and lower capacity  utilization will adversely affect the results
of the Company's operations.

Risk Factors

         The  following  discussion  contains  predictions,  estimates and other
forward-looking  statements  that  involve a number of risks and  uncertainties.
While this discussion  represents the Company's  current  judgment on the future
direction  of the  business,  such risks and  uncertainties  could cause  actual
results to differ  materially  from any  future  performance  suggested  herein.
Factors  that could  cause  actual  results  to differ  include  the  following:
availability of sufficient cash resources; changes in the industry supply-demand
relationship  and related  pricing for  enterprise  and desktop  disk  products;
timely and successful qualification of next-generation products;  utilization of
manufacturing facilities;  changes in manufacturing efficiencies,  in particular
product yields and material input costs;  extensibility of process  equipment to
meet more stringent future product  requirements;  structural changes within the
disk  media  industry  such  as  combinations,   failures,   and  joint  venture
arrangements;  vertical  integration  and  consolidation  within  the  Company's
customer  base;  dependence  of the  Company's  sales  on a  limited  number  of
customers;  increased  competition;  timely  and  successful  deployment  of new
process  technologies  into  manufacturing;  and  the  availability  of  certain
sole-sourced  raw  material  supplies.  See  "Business--Risk  Factors"  for more
detailed discussions of risks and uncertainties facing the Company.

1998 vs. 1997

         Operating results for 1998 were significantly  lower than 1997. Adverse
market conditions,  which began late in the second quarter of 1997,  intensified
during 1998.  Late in the second  quarter of 1997,  demand for  thin-film  media
products  fell  abruptly  as an excess  supply of  enterprise-class  disk drives
caused drive  manufacturers to reduce build plans for this class of drives.  The
decrease in demand for enterprise-class  media,  combined with a major expansion
of media  production  capacity by both  independent  media suppliers and captive
media  operations of disk drive  manufacturers,  resulted in an excess supply of
enterprise-class media. Orders for the Company's enterprise-class media products
were reduced in the third quarter of 1997 as drive  manufacturers  reduced drive
production  and relied more heavily on their own captive media  operations.  Net
sales  decreased  sharply to $129.7  million in the third quarter of 1997,  down
sequentially  from $175.1  million in the second  quarter of 1997. The Company's
gross margin  percentage  fell to 0.2% in the third  quarter of 1997,  down from
20.4% in the second quarter of 1997.  Net sales and the gross margin  percentage
improved to $159.0  million and 11.6%,  respectively,  for the fourth quarter of
1997.

         In December 1997, several disk drive  manufacturers  initiated cutbacks
in their  desktop  product  manufacturing  plans for early 1998 in  response  to
supply and demand imbalances  within that industry 

                                       26
<PAGE>

segment.  Weakened  demand  for  desktop  media  products,   combined  with  the
continuing slow recovery of the enterprise-class market segment, lowered overall
media demand.  The market share available to independent  media suppliers shrank
as captive media  operations  supplied a larger share of the industry's  overall
media requirements.  The resulting excess supply of media in the merchant market
heightened price competition  among  independent media suppliers,  including the
Company.  The  Company's  net sales in the first  quarter  of 1998  dropped  52%
sequentially  to $76.1 million as a result of both a lower unit sales volume and
a decrease of  approximately  10% in the overall  average  selling price for the
Company's products.  Low utilization of the Company's factories during the first
quarter of 1998 pushed unit  production  costs up  substantially  as fixed costs
were spread over fewer  production  units.  The combination of the lower overall
average  selling price and  significantly  higher average unit  production  cost
resulted in a negative gross margin percentage of 41.5% for the first quarter of
1998.

         The second  quarter of 1998 was  negatively  impacted by the  continued
weak  merchant  market  demand for disk media.  The  Company's  net sales in the
second  quarter  of 1998  increased  slightly  on a  sequential  basis  to $78.8
million, the net effect of an 9% increase in unit sales volume and a 5% decrease
in the overall  average  selling  price.  The  combination  of the lower overall
average  selling  price,   increased  inventory  writedowns  and  continued  low
production  volumes  resulted in a negative gross margin  percentage of 45.2% in
the second quarter of 1998.

         Entering the second  quarter of 1998, the Company had expected that net
sales for the second quarter would increase  sequentially to $100-$125  million.
In the middle of the second  quarter  several  customers  reduced orders for the
Company's  products  in response  to  downward  adjustments  in their disk drive
production build  schedules.  In light of the order reductions and the Company's
expectation that the media industry's  supply/demand imbalance would extend into
1999, the Company adjusted its expectations for the utilization of its installed
production capacity. Based on this analysis of the Company's production capacity
and  its  expectations  of the  media  market  over  the  remaining  life of the
Company's  fixed  assets,  the  Company  concluded  that it would not be able to
recover the book value of those assets. As a result,  the Company  implemented a
restructuring  plan in June 1998 and recorded a charge of $187.8  million.  This
charge included an asset  impairment  charge and provisions for facility closure
expenses and  severance-related  costs.  The asset  impairment  component of the
charge was $175.0 million and  effectively  reduced asset  valuations to reflect
the  economic  effect  of the  industry  price  erosion  for disk  media and the
projected underutilization of the Company's production equipment and facilities.

         Net  sales  for the  third  quarter  of 1998  increased  slightly  on a
sequential  basis to $81.3  million as the net result of an 8%  increase in unit
sales and a 4% decrease in the overall average  selling price.  The gross margin
percentage improved sequentially to a negative 3.4%. The asset impairment charge
recorded in the second  quarter of 1998 lowered  depreciation  and  amortization
charges beginning in June 1998. The impairment charge resulted in a reduction in
depreciation  and  amortization  of  approximately  $10.2  million  in the third
quarter of 1998 compared to the second quarter of 1998. Lower payroll costs, and
improved unit demand,  coupled with a favorable impact of certain  non-recurring
inventory adjustments,  also contributed to the improved gross margin percentage
in the third quarter of 1998.

         Net sales for the fourth  quarter of 1998 increased to $92.7 million as
the net result of an 18% increase in unit sales and a 4% decrease in the overall
average selling price. The gross margin  percentage  improved  sequentially to a
positive 7.9%. The higher unit volume,  higher manufacturing yields, and reduced
material input costs generated the substantial sequential quarterly improvement.

Net Sales

         Net sales for 1998 decreased to $328.9 million,  down 47.9% from $631.1
million in 1997. The decrease was due to a combination of a 36% decrease in unit
sales  volume and a 19% decrease in the overall  average  selling  price.  Price
reductions  are common on individual  product  offerings in the thin-film  media
industry. The Company has traditionally  prevented significant reductions in its
overall  

                                       27
<PAGE>

average selling price through transitions to higher-priced, more technologically
advanced  product  offerings.  The effect of price  reductions  in  response  to
significant  pricing  pressures  generated by the imbalance in supply and demand
for thin-film  media during 1998 more than offset the effect of  transitions  to
more advanced product offerings.

         In addition to sales of internally produced disk products,  the Company
has  historically  resold  products  manufactured by its Japanese joint venture,
Asahi  Komag  Co.,  Ltd.   ("AKCL").   Distribution  sales  of  thin-film  media
manufactured  by AKCL were $2.5  million in 1998  compared  to $10.5  million in
1997. The Company expects that distribution  sales of AKCL product will remain a
relatively small percentage of the Company's net sales.

         During  1998,  three  customers  accounted  for  approximately  86%  of
consolidated net sales:  Western Digital Corporation  ("Western  Digital")--43%,
Maxtor   Corporation,    a   subsidiary   of   Hyundai   Electronics    America,
("Maxtor")--25%,  and International Business Machines ("IBM")--18%.  The Company
expects that it will continue to derive a substantial  portion of its sales from
relatively few customers.  The  distribution  of sales among  customers may vary
from quarter to quarter based on the match of the Company's product capabilities
with specific disk drive programs of the customers.

Gross Margin

         The Company  incurred a negative  gross margin  percentage  of 19.1% in
1998  compared to a positive  gross  margin  percentage  of 14.8% in 1997.  Unit
production  decreased  37% in 1998 relative to 1997.  The Company  operated well
below  capacity in 1998 in order to match unit  production  to the sharply lower
demand for its products.  The  combination of the lower overall  average selling
price, higher unit production costs related to underutilized capacity, and lower
manufacturing yields resulted in the negative gross margin percentage in 1998.

Operating Expenses

         Research  and  development  ("R&D")  expenses  increased  19.9%  ($10.2
million) in 1998 relative to 1997. The additional R&D effort was directed toward
the introduction of new product generations, process changes to manufacture such
products,  process  improvements  to increase  yields and reduce  material input
costs of products in volume  production,  and increased  development  efforts to
qualify  new  products  with  customers.  In 1999,  the  Company  plans to spend
approximately  $45-$50  million for R&D.  Selling,  general  and  administrative
("SG&A")  expenses  decreased  $7.8  million  in 1998  compared  to 1997.  Lower
provisions for bonus and profit sharing programs  (decrease of $3.8 million) and
lower  provisions  for bad  debt  (decrease  of $2.4  million)  resulted  in the
majority of the overall decrease in SG&A between the years. Excluding provisions
for bonus and profit sharing  programs and provisions for bad debt in 1998, SG&A
expenses  decreased $1.6 million.  The lower spending was primarily due to lower
payroll and other  employee-related  costs as a direct  result of  restructuring
activities completed in the fourth quarter of 1997 and second quarter of 1998.

         In the second quarter of 1998, the Company  implemented a restructuring
plan which  included a reduction in the Company's  U.S. and Malaysian  workforce
and the cessation of operations at its oldest San Jose,  California  plant.  The
Company  recorded a  restructuring  charge of $187.8 million which included $4.1
million for  severance  costs  (approximately  170  employees,  primarily in the
U.S.), $5.8 million related to equipment order cancellations and other equipment
related costs, and $2.9 million for facility closure costs. The asset impairment
component  of the charge was $175.0  million.  The cash  component  of the total
charge was $12.8 million. Non-cash items in the restructuring/impairment  charge
totaled $175.0 million.

         During  the  third   quarter  of  1997,   the  Company   implemented  a
restructuring  plan  involving  the  consolidation  of  its  U.S.  manufacturing
operations.  The Company  recorded a $52.2  million  restructuring  charge which
included $3.9 million for severance  costs  associated  with  approximately  330
terminated 

                                       28
<PAGE>

employees,  $33.0  million  for the  write-down  of the net book value of excess
equipment  and  disposed of leasehold  improvements,  $10.1  million  related to
equipment  order  cancellations  and  other  equipment-related  costs,  and $5.2
million for facility closure costs. Non-cash items included in the restructuring
charge totaled approximately $33.0 million.
<TABLE>
         The Company  incurred lower facility  closure costs than anticipated in
the  restructuring  charges.  The oldest  Milpitas  plant was sublet sooner than
anticipated  and the  Company  reached a lease  termination  agreement  with its
landlord on the second  Milpitas plant in the third quarter of 1998. The Company
thereby  avoided  expected  future rent payments and the cost of renovating  the
facility to its original lease condition.  Additionally,  the Company determined
that it would  not  close  its  oldest  San  Jose,  California  facility  at the
expiration of its lease. As a result the Company will not incur costs to restore
the  facility  to  its  original  lease   condition  as   contemplated   in  the
restructuring   charge.   Higher  than  expected   costs  for  equipment   order
cancellations  offset the lower facility closure costs. A total of 515 employees
were terminated in the restructuring activities.  The following table summarizes
these restructuring activities.
<CAPTION>
                                                       Restructuring      Incurred
(in millions)                                             Charges      Through 1/3/99
                                                      ---------------- ---------------
<S>                                                            <C>             <C>   
Asset impairment charge                                        $175.0          $175.0
Writedown net book value of equipment
  and leasehold improvements                                     33.0            33.0
Equipment order cancellations and other
  equipment related costs                                        16.0            17.5
Facility closure costs                                            8.0             2.2
Severance costs                                                   7.9             8.1
</TABLE>

         At  January  3,  1999,  $4.1  million  related  to  the   restructuring
activities remained in current  liabilities.  The Company has made cash payments
totaling  approximately  $27.8 million primarily for severance,  equipment order
cancellations  and  facility  closure  costs.  The  majority  of  the  remaining
liability,  primarily  for  equipment  order  cancellations,  is  expected to be
settled through the use of cash by the end of 1999.

Interest Income/Expense and Other Income

         Interest income increased $4.1 million (85.2%) in 1998 relative to 1997
primarily due to a higher average investment  balance in 1998.  Interest expense
increased  $10.1 million  (110.8%) in 1998 compared to 1997. The higher interest
expense was due to a higher outstanding debt balance in 1998 compared to 1997.

Income Taxes

         The Company's  income tax provision of  approximately  $1.3 million for
1998 primarily represents foreign withholding taxes. The Company's  wholly-owned
thin-film  media  operation,  Komag USA  (Malaysia)  Sdn.  ("KMS"),  received an
extension  of its initial  five-year  tax holiday for an  additional  five years
commencing  in July 1998.  KMS has also been  granted a ten-year tax holiday for
its second and third plant sites in Malaysia. The commencement date for this new
tax holiday has not been  determined  as of March 15,  1999.  The tax  provision
benefit of 55% for 1997 primarily represents tax loss carrybacks associated with
the Company's U.S.  operations.  As a result of profitable  operations at 

                                       29
<PAGE>

KMS in 1997, the tax holiday reduced the Company's 1997 consolidated net loss by
approximately  $16.6  million  ($0.32 per share under both the basic and diluted
methods).

Minority  Interest in Consolidated  Subsidiary/Equity  in  Unconsolidated  Joint
Venture

         The  minority  interest  in the net income of  consolidated  subsidiary
during 1998  represented  Kobe Steel USA Holdings  Inc.'s  ("Kobe USA") share of
Komag Material Technology, Inc.'s ("KMT") net income. KMT recorded net income of
$2.7 million and $2.0 million in 1998 and 1997, respectively.

         The Company owns a 50% interest in AKCL and records its share of AKCL's
net  income  (loss) as  equity in net  income  (loss)  of  unconsolidated  joint
venture.  The Company  recorded a loss of $27.0  million as its equity in AKCL's
net loss for 1998  compared  to a net loss of $4.9  million  recorded  for 1997.
AKCL's results for 1997 included a $5.3 million (net of tax) gain on the sale of
its investment in Headway Technologies,  Inc. ("Headway").  The Company's equity
in this gain was $2.6 million.  Excluding the gain, the Company  reported a loss
of $7.5 million as its equity in AKCL's net loss for 1997. The  combination of a
significant  decrease  in the  overall  average  selling  price for AKCL's  disk
products,  lower manufacturing yields, reduced equipment  utilization,  customer
qualification  issues and substantial  equipment  writedowns  adversely affected
AKCL's  financial  results for 1998.  During 1998,  AKCL wrote-off its remaining
in-line  sputtering  equipment  as it ramped  products on its static  sputtering
equipment.  AKCL  believes  that the  products  produced by a static  sputtering
process  are  technically  similar to those  produced  by other  Japanese  media
suppliers,  thus  improving  AKCL's  ability to meet  specific  requirements  of
certain  Japanese  customers  on a timely  basis.  During  1997,  AKCL  operated
substantially  under  capacity  for the  majority  of the  year  due to  product
transition issues related to AKCL's customer qualification and its production of
MR products.

         AKCL's current financing arrangements may not be sufficient in light of
AKCL's  expected  continuing  losses.  There can be no assurance that additional
financing  will be available  to AKCL.  Failure to secure  additional  financing
could have a material  adverse affect on AKCL's business and financial  results.
Further  writedowns of the Company's  investment in AKCL are limited to the book
value of the  investment on the  accompanying  consolidated  balance sheet ($1.4
million at January 3, 1999).

Impact of Year 2000

         Many computer  systems were not designed to handle any dates beyond the
year 1999.  Such  systems  were  designed  using two digits  rather than four to
define the  applicable  year.  Any computer  programs  that have  time-sensitive
software  may  recognize a date using "00" as the year 1900 rather than the year
2000.  This  could  result  in  a  system  failure  or  miscalculations  causing
disruptions  of  operations.  Disruptions  may also  occur if key  suppliers  or
customers  experience  disruptions in their ability to transact with the Company
due to Year 2000 issues.  The Company's  global  operations  rely heavily on the
infrastructures  of the countries in which it conducts  business.  The Year 2000
readiness within infrastructure  suppliers (utilities,  government agencies such
as customs, shipping organizations) will be critical to the Company's ability to
avoid  disruption of its operations.  The Company is working with industry trade
associations  to evaluate the Year 2000 readiness of  infrastructure  suppliers.
The Company is currently in the process of assessing its systems,  equipment and
processes  to  determine  its Year 2000  readiness.  The Company  has  committed
personnel  and  resources to resolve  potential  Year 2000 issues and is working
with  key  suppliers  and  customers  to  ensure  their  Year  2000   readiness.
Additionally,  the  Company  had its Year 2000  assessment  plan  reviewed by an
outside consulting firm to evaluate the effectiveness.  The Company will perform
remediation  procedures  concurrent  with its assessment  planning.  The Company
plans to complete the  assessment  of its Year 2000  readiness by the end of the
first quarter of 1999.

         The  Company's  Year 2000 efforts are focused on three primary areas of
potential  impact:  internal  information  technology  ("IT") systems,  internal
non-IT  systems,  and the  readiness of third  

                                       30
<PAGE>

parties with whom the Company has critical business  relationships.  The Company
has  completed  its  inventory  of internal IT and non-IT  systems.  Testing and
remediation of internal IT and non-IT systems is approximately 60% complete. The
Company  expects to complete the testing and  remediation  for these  systems by
July 31, 1999. The Company has developed a process for identifying and assessing
Year 2000 readiness of its critical  suppliers.  This process generally involves
the following steps:  initial supplier survey,  follow-up  supplier review,  and
contingency  planning.  The Company is following up with critical suppliers that
either did not respond  initially or whose  responses  were  unsatisfactory.  To
date,  the  Company  has  received  responses  from a majority  of its  critical
suppliers,  most of whom have  responded  that they  expect to address all their
significant Year 2000 issues on a timely basis.

         The Company  currently  believes that the remediation costs of the Year
2000 issue will not be  material  to the  Company's  results  of  operations  or
financial  position.  Cumulatively  through  February  28,  1999 the Company has
incurred  remediation  costs of  approximately  $0.1 million.  While the Company
currently expects that the Year 2000 issue will not pose significant operational
problems,  delays in the implementation of new information systems, or a failure
to fully identify all Year 2000 dependencies in the Company's systems and in the
systems  of its  suppliers,  customers  and  financial  institutions  could have
material  adverse  consequences,  including  delays in the  delivery  or sale of
products.  Therefore, the Company is developing contingency plans for continuing
operations in the event such problems arise. The Company intends to complete the
contingency planning phase of its Year 2000 readiness by July 31, 1999.

         The  Company is working to identify  and  analyze  the most  reasonably
likely  worst-case  scenarios  where  it may be  affected  by Year  2000-related
interruptions.  These scenarios could include possible infrastructure  collapse,
the  failure  of power and water  supplies,  major  transportation  disruptions,
unforeseen  product  shortages  due to hoarding of  materials  and  supplies and
failures of  communications  and financial  systems.  Any one of these scenarios
could have a major and material  effect on the Company's  ability to produce and
deliver products to its customers.  While the Company is developing  contingency
plans to address issues under its control, an infrastructure  problem outside of
its control or some  combination  of several of these problems could result in a
delay in product shipments depending on the nature and severity of the problems.
The Company would expect that most utilities and service providers would be able
to restore service within days although more pervasive system problems involving
multiple  providers  could  last  several  weeks  or  longer  depending  on  the
complexity of the systems and the effectiveness of their contingency plans.

         The Company's  products are not  date-sensitive and the Company expects
that it will have limited  exposure to product  liability  litigation  resulting
from Year 2000-related failures.  Disk drive manufacturers have generally stated
that disk drives as a stand-alone product are not date-sensitive.  However, disk
drives using the Company's  thin-film media products have been incorporated into
computer systems which could experience Year 2000-related  failures. The Company
anticipates  that litigation may be brought  against  suppliers of all component
products of systems that are unable to properly handle Year 2000 issues.


1997 vs. 1996

         Operating  results  for 1997 were  dramatically  lower  than  1996.  An
imbalance  between media supply and demand as well as product  transitions  were
significant factors in 1997. In the last half of 1996, the Company began a rapid
transition to MR and  proximity-inductive  thin-film media  products.  Quarterly
sales in excess of $150 million and gross margins exceeding 40% during the first
half of 1996  decreased to $131.5  million and 24%,  respectively,  in the third
quarter  of 1996 and  $141.2  million  and  11.7%,  respectively,  in the fourth
quarter  of 1996.  During  the  first and  second  quarters  of 1997,  net sales
increased  sequentially  to $167.2  million  and $175.1  million,  respectively,
primarily due to manufacturing capacity additions.  The gross margin percentages
for the first and second  quarters  of 1997 were 23.5% and 20.4%,  respectively.
Demand  for  thin-film  media  products  fell  sharply  at the end 

                                       31
<PAGE>

of the  second  quarter  of 1997 as an excess  supply of  enterprise-class  disk
drives caused drive  manufacturers to reduce their build plans for this class of
drives. The resulting imbalance between media supply and demand caused a loss of
sales and  prevented  the Company from fully  utilizing  its  expanded  capacity
during the last half of 1997.  Net sales and the gross  margin  percentage  fell
sharply to $129.7 million and 0.2%,  respectively,  in the third quarter of 1997
and to $159.0  million and 11.6%,  respectively,  in the fourth quarter of 1997.
Additionally,  the Company  recorded a  restructuring  charge to consolidate its
U.S. manufacturing operations during the third quarter of 1997.

Net Sales

         Net  sales for 1997  increased  to $631.1  million,  up 9% from  $577.8
million in 1996.  The  increase was  primarily  due to an increase in unit sales
volume.  The  overall  average  selling  price  increased  less  than 1% in 1997
relative  to 1996.  The  effect of the sales mix shift to  higher-priced  MR and
proximity-inductive  media more than  offset the effect of price  reductions  on
maturing  inductive  disk  products  and  resulted in the flat  overall  average
selling price.  Distribution sales of product  manufactured by AKCL increased to
$10.5 million in 1997 from $5.7 million in 1996.

         Unit  production  increased  6% in 1997  relative to 1996.  The Company
increased  capacity 25% in 1997 relative to 1996.  Equipment  utilization rates,
therefore, decreased significantly as the Company operated below capacity in the
last half of 1997 due to weak market demand for enterprise-class  disk products.
In addition,  overall  manufacturing  yields declined as the Company experienced
continuing  yield  losses on MR  products.  During the first  half of 1996,  the
overall  manufacturing yield was substantially higher prior to the transition to
proximity-inductive and MR media.

Gross Margin

         The gross margin  percentage for 1997 decreased to 14.8% from 30.4% for
1996  primarily  due to a combination  of lower  manufacturing  yields,  reduced
equipment  utilization rates and inherently higher material and processing costs
for  MR  and  advanced  proximity  disks.  Additionally,  the  Company  incurred
inventory  write-downs in 1997, which accounted for approximately  one-fourth of
the decrease in the gross margin percentage.

Operating Expenses

         Research and development ("R&D") expenses increased 75% ($22.0 million)
in 1997  relative to 1996.  The increase was  primarily  due to higher  facility
costs associated with a newly constructed  188,000-square-foot  R&D facility and
increased R&D staffing.  Selling,  general and administrative  ("SG&A") expenses
decreased  $6.1 million in 1997 compared to 1996. The decrease was mainly due to
a decrease of $10.2 million in provisions for bonus and profit sharing  programs
offset  by  increased  provisions  for  bad  debt  of  $2.4  million.  Excluding
provisions for  bonus/profit  sharing programs and provisions for bad debt, SG&A
expenses   increased   $1.7  million  due   primarily  to  higher   payroll  and
facility-related   costs   connected  with  the  Company's   newly   constructed
administration facility in 1997.

         In 1997,  the Company  implemented a  restructuring  plan involving the
consolidation of its U.S.  manufacturing  operations.  The restructuring  charge
primarily  related  to  disposing  of  assets,  equipment  order  cancellations,
provisions  for facility  closure  expenses  and  severance-related  costs.  The
Company  recorded a $52.2  million  restructuring  charge  which  included  $3.9
million  for  severance  costs  associated  with  approximately  330  terminated
employees,  $33.0  million  for the  write-down  of the net book value of excess
equipment  and  disposed of leasehold  improvements,  $10.1  million  related to
equipment  order  cancellations  and  other  equipment-related  costs,  and $5.2
million for facility closure costs. Non-cash items included in the restructuring
charge totaled approximately $33.0 million.

                                       32
<PAGE>

Interest Income/Expense and Other Income

         Interest  income  decreased $1.7 million (26%) in 1997 relative to 1996
primarily due to a lower average  investment  balance in 1997.  Interest expense
increased  $8.5 million in 1997 compared to 1996. The Company was debt free from
late 1995 until  November 1996.  Between  November 1996 and the end of 1997, the
Company  borrowed  $245  million  under  its  credit  facilities.  Other  income
increased  $1.3 million in 1997 relative to 1996 mainly due to foreign  currency
gains generated by the weakening of the Malaysian ringgit.

Income Taxes

         The  tax  provision  benefit  of  55%  for  1997  represents  tax  loss
carrybacks  associated with the Company's U.S. operations.  The effective income
tax rate for 1996 of 17% was  lower  than the 1996  combined  federal  and state
statutory rate of 41% primarily as a result of an initial  five-year tax holiday
granted to the  Company's  wholly owned  thin-film  media  operation,  Komag USA
(Malaysia)  Sdn.  ("KMS"),  which commenced in July 1993. The impact of this tax
holiday was to reduce the Company's 1997 net loss by approximately $16.6 million
($0.32 per share under both the basic and diluted methods) and increase 1996 net
income by  approximately  $21.8 million  ($0.43 basic income per share and $0.41
diluted income per share).

Minority  Interest in Consolidated  Subsidiary/Equity  in  Unconsolidated  Joint
Venture

         The  minority  interest  in the net income of  consolidated  subsidiary
during 1997  represented  Kobe Steel USA Holdings  Inc.'s  ("Kobe USA") share of
Komag Material Technology, Inc.'s ("KMT") net income. KMT recorded net income of
$2.0 million and $3.5 million in 1997 and 1996, respectively.

         The Company owns a 50% interest in AKCL and records its share of AKCL's
net  income  (loss) as  equity in net  income  (loss)  of  unconsolidated  joint
venture.  As its share of AKCL's net income (loss),  the Company recorded a loss
of $4.9  million in 1997  compared to income of $10.1  million in 1996.  Product
transition  issues  related to AKCL's  qualification  and  production  of new MR
products  resulted in AKCL's  underutilization  of its  capacity  and  adversely
affected 1997 results.

Liquidity and Capital Resources

         Cash and  short-term  investments  of $127.8 million at the end of 1998
decreased  from  $166.2  million  at the  end of  1997.  Consolidated  operating
activities  generated $23.6 million in cash during 1998. The $366.3 million loss
for 1998, net of non-cash  depreciation  charges of $116.7 million, the non-cash
asset impairment charge of $175.0 million and the non-cash equity loss from AKCL
of $27.0  million,  consumed  $47.6  million.  Changes in  operating  assets and
liabilities provided $71.0 million. The Company borrowed $15.0 million under its
credit facilities and spent $89.0 million on capital  requirements  during 1998.
Proceeds  from sales of property,  plant and  equipment  (primarily  the sale of
vacant land in Milpitas,  California)  generated  $5.5 million.  Sales of Common
Stock under the Company's stock option programs generated $5.7 million.

         Working  capital  decreased by $388.9  million in 1998 primarily due to
the  reclassification  of $260.0  million  of the  Company's  long-term  debt to
current  liabilities  as a result of a  technical  default  under the  Company's
credit  facilities  (see  further   discussion  in  the  following   paragraph).
Additionally,  capital  expenditures  of $89.0 million  further  reduced working
capital in 1998.  Accounts  receivable and inventory decreased $39.6 million and
$33.1 million, respectively, in line with reductions in sales.

         Current  noncancellable  capital  commitments  total  approximately $17
million.   Total  capital   expenditures  for  1999  are  currently  planned  at
approximately  $40 million.  The 1999 capital  spending 

                                       33
<PAGE>

plan  primarily  includes  costs for  projects  designed  to  improve  yield and
productivity. The size of the Company's second quarter 1998 net loss resulted in
a default  under certain  financial  covenants  contained in the Company's  bank
credit  facilities.  The Company is not in payment  default  under these  credit
facilities as all interest  charges and fees  associated  with these  facilities
have been paid on their scheduled due dates. At the time of the covenant default
the  Company  had $260  million of debt  outstanding  against a total  borrowing
capacity of $345.0 million under the various senior unsecured credit facilities.
As a result of the covenant  default,  the  Company's  lenders  withdrew the $85
million in unused borrowing capacity.  To date, the lenders have not accelerated
any principal payments under the credit facilities. As a result of the technical
default  and  reclassification  of the bank  debt to  current  liabilities,  the
Company's  auditors  have  included a going  concern  paragraph  in their  audit
opinion  to  highlight  the  Company's  need to  amend or  restructure  its debt
obligations.

         The Company is currently negotiating with its lenders for amendments to
the existing  credit  facilities.  If we  successfully  amend or restructure our
credit  facilities  we will  seek to have our  auditors  reissue  their  opinion
without the going concern paragraph.  There can be no assurance that the Company
will be able to obtain such amendments to its credit  facilities on commercially
reasonable  terms.  If the Company  does not  successfully  amend  these  credit
facilities,  it would  remain in  technical  default  of its bank  loans and the
lenders  would  retain  their  rights and  remedies  under the  existing  credit
agreements.  As long as the  lenders  choose  not to  accelerate  any  principal
payments,  the Company  would  continue to operate in default for the near term.
However,  the Company will likely need to raise  additional funds to restructure
its debt obligations and to operate its business for the long term.

         Over the next several years the Company will need  financial  resources
for capital expenditures,  working capital and research and development.  During
1997 and 1998,  the Company  spent  approximately  $199 million and $89 million,
respectively,  on property,  plant and equipment.  In 1999, the Company plans to
spend approximately $40 million on property, plant and equipment,  primarily for
projects designed to improve yield and  productivity.  The Company believes that
in order to achieve its long-term growth objectives and maintain and enhance its
competitive  position,  such  additional  financial  resources will be required.
There can be no assurance that the Company will be able to secure such financial
resources on commercially  reasonable  terms. If the Company is unable to obtain
adequate  financing,  it could be required to  significantly  reduce or possibly
suspend its operations, and/or to sell additional securities on terms that would
be highly dilutive to current stockholders.

         In July  1998,  at a  Special  Meeting  of  Stockholders,  the  Company
received  authorization  to sell and issue up to $350,000,000 of Common Stock in
equity or equity-linked  private transactions from time to time through July 22,
1999 at a price below book value but at or above the then  current  market value
of the Company's Common Stock. Additionally, the Company's stockholders approved
a proposal to increase the amount of Common Stock the Company is  authorized  to
issue from 85,000,000 to 150,000,000 shares.

Other

         In June  1998,  the  FASB  issued  Statement  of  Financial  Accounting
Standards  No.  133,   "Accounting   for  Derivative   Instruments  and  Hedging
Activities"  ("SFAS  133").  SFAS  133  establishes   accounting  and  reporting
standards for derivative  instruments  and for hedging  activities.  It requires
that  derivatives be recognized in the balance sheet at fair value and specifies
the  accounting  for changes in fair value.  This statement is effective for all
fiscal  quarters of fiscal  years  beginning  after June 15,  1999,  and will be
adopted by the  Company  for its  fiscal  year 2000.  The  Company is  currently
assessing  the  impact  of  adoption  of  this  pronouncement  on its  financial
statements.

                                       34
<PAGE>

ITEM 7A.  FINANCIAL MARKET RISKS

         The Company is exposed to financial market risks,  including changes in
interest rates and foreign currency exchange rates. To mitigate these risks, the
Company  utilizes  derivative  financial  instruments.  The Company does not use
derivative financial instruments for speculative or trading purposes.

         The primary  objective of the  Company's  investment  activities  is to
preserve   principal   while  at  the  same  time   maximizing   yields  without
significantly  increasing  risk. The Company invests  primarily in high-quality,
short-term debt instruments.  A hypothetical 60 basis point increase in interest
rates would result in an approximate $2.2 million decrease  (approximately 0.3%)
in the fair value of the Company's available-for-sale securities.

         The Company has  long-term  debt with a notional  value of $260 million
which  includes  both term  debt and lines of  credit.  Term debt  totaling  $75
million  bears  interest at a fixed rate of 7.4% per annum.  The lines of credit
totaling $185 million bear interest at the lenders' base rate (currently 7.75%).
The Company has not hedged its  exposure to  fluctuations  in the base  interest
rate. A  hypothetical  60 basis point increase in interest rates would result in
approximately $1.1 million of additional interest expense per year.

         The Company enters into foreign currency forward exchange  contracts to
reduce the impact of currency  fluctuations  on firm purchase order  commitments
for  equipment  and  construction-in-process.  Gains and losses on these foreign
currency investments would generally be offset by corresponding losses and gains
on the related hedging instruments,  resulting in negligible net exposure to the
Company.

         A substantial  majority of the Company's  revenue,  expense and capital
purchasing activities are transacted in U.S. dollars.  However, the Company does
enter into these  transactions  in other  currencies,  primarily,  the Malaysian
ringgit.  The Company cannot eliminate the impact of foreign  currency  exchange
rate  movements  on the  expenses it incurs in  ringgits.  An adverse  change in
exchange  rates  (defined as 20% in the Malaysian  ringgit to U.S.  dollar rate)
would result in a decline in income before taxes of approximately $17 million.

                                       35
<PAGE>



                      [This Page Intentionally Left Blank]



                                       36
<PAGE>

ITEM 8.  CONSOLIDATED FINANCIAL STATEMENTS

                               KOMAG, INCORPORATED

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                            Page

Report of Ernst & Young LLP, Independent Auditors                             37
Consolidated Statements of Operations,
     1998, 1997 and 1996                                                      38
Consolidated Balance Sheets, 1998 and 1997                                 39-40
Consolidated Statements of Cash Flows,
     1998, 1997 and 1996                                                   41-42
Consolidated Statements of Stockholders' Equity,
     1998, 1997 and 1996                                                      43
Notes to Consolidated Financial Statements                                 44-64

                                       37
<PAGE>

                Report of Ernst & Young LLP, Independent Auditors

The Board of Directors and Stockholders
Komag, Incorporated

     We have  audited the  accompanying  consolidated  balance  sheets of Komag,
Incorporated  as of January  3, 1999 and  December  28,  1997,  and the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three  years in the period  ended  January 3, 1999.  Our audits also
included the  financial  statement  schedule  listed in the Index at Item 14(a).
These financial  statements and schedule are the responsibility of the Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements  and  schedule  based on our audits.  We did not audit the  financial
statements  of Asahi Komag Co., Ltd. (a  corporation  in which the Company has a
50%  interest) as of January 3, 1999 and December 28, 1997,  and for each of the
three years in the period ended January 3, 1999. Those financial statements were
audited by other  auditors  whose  reports  have been  furnished  to us, and our
opinion,  insofar as it relates to data included for Asahi Komag Co., Ltd. as of
January 3, 1999 and December  28,  1997,  and for each of the three years in the
period  ended  January  3,  1999,  is based  solely  on the  report of the other
auditors.

     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 and the report of other auditors provide a reasonable
basis for our opinion.

     In our opinion,  based on our audits and the report of other auditors,  the
financial statements referred to above present fairly, in all material respects,
the consolidated  financial  position of Komag,  Incorporated at January 3, 1999
and December 28, 1997,  and the  consolidated  results of its operations and its
cash flows for each of the three years in the period ended  January 3, 1999,  in
conformity with generally accepted accounting principles.  Also, in our opinion,
the related  financial  statement  schedule,  when considered in relation to the
basic  financial  statements  taken as a whole,  presents fairly in all material
respects the information set forth therein.

     The  accompanying  financial  statements  have been prepared  assuming that
Komag, Incorporated will continue as a going concern. As more fully described in
Note  1,  the  Company  has  incurred  recent  operating  losses  and  is out of
compliance with certain  covenants of loan  agreements  with its lenders.  These
conditions raise  substantial doubt about the Company's ability to continue as a
going concern.  Management's plans in regard to these matters are also described
in Note 1. The financial  statements do not include any  adjustments  to reflect
the possible future effects on the  recoverability  and classification of assets
or the  amounts  and  classification  of  liabilities  that may result  from the
outcome of this uncertainty.

                                                               ERNST & YOUNG LLP

San Jose, California
January 22, 1999

                                       38
<PAGE>

<TABLE>
                                                     KOMAG, INCORPORATED
                                            CONSOLIDATED STATEMENTS OF OPERATIONS
                                          (In thousands, except per share amounts)
<CAPTION>
                                                                                        Fiscal Year Ended
                                                                      -----------------------------------------------------
                                                                           1998               1997               1996
                                                                      ----------------   ----------------   ---------------
<S>                 <C>                                                     <C>                 <C>               <C>     
Net sales (see Note 13)                                                     $ 328,883           $631,082          $577,791
Cost of sales (see Notes 12 and 13)                                           391,635            537,536           402,224
                                                                      ----------------   ----------------   ---------------
              Gross profit (loss)                                             (62,752)            93,546           175,567

Operating expenses:
   Research, development and engineering                                       61,637             51,427            29,409
   Selling, general and administrative                                         19,762             27,523            33,665
   Restructuring charge                                                       187,768             52,157                 -
                                                                      ----------------   ----------------   ---------------
                                                                              269,167            131,107            63,074
               
                                                                      ----------------   ----------------   ---------------
              Operating income (loss)                                        (331,919)           (37,561)          112,493

Other income (expense):
    Interest income                                                             8,804              4,753             6,437
    Interest expense                                                          (19,212)            (9,116)             (625)
    Other, net                                                                  4,853              4,104             2,843
                                                                      ----------------   ----------------   ---------------
                                                                               (5,555)              (259)            8,655

                                                                      ----------------   ----------------   ---------------
              Income (loss) before income taxes, minority
                interest and equity in joint venture income (loss)           (337,474)           (37,820)          121,148

Provision (benefit) for income taxes                                            1,315            (20,982)           20,595
                                                                      ----------------   ----------------   ---------------
              Income (loss) before minority interest and equity
                in joint venture income (loss)                               (338,789)           (16,838)          100,553
Minority interest in net income of
   consolidated subsidiary                                                        544                400               695
Equity in net income (loss) of unconsolidated joint venture                   (27,003)            (4,865)           10,116

                                                                      ----------------   ----------------   ---------------
              Net income (loss)                                             $(366,336)          $(22,103)         $109,974
                                                                      ================   ================   ===============


Basic income (loss) per share                                               $   (6.89)          $  (0.42)         $   2.15
                                                                      ================   ================   ===============
Diluted income (loss) per share                                             $   (6.89)          $  (0.42)         $   2.07
                                                                      ================   ================   ===============

Number of shares used in basic computation                                     53,169             52,217            51,179
                                                                      ================   ================   ===============
Number of shares used in diluted computation                                   53,169             52,217            53,132
                                                                      ================   ================   ===============

<FN>
                                       See notes to consolidated financial statements.
</FN>
</TABLE>


                                                             39
<PAGE>

<TABLE>

                                                 KOMAG, INCORPORATED
                                             CONSOLIDATED BALANCE SHEETS
                                      (In thousands, except per share amounts)
<CAPTION>

                                                                                        Fiscal Year End
                                                                              -------------------------------------
                                                                                    1998                 1997
                                                                              -----------------     ---------------
Assets
<S>                                                                                    <C>              <C>
Current Assets
   Cash and cash equivalents                                                           $64,467          $  133,897
   Short-term investments                                                               63,350              32,300
   Accounts receivable, less allowances of $2,847 in 1998
      and $4,424 in 1997                                                                42,922              77,792
   Accounts receivable from related parties                                                512               4,106
   Inventories:
      Raw materials                                                                      8,434              33,730
      Work-in-process                                                                   10,672              17,490
      Finished goods                                                                    14,534              15,558
                                                                              -----------------     ---------------
         Total inventories                                                              33,640              66,778
   Prepaid expenses and deposits                                                         4,348               3,697
   Refundable income taxes                                                               2,216              24,524
   Deferred income taxes                                                                 7,883              28,595
                                                                              -----------------     ---------------
          Total current assets                                                         219,338             371,689


Investment in Unconsolidated Joint Venture                                               1,399              30,126


Property, Plant and Equipment
   Land                                                                                  7,785               9,526
   Building                                                                            128,359             126,405
   Leasehold improvements                                                               86,565             141,111
   Furniture                                                                            10,911              11,791
   Equipment                                                                           686,169             793,561
                                                                              -----------------     ---------------
                                                                                       919,789           1,082,394
    Less allowances for depreciation and amortization                                 (449,772)           (403,798)
                                                                              -----------------     ---------------
            Net property, plant and equipment                                          470,017             678,596

Deposits and Other Assets                                                                3,341               4,253

                                                                              -----------------     ---------------
                                                                                      $694,095          $1,084,664
                                                                              =================     ===============
</TABLE>


                                                         40
<PAGE>

<TABLE>
<CAPTION>
                                                                                     Fiscal Year End
                                                                        ---------------------------------------
                                                                              1998                  1997
                                                                        ------------------     ----------------
Liabilities and Stockholders' Equity
<S>                                                                              <C>                <C>
Current Liabilities
    Current portion of long-term debt                                            $260,000           $        -
    Trade accounts payable                                                         27,274               40,043
    Accounts payable to related parties                                             1,848                7,093
    Accrued compensation and benefits                                              15,544               13,596
    Other liabilities                                                               3,254                3,596
    Income taxes payable                                                              134                    9
    Restructuring liability                                                         4,128               11,253
                                                                        ------------------     ----------------
            Total current liabilities                                             312,182               75,590

Long-term Debt, Less Current Portion                                                    -              245,000

Deferred Income Taxes                                                              52,564               73,335

Other Long-term Liabilities                                                         1,403                  960

Minority Interest in Consolidated Subsidiary                                        4,139                3,595

Commitments

Stockholders' Equity
   Preferred Stock, $0.01 par value per share:
       Authorized-1,000 shares
       No shares issued and outstanding                                                 -                    -
   Common Stock, $0.01 par value per share:
       Authorized-150,000 shares in 1998
           and 85,000 shares in 1997
       Issued and outstanding 53,887 shares
           in 1998 and 52,794 shares in 1997                                          539                  528
   Additional paid-in capital                                                     407,549              401,869
   Retained earnings/(accumulated deficit)                                        (84,860)             281,476
   Accumulated other comprehensive income                                             579                2,311
                                                                        ------------------     ----------------
           Total stockholders' equity                                             323,807              686,184

                                                                        ------------------     ----------------
                                                                                 $694,095           $1,084,664
                                                                        ==================     ================

<FN>
                                 See notes to consolidated financial statements.
</FN>
</TABLE>

                                                       41
<PAGE>

<TABLE>
                                                   KOMAG, INCORPORATED
                                          CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                     (In thousands)
<CAPTION>

                                                                                     Fiscal Year Ended
                                                                     --------------------------------------------------
                                                                          1998             1997              1996
                                                                     ---------------   --------------   ---------------
<S>                                                                         <C>             <C>               <C>
Operating Activities
Net cash provided by operating activities-
   see detail on following page                                             $23,601         $ 84,396          $200,892

Investing Activities
Acquisition of property, plant and equipment                                (89,033)        (199,112)         (403,062)
Purchases of short-term investments                                         (31,050)         (37,585)             (163)
Proceeds from short-term investments at maturity                                  -            7,785           196,462


Proceeds from disposal of property, plant and equipment                       5,449              550             1,883
Deposits and other assets                                                       912           (1,190)             (649)
Dividend distribution from unconsolidated joint venture                           -            1,535                 -
                                                                     ---------------   --------------   ---------------
              Net cash used in investing activities                        (113,722)        (228,017)         (205,529)

Financing Activities
Proceeds from long-term obligations                                          15,000          175,000            70,000
Sale of Common Stock, net of issuance costs                                   5,691           11,777            10,778
Distribution to minority interest holder                                          -                -              (279)
                                                                     ---------------   --------------   ---------------
              Net cash provided by financing activities                      20,691          186,777            80,499

                                                                     ---------------   --------------   ---------------
Increase (decrease) in cash and cash equivalents                            (69,430)          43,156            75,862

Cash and cash equivalents at beginning of year                              133,897           90,741            14,879

                                                                     ---------------   --------------   ---------------
               Cash and cash equivalents at end of year                     $64,467         $133,897          $ 90,741
                                                                     ===============   ==============   ===============
</TABLE>


                                                           42
<PAGE>

<TABLE>
<CAPTION>
                                                                                      Fiscal Year Ended
                                                                    ---------------------------------------------------
                                                                          1998              1997             1996
                                                                    -----------------   --------------   --------------
<S>                                                                        <C>               <C>              <C>     
Net income (loss)                                                          $(366,336)        $(22,103)        $109,974
Adjustments to reconcile net income (loss) to net cash
     provided by operating activities:
         Depreciation and amortization                                       116,682          128,542           86,928
         Provision for losses on accounts receivable                          (1,125)           1,315           (1,011)
         Equity in net (income) loss of unconsolidated
            joint venture                                                     27,003            4,865          (10,117)
         Loss on disposal of equipment                                           481            2,854              445
         Impairment charge related to property, plant and
            equipment                                                        175,000                -                -
         Non-cash portion of restructuring charge
            related to write-off of property, plant and equipment                  -           33,013                -
         Deferred income taxes                                                   (59)           2,513           13,153
         Deferred rent                                                           443              463               23
         Minority interest in net income of
            consolidated subsidiary                                              544              400              695
         Changes in operating assets and liabilities:
             Accounts receivable                                              35,995          (23,431)           6,995
             Accounts receivable from related parties                          3,594            4,343           (3,415)
             Inventories                                                      33,138           (4,818)         (32,939)
             Prepaid expenses and deposits                                      (659)            (831)             974
             Trade accounts payable                                          (12,769)         (40,046)          51,372
             Accounts payable to related parties                              (5,245)           3,799           (4,467)
             Accrued compensation and benefits                                 1,948           (8,239)         (10,131)
             Other liabilities                                                  (342)           1,683             (183)
             Income taxes (payable) refundable                                22,433          (11,179)          (7,404)
             Restructuring liability                                          (7,125)          11,253                -
                                                                    -----------------   --------------   --------------
              Net cash provided by operating activities                    $  23,601         $ 84,396         $200,892
                                                                    =================   ==============   ==============


Supplemental disclosure of cash flow information
      Cash paid for interest                                               $  19,683         $  8,148         $    340
      Cash paid (refunded) for income taxes                                  (21,017)         (12,305)          15,280
      Income tax benefit from stock
           options exercised                                                       -            1,834            3,138
<FN>
                                     See notes to consolidated financial statements.
</FN>
</TABLE>

                                                           43
<PAGE>

<TABLE>
                                                       KOMAG, INCORPORATED
                                         CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<CAPTION>

                                                                                    
                                                                                      Retained       Accumulated
                                                  Common Stock        Additional      Earnings/         Other   
                                            -----------------------    Paid-in      (Accumulated    Comprehensive               
                                                Shares     Amount      Capital        Deficit)          Income            Total
                                            -----------  ---------- ------------- --------------- -----------------  -------------

<S>                                             <C>           <C>       <C>             <C>                 <C>          <C>     
Balance at December 31, 1995                    50,714        $507      $374,399        $193,605            $6,053       $574,564

Net Income                                                                               109,974                          109,974
                                                                                                              (514)          (514)
Accumulated translation adjustment                                                                                   -------------
Total Comprehensive Income                                                                                                109,460
                                                                                                                     -------------

Common Stock issued under stock
     option and purchase plans, including
     related tax benefits                          982          10        13,906                                           13,916
                                            -----------  ---------- ------------- --------------- -----------------  -------------

Balance at December 29, 1996                    51,696         517       388,305         303,579             5,539        697,940

Net Loss                                                                                 (22,103)                         (22,103)
                                                                                                            (3,228)        (3,228)
Accumulated translation adjustment                                                                                   -------------
Total Comprehensive Income                                                                                                 (25,331)
                                                                                                                     -------------

Common Stock issued under stock   
option and purchase plans, including
related tax benefits                             1,098          11        13,564                                           13,575
                                            -----------  ---------- ------------- --------------- -----------------  -------------

Balance at December 28, 1997                    52,794         528       401,869         281,476             2,311        686,184

Net Loss                                                                                (366,336)                        (366,336)

Accumulated translation adjustment                                                                          (1,732)        (1,732)
                                                                                                                     -------------
Total Comprehensive Loss                                                                                                 (368,068)
Common Stock issued under stock                                                                                      -------------
option and purchase plans                        1,093          11         5,680                                            5,691
                                            -----------  ---------- ------------- --------------- -----------------  -------------
Balance at January 3, 1999                      53,887        $539      $407,549        ($84,860)           $  579       $323,807
                                            ===========  ========== ============= =============== =================  =============

</TABLE>

                                                               44
<PAGE>

                               KOMAG, INCORPORATED
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of  Consolidation:  The  consolidated  financial  statements  include  the
accounts of the Company,  its wholly owned and majority-owned  subsidiaries (see
Note 12) and  equity in its  unconsolidated  joint  venture  (see Note 13).  All
significant  intercompany  accounts and  transactions  have been  eliminated  in
consolidation.

The  financial  statements  have been  prepared on a going  concern  basis.  The
Company has  incurred  recent  operating  losses and is not in  compliance  with
certain financial covenants of its various bank agreements.  Such non-compliance
constitutes an event of default under the  agreements.  The Company has not been
in payment  default under these credit  facilities  and has continued to pay all
interest  charges  and other  fees  associated  with these  facilities  on their
scheduled due dates. Amounts outstanding under these unsecured credit agreements
at January 3, 1999 amounted to $260,000,000. To date, the Company's lenders have
not accelerated any principal  payments under these  facilities.  The Company is
currently  negotiating  with its lenders for  amendments to its existing  credit
facilities.  There can be no  assurance  that the Company will be able to obtain
such amendments to its credit  facilities on commercially  reasonable  terms. In
the event that the Company does not successfully  amend its credit facilities or
restructure its debt obligations, the Company could be required to significantly
reduce or possibly suspend its operations,  and/or sell additional securities on
terms that would be highly dilutive to current  stockholders of the Company. The
financial  statements  do not include any  adjustments  to reflect the  possible
future effects on the recoverability and classification of assets or the amounts
and classification of assets and liabilities that may result from the outcome of
this uncertainty.

Foreign  Currency   Translation:   The  functional  currency  of  the  Company's
unconsolidated  joint  venture  is the  Japanese  yen.  Translation  adjustments
relating  to the  translation  of these  statements  are  included as a separate
component of stockholders' equity and not included in net income. The functional
currency for the Company's Malaysian operation is the U.S. dollar. Remeasurement
gains and  losses,  resulting  from the  process of  remeasuring  these  foreign
currency financial statements into U.S. dollars, are included in operations.

Foreign  Exchange  Gains and Losses:  The Company  enters into foreign  currency
forward exchange contracts to reduce the impact of currency fluctuations on firm
purchase order commitments for equipment and construction-in-process.  Gains and
losses  related  to these  contracts  are  included  in the  cost of the  assets
acquired. The Company had approximately $767,000 of Japanese yen and $129,000 of
Singapore dollar based firm purchase  commitments at January 3, 1999. There were
no foreign  exchange  contracts  outstanding at January 3, 1999. The Company had
approximately   $14,095,000  in  foreign  exchange  forward  purchase  contracts
outstanding  at  December  28,  1997.  These  forward  exchange  contracts  were
comprised  of  Japanese  yen  and  Malaysian  ringgit  foreign   currencies  and
approximated fair market value at December 28, 1997.

Cash  Equivalents:  The Company considers as a cash equivalent any highly liquid
investment that matures within three months of its purchase date.

Short-Term  Investments:  The Company  invests its excess cash in  high-quality,
short-term  debt  instruments.  None of the Company's debt security  investments
have  maturities  greater  than one year.  At January 3,  1999,  all  short-term
investments are designated as available for sale.  Interest and dividends on the
investments are included in interest income.

                                       45
<PAGE>

The following is a summary of the Company's  investments  by major security type
at amortized cost, which approximates fair value:

                                                        Fiscal Year Ended
                                                 -------------------------------
                                                      1998            1997
                                                 --------------- ---------------
                                                          (in thousands)
Municipal auction rate preferred stock                  $63,350         $32,300
Corporate debt securities                                33,765          56,837
Mortgage-backed securities                               34,060          79,419
                                                 --------------- ---------------
                                                       $131,175        $168,556
                                                 =============== ===============

Amounts included in cash and cash equivalents           $67,825        $136,256
Amounts included in short-term investments               63,350          32,300
                                                 --------------- ---------------
                                                       $131,175        $168,556
                                                 =============== ===============

There were no realized gains or losses on the Company's  investments during 1998
as all investments  were held to maturity during the year. The Company  utilizes
zero-balance  accounts and other cash  management  tools to invest all available
funds, including bank balances in excess of book balances.

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

Property, Plant and Equipment:  Property, plant and equipment are stated at cost
less accumulated depreciation and amortization.  Depreciation is computed by the
straight-line  method  over  the  estimated  useful  lives  of the  assets.  The
estimated  useful life of the  Company's  buildings is 30 years.  Furniture  and
equipment are generally depreciated over 3 to 5 years and leasehold improvements
are amortized over the shorter of the lease term or the useful life.

Revenue  Recognition:  The Company  records  sales upon shipment and provides an
allowance for estimated returns of defective products.

Research  and  Development:  Research  and  development  costs are  expensed  as
incurred.

Stock  Compensation:  The Company has adopted Statement of Financial  Accounting
Standard No. 123,  "Accounting  for  Stock-Based  Compensation"  ("FAS 123"). In
accordance  with the  provisions of FAS 123, the Company  applies APB Opinion 25
and related  Interpretations  in  accounting  for its  stock-based  compensation
plans. Note 5 to the Consolidated Financial Statements contains a summary of the
pro forma  effects to reported  net income  (loss) and basic and diluted  income
(loss)  per share for  1998,  1997 and 1996 as if the  Company  had  elected  to
recognize  compensation  cost based on the fair value of the options  granted at
grant date as prescribed by FAS 123.

Income  Taxes:  The  provision  (benefit)  for  income  taxes is based on pretax
financial  accounting  income (loss).  Deferred tax assets and  liabilities  are
recognized for the expected tax  consequences of temporary  differences  between
the tax and book basis of assets and liabilities.

                                       46
<PAGE>

<TABLE>
Income (Loss) Per Share: The Company determines earnings per share in accordance
with  Financial  Accounting  Standards  Board  Statement No. 128,  "Earnings per
Share" ("FAS 128").
<CAPTION>
                                                                      Fiscal Year Ended
                                                 ------------------------------------------------------------
                                                        1998                1997                 1996
                                                 ------------------- -------------------  -------------------
                                                                (in thousands, except per share amounts)
<S>                                                       <C>                  <C>                  <C>     
Numerator:  Net income (loss)                             ($366,336)           ($22,103)            $109,974
                                                 ------------------- -------------------  -------------------

Denominator for basic
       income (loss) per share -
       weighted-average shares                               53,169              52,217               51,179
                                                 ------------------- -------------------  -------------------

Effect of dilutive securities:
       Employee stock options                                     -                   -                1,953

Denominator for diluted
                                                 ------------------- -------------------  -------------------
       income (loss) per share                               53,169              52,217               53,132
                                                 ------------------- -------------------  -------------------

Basic income (loss) per share                                ($6.89)             ($0.42)               $2.15
                                                 =================== ===================  ===================

Diluted income (loss) per share                              ($6.89)             ($0.42)               $2.07
                                                 =================== ===================  ===================
</TABLE>

No stock options were included in the  computation of diluted loss per share for
1998 and 1997 as their effect would have been antidilutive.

Comprehensive  Income (Loss): In June 1997, the Financial  Accounting  Standards
Board issued  Statement of Financial  Accounting  Standards No. 130,  "Reporting
Comprehensive  Income"  ("SFAS 130").  SFAS 130 requires that all items that are
required  to  be  recognized  under   accounting   standards  as  components  of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial  statements.  This statement is effective
for the Company's 1998 fiscal year.  Prior year financial  statements  have been
reclassified to conform to the  requirements of Statement 130.  Adoption of this
pronouncement  did  not  have  a  material  impact  on the  Company's  financial
statements.  Accumulated other  comprehensive  income is primarily  comprised of
accumulated translation adjustments.

Segment  Information:  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
replaces Statement of Financial  Accounting Standards No. 14 and changes the way
public companies report segment information. This statement is effective for the
Company's  1998  fiscal  year.  Adoption  of this  pronouncement  did not have a
material impact on the Company's financial statements

Fiscal  Year:  The  Company  uses a 52-53 week  fiscal year ending on the Sunday
closest  to  December  31. The year ended  January 3, 1999 was  comprised  of 53
weeks.  The years  ended  December  28,  1997 and  December  29,  1996 were each
comprised of 52 weeks.

Derivative  Instruments  and Hedging  Activities:  In June 1998, the FASB issued
Statement of Financial  Accounting Standards No. 133, "Accounting for Derivative
Instruments  and  Hedging   Activities"

                                       47
<PAGE>

("SFAS  133").  SFAS 133  establishes  accounting  and  reporting  standards for
derivative instruments and for hedging activities.  It requires that derivatives
be recognized  in the balance  sheet at fair value and specifies the  accounting
for changes in fair value.  This statement is effective for all fiscal  quarters
of fiscal  years  beginning  after  June 15,  1999,  and will be  adopted by the
Company for its fiscal year 2000. The Company is currently  assessing the impact
of adoption of this pronouncement on its financial statements.

Use of Estimates:  The  preparation of financial  statements in conformity  with
generally accepted  accounting  principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.


NOTE 2.  SEGMENT AND GEOGRAPHIC INFORMATION

The  Company  operates  in one  business  segment,  which  is  the  development,
production  and marketing of  high-performance  thin-film  media for use in hard
disk drives. The Company sells to original equipment  manufacturers in the rigid
disk drive market and computer system  manufacturers that produce their own disk
drives.

The  Company  adopted  Statement  of  Financial  Accounting  Standards  No. 131,
"Disclosures  About  Segments of an Enterprise and Related  Information"  ("SFAS
131") at January 3, 1999.  SFAS 131  establishes  annual and  interim  reporting
standards for an enterprise's  operating segments and related  disclosures about
its products,  services,  geographic areas and major customers.  Under SFAS 131,
the Company's operations are treated as one operating segment as it only reports
profit and loss  information on an aggregate basis to chief  operating  decision
makers of the Company.

                                       48
<PAGE>

<TABLE>
Summary  information for the Company's  operations by geographic  location is as
follows:
<CAPTION>
                                                                1998              1997              1996
                                                          ----------------- ------------------ ---------------
                                                                              (in thousands)
<S>                                                              <C>               <C>             <C>
Net sales
    To customers from U.S. operations                            $ 157,408         $  290,986      $  316,658
    To customers from Far East operations                          171,475            340,096         261,133
    Intercompany from Far East operations                           88,890            121,945          75,608
    Intercompany from U.S. operations                               33,360             38,310          22,232
                                                          ----------------- ------------------ ---------------
                                                                   451,133            791,337         675,631
    Eliminations                                                  (122,250)          (160,255)        (97,840)
                                                          ----------------- ------------------ ---------------
    Total net sales                                              $ 328,883         $  631,082      $  577,791
                                                          ================= ================== ===============

Operating income (loss)
    U.S. operations                                              $(205,852)        $ (112,022)         $9,108
    Far East operations                                           (127,837)            70,821         107,774
                                                          ----------------- ------------------ ---------------
                                                                  (333,689)           (41,201)        116,882
    Eliminations                                                     1,770              3,640          (4,389)
                                                          ----------------- ------------------ ---------------
    Total operating income (loss)                                $(331,919)        $  (37,561)     $  112,493
                                                          ================= ================== ===============

Identifiable assets
    U.S. operations                                              $ 538,989         $  768,395      $  708,436
    Far East operations                                            263,153            467,990         381,015
                                                          ----------------- ------------------ ---------------
                                                                   802,142          1,236,385       1,089,451
    Eliminations                                                  (108,047)          (151,721)       (151,094)
                                                          ----------------- ------------------ ---------------
    Total identifiable assets                                    $ 694,095         $1,084,664      $  938,357
                                                          ================= ================== ===============

Export sales by domestic operations included the following:

                                                                           Fiscal Year Ended
                                                          ----------------------------------------------------
                                                                1998              1997              1996
                                                          ----------------- ------------------ ---------------
                                                                              (in thousands)
Far East (see Note 13)                                            $109,842           $268,117        $249,130
Europe                                                              23,973             11,896               -
</TABLE>

                                       49
<PAGE>

NOTE 3.  CONCENTRATION OF CUSTOMER AND SUPPLIER RISK

The Company  performs  ongoing credit  evaluations  of its customers'  financial
conditions and generally requires no collateral. Significant customers accounted
for the following percentages of net sales in 1998, 1997 and 1996:

                                                Fiscal Year Ended
                                    ------------------------------------------
                                        1998          1997           1996
                                    ------------- -------------- -------------
Western Digital Corporation                   43%           38%            22%
Maxtor Corporation                            25%           19%  Less than 10%
International Business Machines               18%           10%  Less than 10%
Quantum Corporation/MKE             Less than 10%           15%            18%
Seagate Technology, Inc.            Less than 10%           14%            52%


In early 1996, Seagate merged with Conner Peripherals, Inc. In addition, Quantum
ceased disk drive  production in Milpitas,  California and Penang,  Malaysia and
contracted  with  its  Japanese   manufacturing   partner,   Matsushita-Kotobuki
Electronics  Industries,  Ltd.  ("MKE"),  to manufacture all of its disk drives.
Percentages   for  1998,   1997  and  1996   represent  the  combined  sales  to
Seagate/Conner and Quantum/MKE.

Kobe Steel, Ltd.  ("Kobe") supplies aluminum  substrate blanks to Komag Material
Technology,  Inc. ("KMT"), and the Company in turn purchases KMT's entire output
of finished  substrates.  The Company  also relies on a limited  number of other
suppliers,  in some cases a sole supplier,  for certain other  materials used in
its manufacturing  processes.  These materials include nickel plating solutions,
certain polishing and texturing supplies and sputtering target materials.  These
suppliers  work closely with the Company to optimize  the  Company's  production
processes.  Although this reliance on a limited  number of suppliers,  or a sole
supplier,  entails some risk that the  Company's  production  capacity  would be
limited if one or more of such materials were to become unavailable or available
in reduced  quantities,  the Company  believes  that the  advantages  of working
closely with these suppliers  outweigh such risks.  If such materials  should be
unavailable  for  a  significant  period  of  time,  the  Company's  results  of
operations could be adversely affected.


NOTE 4.  STOCKHOLDER'S EQUITY

In July  1998,  the  Company's  stockholders  approved  at a Special  Meeting of
Stockholders  a proposal to increase  the amount of Common  Stock the Company is
authorized to issue from 85,000,000 to 150,000,000 shares.

In July  1998,  at a Special  Meeting  of  Stockholders,  the  Company  received
authorization  to sell and issue up to $350,000,000 of Common Stock in equity or
equity-linked  private transactions from time to time through July 22, 1999 at a
price  below book  value but at or above the then  current  market  value of the
Company's Common Stock.

                                       50
<PAGE>

NOTE 5.  STOCK OPTION PLANS AND STOCK PURCHASE PLAN
<TABLE>
At January 3, 1999, the Company has stock-based  compensation  plans,  which are
described below. The Company has elected to follow  Accounting  Principles Board
Opinion  No.  25,  "Accounting  for  Stock  Issued  to  Employees"  and  related
Interpretations in accounting for its plans.  Accordingly,  no compensation cost
has been  recorded in the  financial  statements  for its stock option and stock
purchase plans. Had  compensation  cost for the stock-based  compensation  plans
been determined  consistent with Statement of Financial  Accounting Standard No.
123,  "Accounting  for Stock-Based  Compensation,"  the Company's net income and
earnings  per share would have been reduced to the pro forma  amounts  indicated
below:
<CAPTION>
                                                                       Fiscal Year Ended
                                                      -----------------------------------------------------
                                                            1998              1997               1996
                                                      -----------------  ----------------    --------------
                                                              (in thousands, except per share amounts)
<S>                                                          <C>                <C>               <C>     
Net income (loss):             As reported                   ($366,336)         ($22,103)         $109,974
                               Pro forma                      (396,390)          (36,833)          102,355

Basic EPS:                     As reported                      ($6.89)           ($0.42)            $2.15
                               Pro forma                         (7.46)            (0.71)             2.00

Diluted EPS:                   As reported                      ($6.89)           ($0.42)            $2.07
                               Pro forma                         (7.46)            (0.71)             1.93
</TABLE>
Since FAS 123 is applicable only to options  granted  subsequent to December 31,
1994, its pro forma effect will not be fully reflected until 1999.

In  September  1997,  the  Company's  Board  of  Directors   approved  the  1997
Supplemental  Stock Option Plan  ("Supplemental  Plan").  Under the Supplemental
Plan,  the  Company  may grant  nonqualified  stock  options to  purchase  up to
3,600,000  shares  of  Common  Stock.  In  January  1998 and in June  1998,  the
Company's  Board of Directors  approved  increases of  1,000,000  and  1,500,000
shares, respectively, in the total number of shares that may be issued under the
Supplemental Plan.

Under the Company's  stock option plans  ("Plans"),  including the  Supplemental
Plan,  the Company may grant  options to  purchase  up to  24,360,000  shares of
Common  Stock.  Options  may be granted  to  employees,  directors,  independent
contractors  and  consultants.  Options  under  the  Supplemental  Plan may not,
however,  be granted to the Company's  executive officers or nonemployee members
of the  Company's  Board of  Directors.  The  Plans  provide  for  issuing  both
incentive stock options and  nonqualified  stock options,  both of which must be
granted at fair market value at the date of grant. Outstanding options generally
vest over four  years and expire no later than ten years from the date of grant.
Options may be  exercised  in  exchange  for cash or  outstanding  shares of the
Company's Common Stock.  Approximately  16,000 and 5,000 shares of the Company's
Common Stock were  received in exchange  for option  exercises in 1997 and 1996,
respectively.  No options were exercised in exchange for  outstanding  shares of
the Company's Common Stock in 1998.

In October 1997, the Company's  Board of Directors  approved an option  exchange
program,  subject to election by the option holders, whereby options to purchase
1,806,000  shares of the Company's Common Stock at prices ranging from $19.75 to
$36.00 per share were  canceled and reissued at $19.44 per share,  which was the
fair  market  value of the  Company's  Common  Stock at that time.  The  average
exercise price of the canceled options was  approximately  $26.62 per share. The
new options  generally vest over two to four years.  The option exchange program
was not available to the Company's  executive officers or nonemployee members of
the Company's Board of Directors.

                                       51
<PAGE>

In June 1998,  the  Company's  Board of  Directors  approved an option  exchange
program,  subject to election by the option holders, whereby options to purchase
7,551,000  shares of the Company's  Common Stock at prices ranging from $6.19 to
$31.06 per share were  canceled and  reissued at $5.35 per share,  which was the
fair  market  value of the  Company's  Common  Stock at that time.  The  average
exercise  price of the  canceled  options  was  approximately  $15.65 per share.
Vesting  under the new options  remained  unchanged,  however,  the options were
subject to a one year prohibition on exercisability. The option exchange program
was  available to  executive  officers  but was not  available to the  Company's
nonemployee members of the Company's Board of Directors.

At January 3, 1999, approximately 6,882,000 shares of Common Stock were reserved
for future option grants and 8,816,000  shares of Common Stock were reserved for
the  exercise of  outstanding  options.  Approximately  950,000,  2,297,000  and
1,917,000  of the  outstanding  options  were  exercisable  at  January 3, 1999,
December 28, 1997 and December 29, 1996, respectively.

For purposes of the pro forma disclosure, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model with
the following assumptions used for grants in 1998, 1997 and 1996,  respectively:
risk-free  interest  rates of 5.5%,  6.3% and 6.1%;  volatility  factors  of the
expected market price of the Company's  Common Stock of 63.4%,  61.9% and 60.0%;
and a  weighted-average  expected life of the options of 4.7, 6.5 and 5.9 years.
There was no dividend yield included in the  calculation as the Company does not
pay dividends.  The weighted-average  fair value of options granted during 1998,
1997 and 1996 was $4.29, $11.06 and $12.88, respectively.

                                       52
<PAGE>

A summary of stock option transactions is as follows:

                                                    Weighted-
                                                     average
                                     Shares      Exercise Price       Total
                                  ------------- ----------------- -------------
                                              (in thousands, except
                                                per share amounts)

Outstanding at December 31, 1995         5,028            $11.13       $55,954
    Granted                              1,651             25.65        42,351
    Exercised                             (635)             9.00        (5,714)
    Cancelled                             (299)            16.43        (4,913)
                                  ------------- ----------------- -------------

Outstanding at December 29, 1996         5,745             15.26        87,678
    Granted                              4,141             22.38        92,685
    Exercised                             (678)             9.66        (6,549)
    Cancelled                           (2,314)            25.42       (58,817)
                                  ------------- ----------------- -------------

Outstanding at December 28, 1997         6,894             16.68       114,997
    Granted                             11,290              7.43        83,842
    Exercised                             (168)             8.55        (1,432)
    Cancelled                           (9,200)            15.23      (140,122)
                                  ------------- ----------------- -------------

Outstanding at January 3, 1999           8,816            $ 6.50       $57,285
                                  ============= ================= =============


                                       53

<PAGE>

<TABLE>
The following table summarizes  information concerning currently outstanding and
exercisable options (option shares in thousands):
<CAPTION>

                                         Options Outstanding                        Options Exercisable
                        ---------------------------------------------------------------------------------------
                                            Remaining
       Range of             Number         Contractual       Exercise             Number          Exercise
   Exercise Prices        Outstanding      Life (yrs)*        Price*            Exercisable        Price*
----------------------- ---------------- ---------------- ----------------    ---------------- ----------------

<S>    <C>     <C>                <C>        <C>                 <C>                                  <C>   
       $2.19 - $5.25              145        9.6                 $ 3.00                   -           $    -
        5.26 -  5.35            7,398        7.9                   5.35                   -                -
        5.36 - 12.56              893        5.4                   9.04                 665             8.52
       12.57 - 20.75              154        6.5                  16.28                 132            16.07
       20.76 - 34.13              226        7.6                  29.56                 153            31.62
                        ----------------                                      ----------------
                                8,816                                                   950
                        ================                                      ================

*Weighted-average
</TABLE>

Under the terms of the Employee Stock Purchase Plan ("ESPP Plan"), employees may
elect to  contribute  up to 10% of their  compensation  toward the  purchase  of
shares of the Company's  Common Stock.  The purchase price per share will be the
lesser of 85% of the fair market value of the stock on the first day or the last
day of each semi-annual offering period.

In May 1998, the Company's  shareholders approved a 1,300,000-share  increase in
the total  number of shares  that may be issued  under the ESPP Plan.  The total
number of  shares of stock  that may be  issued  under  the Plan  cannot  exceed
4,850,000  shares.  Shares  issued  under  the ESPP Plan  approximated  925,000,
436,000 and 352,000 in 1998,  1997 and 1996,  respectively.  At January 3, 1999,
approximately  735,000 shares of Common Stock were reserved for future  issuance
under the ESPP Plan.

For  purposes  of the pro forma  disclosure,  the fair  value of the  employees'
purchase  rights  has been  estimated  using the  Black-Scholes  model  assuming
risk-free  interest  rates of  5.5%,  6.5%  and  5.6% in  1998,  1997 and  1996,
respectively.  Volatility  factors of the expected market price were 63.5%,  60%
and 60% for 1998, 1997 and 1996,  respectively.  The  weighted-average  expected
life of the  purchase  rights  was six  months  for  1998,  1997 and  1996.  The
weighted-average  fair value of those purchase  rights granted in 1998, 1997 and
1996 was $3.09, $6.37 and $5.09, respectively.


NOTE 6.  BONUS AND PROFIT SHARING PLANS

Under the terms of the  Company's  cash profit  sharing  plan, a  percentage  of
consolidated  semi-annual operating profit, as defined in the plan, is allocated
among all employees who meet certain criteria.  Under the terms of the Company's
bonus plans, a percentage of consolidated annual operating profit, as defined in
the respective  bonus plans,  is paid to eligible  employees.  No bonus and cash
profit  sharing  provision  was  recorded  during  1998.  The  Company  expensed
$1,966,000  and  $9,078,000  under these bonus and cash profit  sharing plans in
1997 and 1996, respectively.

The Company and its  subsidiaries  maintain  savings and deferred profit sharing
plans.  Employees  who meet certain  criteria are  eligible to  participate.  In
addition  to  voluntary  employee  contributions  to these  plans,  the  Company
contributes  four  percent of  semi-annual  consolidated  operating  profit,  as
defined  in the  plans.  These  contributions  are  allocated  to  all  eligible
employees.  Furthermore,  the  Company  matches  a  portion  of each  employee's
contributions to the plans up to a maximum amount. The

                                       54
<PAGE>

Company  contributed  $695,000,  $2,534,000 and $5,573,000 to the plans in 1998,
1997 and 1996, respectively.

Expenses  for the  Company's  bonus and profit  sharing  plans are  included  in
selling, general and administrative expenses.


NOTE 7.  INCOME TAXES

The provision (benefit) for income taxes consists of the following:

                                              Fiscal Year Ended
                               -----------------------------------------------
                                     1998            1997           1996
                               ----------------- -------------- --------------
                                                 (in thousands)
Federal:
     Current                             $   59       $(24,036)       $ 3,988
     Deferred                               (59)         2,192         10,265
                               ----------------- -------------- --------------
                                              -        (21,844)        14,253
State:
     Current                                  2           (490)           496
     Deferred                                 -            321          2,888
                               ----------------- -------------- --------------
                                              2           (169)         3,384
Foreign:
     Current                              1,313          1,031          2,958
                               ----------------- -------------- --------------

                                         $1,315       $(20,982)       $20,595
                               ================= ============== ==============

The  foreign  provision  above  consists  of  withholding  taxes on royalty  and
interest payments and foreign taxes of subsidiaries.

                                       55
<PAGE>

Deferred tax assets (liabilities) are comprised of the following:

                                                        Fiscal Year End
                                                --------------------------------
                                                      1998            1997
                                                ----------------- --------------
                                                         (in thousands)
Depreciation                                            $      -       $(22,118)
State income taxes                                       (10,649)       (10,299)
Deferred income                                          (34,023)       (34,023)
Other                                                     (7,892)        (6,895)
                                                ----------------- --------------
Gross deferred tax liabilities                           (52,564)       (73,335)
                                                ----------------- --------------

Depreciation                                                 319              -
Inventory valuation adjustments                            2,283          8,971
Accrued compensation and benefits                          2,442          3,175
State income taxes                                         2,484          2,484
Other                                                        355         13,965
Tax benefit of net operating losses                       97,846         43,046
Tax benefit of credit carryforwards                       33,085         24,000
                                                ----------------- --------------
Gross deferred tax assets                                138,814         95,641
                                                ----------------- --------------

Deferred tax asset valuation allowance                  (130,931)       (67,046)
                                                ----------------- --------------

                                                        $(44,681)      $(44,740)
                                                ================= ==============


As of January 3, 1999,  the Company has federal and state tax net operating loss
carryforwards of approximately $165,100,000 and $90,200,000,  respectively.  The
Company  also has federal and state tax credit  carryforwards  of  approximately
$15,500,000 and $17,500,000,  respectively.  The Company's federal net operating
losses expire  beginning in 2013 through 2019 and the state net operating losses
expire  beginning  in 2003  through  2004.  The  Company's  federal  tax  credit
carryovers  expire  beginning  in 2000  through  2019 and the state  tax  credit
carryforwards  expire  beginning in 2003 through 2006. Due to the uncertainty of
the timing and amount of future  income,  the Company has fully reserved for the
potential future tax benefit of all net operating loss and credit  carryforwards
in the deferred tax asset valuation allowance.

Dastek Holding Company, a 60%-owned subsidiary of the Company, has a federal tax
net operating loss carryforward of approximately  $100,000,000.  The Company has
fully  reserved  for the  potential  future  federal  tax  benefit  of this  net
operating  loss in the deferred tax asset  valuation  allowance  due to the fact
that its utilization is limited to the subsidiary's  separately  computed future
taxable income and that the subsidiary has no history of operating profits.  The
net operating losses expire beginning in 2009 through 2011.

The deferred tax asset  valuation  allowance  increased  $63,885,000 in 1998 and
$32,000,000 in 1997.

                                       56
<PAGE>

<TABLE>
A reconciliation  of the income tax provision at the 35% federal  statutory rate
to the income tax provision at the effective tax rate is as follows:
<CAPTION>
                                                                       Fiscal Year Ended
                                                         -----------------------------------------------
                                                               1998            1997           1996
                                                         ----------------- -------------- --------------
                                                                           (in thousands)
<S>                                                             <C>             <C>             <C>    
Income taxes computed at federal statutory rate                 $(118,116)      $(13,237)       $42,402

State and foreign income taxes, net of federal
    benefit                                                         1,315            907          5,021

Permanently reinvested foreign (earnings) losses                   46,446        (25,597)       (26,050)

Losses for which no current year benefit available                 70,995         16,561              -

Other                                                                 675            384           (778)
                                                         ----------------- -------------- --------------
                                                                $   1,315       $(20,982)       $20,595
                                                         ================= ============== ==============
</TABLE>

Foreign pretax income (loss) was ($131,400,000), $74,400,000 and $104,300,000 in
1998, 1997 and 1996, respectively.

Komag USA (Malaysia) Sdn.  ("KMS"),  the Company's  wholly owned thin-film media
operation in Malaysia,  was granted an  extension of its initial  five-year  tax
holiday by the Malaysian  government for an additional five years  commencing in
July 1998.  The tax holiday had no impact on the Company's 1998 net loss, but in
1997 the tax holiday reduced the Company's net loss by approximately $16,596,000
($0.32 per share  under both the basic and  diluted  methods).  Losses  incurred
prior to the commencement of the initial tax holiday,  approximately $6,237,000,
are  available for  carryforward  to years  following the  expiration of the tax
holiday.  KMS has also been granted an  additional  ten-year tax holiday for its
second and third  plant  sites in  Malaysia.  This new tax  holiday  had not yet
commenced at January 3, 1999.

The Company has generated  $59,059,000 of cumulative  earnings for which no U.S.
tax has been provided as of January 3, 1999. These earnings are considered to be
permanently invested outside the United States.


NOTE 8.  TERM DEBT AND LINES OF CREDIT

The Company has borrowed  $260,000,000 and $245,000,000  under its term debt and
line  of  credit   facilities   at  January  3,  1999  and  December  28,  1997,
respectively.  At January 3, 1999, these borrowings incurred interest at 7.4% to
7.75%, with interest-only payments due quarterly.

The size of the  Company's  second  quarter 1998 net loss  resulted in a default
under  certain  financial  covenants  contained  in the  Company's  bank  credit
facilities.  The Company is not in payment default under these credit facilities
as all interest charges and fees associated with these facilities have been paid
on their  scheduled due dates.  At the time of the covenant  default the Company
had  $260,000,000  of debt  outstanding  against a total  borrowing  capacity of
$345,000,000 under the various senior unsecured credit  facilities.  As a result
of the covenant  default,  the Company's  lenders  withdrew the  $85,000,000  in
unused  borrowing  capacity.  To date,  the  lenders  have not  accelerated  any
principal  payments  under the  credit  facilities.  The  Company  is  currently
negotiating with its lenders for amendments to the existing credit facilities.

                                       57
<PAGE>

NOTE 9.  FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying values of cash and short-term investments,  accounts receivable and
certain other  liabilities on the Consolidated  Balance Sheets  approximate fair
value at January  3, 1999 and  December  28,  1997 due to the  relatively  short
period to maturity of the instruments.  The carrying value of the Company's debt
borrowings on the  Consolidated  Balance  Sheets  approximated  fair value as of
December 28, 1997. As of January 3, 1999, the Company was in default of its debt
covenants and the fair value of the Company's debt borrowings was  approximately
$251,000,000.  The fair value of the bank  borrowings was based on quoted market
prices or pricing models using current  market rates.  See Note 1 for fair value
of foreign currency hedge contracts.


NOTE 10.  LEASES AND COMMITMENTS

The Company leases certain  production,  research and administrative  facilities
under  operating  leases that  expire at various  dates  between  1999 and 2007.
Certain of these  leases  include  renewal  options  varying  from ten to twenty
years.

At January  3,  1999,  the future  minimum  commitments  for all  noncancellable
operating leases are as follows (in thousands):

         1999                                              $5,769
         2000                                               4,778
         2001                                               4,820
         2002                                               4,815
         2003                                               4,815
         Thereafter                                        14,313
                                                    -------------
         Total minimum lease payments                     $39,310
                                                    =============

Rental expense for all operating  leases amounted to $6,573,000,  $8,047,000 and
$4,838,000 in 1998, 1997 and 1996, respectively.

The Company has current  noncancellable  capital  commitments  of  approximately
$17,000,000.


NOTE 11.  RESTRUCTURING CHARGES

During the third quarter of 1997, the Company  implemented a restructuring  plan
based on an  evaluation  of the size and  location  of its  existing  production
capacity  relative  to the  short-term  market  demand  outlook.  Under the 1997
restructuring plan, the Company consolidated its U.S.  manufacturing  operations
onto its new campus in San Jose,  California  and closed two older  factories in
Milpitas,  California. The first of the two Milpitas factories was closed at the
end of the third  quarter of 1997 and the second  factory  was closed in January
1998. The 1997  restructuring  actions resulted in a charge of $52.2 million and
included  reducing   headcount,   vacating  leased   facilities,   consolidating
operations  and  disposing of assets.  The  restructuring  charge  included $3.9
million  for  severance  costs  associated  with  approximately  330  terminated
employees,  $33.0 million for the  write-down of the net book value of equipment
and  leasehold   improvements,   $10.1  million   related  to  equipment   order
cancellations and other  equipment-related  costs, and $5.2 million for facility
closure  costs.  Non-cash  items  included in the  restructuring  charge totaled
approximately $33.0 million.

                                       58
<PAGE>

In the second quarter of 1998 several customers reduced orders for the Company's
products  in response to  downward  adjustments  in their disk drive  production
build schedules.  In light of the order reductions and the Company's expectation
that the media  industry's  supply/demand  imbalance would extend into 1999, the
Company   adjusted  its  expectations  for  the  utilization  of  its  installed
production capacity. Based on this analysis of the Company's production capacity
and  its  expectations  of the  media  market  over  the  remaining  life of the
Company's  fixed  assets,  the  Company  concluded  that it would not be able to
recover the book value of those assets. As a result,  the Company  implemented a
restructuring  plan in June 1998 and recorded a charge of $187.8  million.  This
charge included an asset  impairment  charge and provisions for facility closure
expenses and  severance-related  costs.  The asset  impairment  component of the
charge was $175.0 million and  effectively  reduced asset  valuations to reflect
the  economic  effect of recent  industry  price  erosion for disk media and the
projected underutilization of the Company's production equipment and facilities.
Non-cash items in the  restructuring/impairment  charge totaled $175.0  million.
The cash component of the total charge was $12.8 million.

The  restructuring  plan  included  reducing the  Company's  U.S. and  Malaysian
workforce and ceasing  operations at its oldest San Jose,  California plant. The
restructuring  charge included $4.1 million for severance  costs  (approximately
170 employees,  primarily in the U.S.),  $5.8 million related to equipment order
cancellations  and other equipment  related costs, and $2.9 million for facility
closure costs.  Production equipment and leasehold improvements at the Company's
U.S.  and  Malaysian  facilities  with a net book value of $562.8  million  were
written down to their fair value as a result of the  impairment.  The fair value
of these assets was determined  based upon the estimated future cash flows to be
generated by the assets, discounted at a market rate of interest (15.8%).

The Company  incurred lower facility  closure costs than anticipated in its 1997
and 1998 restructuring charges. The oldest Milpitas plant was sublet sooner than
anticipated  and the  Company  reached a lease  termination  agreement  with its
landlord on the second  Milpitas plant in the third quarter of 1998. The Company
thereby  avoided  expected  future rent payments and the cost of renovating  the
facility to its original lease condition.  Additionally,  the Company determined
that it would  not  close  its  oldest  San  Jose,  California  facility  at the
expiration of its lease. The Company plans to devote the front-end operations in
this facility for glass media development.  Back-end operations in this facility
ceased in the fourth  quarter of 1998.  As a result the  Company  will not incur
costs to restore the facility to its original lease condition as contemplated in
the restructuring  charge. Higher costs for equipment order cancellations offset
the  lower  facility  closure  costs.  A  total  of 515  employees  were  in the
restructuring  activities.  The following table summarizes  these  restructuring
activities.

                                                Restructuring      Incurred
  (in millions)                                    Charges      Through 1/3/99
                                               ---------------- ----------------
  Asset impairment charge                               $175.0          $175.0
  Writedown net book value of equipment
    and leasehold improvements                            33.0            33.0
  Equipment order cancellations and other
    equipment related costs                               16.0            17.5
  Facility closure costs                                   8.0             2.2
  Severance costs                                          7.9             8.1

At January 3, 1999, $4,128,000 related to the restructuring  activities remained
in  current   liabilities.   The  Company  has  made  cash   payments   totaling
approximately $27,784,000 primarily for severance, equipment order cancellations
and facility closure costs. The majority of the remaining  liability,

                                       59
<PAGE>

primarily for equipment  order  cancellations  is expected to be settled through
the use of cash by the end of 1999.


NOTE 12.  KOMAG MATERIAL TECHNOLOGY, INC.

The Company's  financial  statements  include the consolidation of the financial
results of Komag Material Technology, Inc. ("KMT"), which manufactures and sells
aluminum disk substrate  products for  high-performance  magnetic storage media.
KMT is owned 80% by the Company and 20% by Kobe Steel USA Holdings  Inc.  ("Kobe
USA"), a U.S. subsidiary of Kobe Steel, Ltd. ("Kobe").
<TABLE>
Other  transactions  between  Kobe or its  distributors  and the Company were as
follows:
<CAPTION>
                                                                            Fiscal Year Ended
                                                                -------------------------------------------
                                                                    1998           1997           1996
                                                                -------------  -------------  -------------
                                                                              (in thousands)
<S>                                                                   <C>            <C>            <C>
Accounts payable to Kobe or its distributors:
    Beginning of year                                                 $4,830         $2,430         $3,302
        Purchases                                                     23,758         52,308         53,554
        Payments                                                     (26,789)       (49,908)       (54,426)
                                                                -------------  -------------  -------------
           End of year                                                $1,799         $4,830         $2,430
                                                                =============  =============  =============
</TABLE>

NOTE 13.  UNCONSOLIDATED JOINT VENTURE

In  1987,  the  Company  formed  a  partnership,   Komag   Technology   Partners
("Partnership"),  with the  U.S.  subsidiaries  of two  Japanese  companies  and
simultaneously formed a subsidiary,  Asahi Komag Co., Ltd. ("AKCL"). The Company
contributed  technology in exchange for a 50% interest in the  Partnership.  The
Partnership and its subsidiary  (joint venture)  established a facility in Japan
to manufacture and sell the Company's  thin-film  media products in Japan.  AKCL
also sells its products to the Company for resale outside of Japan. In 1996, the
Company  granted  AKCL  various  licenses  to sell  its  products  to  specified
customers  outside of Japan in  exchange  for a 5% royalty on these  sales.  The
Company  recorded  approximately  $1,989,000  and $1,388,000 of royalty in other
income in 1998 and 1997, respectively.

The Company's share of the joint venture's net income (loss) was  ($27,003,000),
($4,865,000) and $10,116,000 in 1998, 1997 and 1996, respectively.

                                       60
<PAGE>

<TABLE>
Other transactions between the joint venture and the Company were as follows:
<CAPTION>
                                                                            Fiscal Year Ended
                                                                -------------------------------------------
                                                                    1998           1997           1996
                                                                -------------  -------------  -------------
                                                                               (in thousands)
<S>                                                                   <C>            <C>            <C>
Accounts receivable from joint venture:
    Beginning of year                                                 $4,053         $8,316         $4,906
        Sales                                                         15,799         95,302         69,311
        Cash receipts                                                (19,393)       (99,565)       (65,901)
                                                                -------------  -------------  -------------
           End of year                                                $  459         $4,053         $8,316
                                                                =============  =============  =============

Accounts payable to joint venture:
    Beginning of year                                                 $2,256         $  549         $  355
        Purchases                                                      4,153         14,686         12,145
        Payments                                                      (6,390)       (12,979)       (11,951)
                                                                -------------  -------------  -------------
           End of year                                                $   19         $2,256         $  549
                                                                =============  =============  =============
</TABLE>

Equipment  purchases  by the  Company  from  its  joint  venture  partners  were
$14,458,000, $17,836,000 and $20,655,000 in 1998, 1997 and 1996, respectively.
<TABLE>
Summary  combined  financial  information  for the  Partnership and AKCL for the
years ended  December 31, 1998,  1997 and 1996,  and as of December 31, 1998 and
1997 is as follows. The subsidiary's total assets, liabilities,  revenues, costs
and expenses approximate 100% of the combined totals.
<CAPTION>
                                                                       Fiscal Year Ended
                                                -------------------------------------------------
                                                    1998             1997              1996
                                                --------------  ----------------  ---------------
                                                                 (in thousands)
<S>                                                  <C>               <C>              <C>
Summarized Statements of Operations:
     Net sales                                       $138,330          $186,474         $230,904
     Costs and expenses                               192,311           200,305          188,707
     Income tax provision (benefit)                        25            (4,101)          21,965
                                                --------------  ----------------  ---------------
        Net Income (loss)                            $(54,006)         $ (9,730)        $ 20,232
                                                ==============  ================  ===============
</TABLE>


                                       61
<PAGE>

<TABLE>
<CAPTION>
                                                                         Fiscal Year End
                                                                ---------------------------------
                                                                     1998              1997
                                                                ----------------  ---------------
                                                                          (in thousands)
<S>                                                                    <C>              <C>
Summarized Balance Sheets:
     Current assets                                                    $ 69,773         $ 63,512
     Noncurrent assets                                                  163,035          151,540
                                                                ----------------  ---------------
        Total Assets                                                   $232,808         $215,052
                                                                ================  ===============

     Current liabilities                                               $139,043         $115,106
     Long-term obligations                                               88,892           41,975
     Partners' capital                                                    4,873           57,971
                                                                ----------------  ---------------
        Total Liabilities and Partners' Capital                        $232,808         $215,052
                                                                ================  ===============
</TABLE>

NOTE 14.  PARTICIPATION IN HEADWAY TECHNOLOGIES, INC.

Headway Technologies,  Inc. ("Headway") was formed in 1994 to research,  develop
and  manufacture  advanced  magnetoresistive  ("MR")  heads for the data storage
industry.  Hewlett-Packard  Company  ("HP") and AKCL (see Note 13)  provided the
initial cash funding to Headway in exchange  for equity  interests.  The Company
and Asahi America  licensed to Headway MR technology  developed  through a prior
joint  venture and  contributed  certain  research and  production  equipment in
exchange  for equity.  As a result of these  transactions,  the  Company  held a
direct voting  interest in Headway of less than 20% and had no cost basis in its
investment in Headway. In 1997, the Company sold its interest in Headway.

AKCL  invested  in  Headway  in 1994 and  recorded  partial  write-downs  of its
investment  through 1995 based upon net losses  incurred at Headway.  During the
third quarter of 1996,  Headway's major customer,  HP,  announced the closure of
its disk drive manufacturing operations. Based upon anticipated future operating
losses at Headway  arising  from the loss of HP's  business,  AKCL wrote off its
remaining  Headway  investment at the end of the third quarter of 1996. In 1997,
AKCL sold its entire  interest  in  Headway  for  $10,800,000  to a group of new
investors as part of a recapitalization and AKCL recorded the proceeds from this
sale as a gain ($5,300,000, net of tax).

                                       62
<PAGE>

<TABLE>
NOTE 15.  QUARTERLY SUMMARIES
(in thousands, except per share amounts, unaudited)
<CAPTION>
                                                                                            1998
                                          --------------------------------------------------------------------------------------
                                                    1st Quarter         2nd Quarter(1)         3rd Quarter           4th Quarter
                                          --------------------- -------------------- --------------------- ---------------------
<S>                                                   <C>                  <C>                   <C>                   <C>     
Net sales                                             $ 76,057             $ 78,808              $ 81,314              $ 92,704
Gross profit (loss)                                    (31,595)             (35,637)               (2,803)                7,283
Net loss                                               (58,158)            (261,884)              (27,449)              (18,845)

Basic loss per share                                    ($1.10)              ($4.95)               ($0.51)               ($0.35)
Diluted loss per share                                  ($1.10)              ($4.95)               ($0.51)               ($0.35)

                                                                                            1997
                                          --------------------------------------------------------------------------------------
                                                    1st Quarter           2nd Quarter         3rd Quarter(2)         4th Quarter
                                          --------------------- -------------------- --------------------- ---------------------
Net sales                                             $167,242             $175,121              $129,694              $159,025
Gross profit                                            39,315               35,661                   202                18,368
Net income (loss)                                       17,799               11,677               (52,748)                1,169

Basic income (loss) per share                         $   0.34             $   0.22                ($1.01)             $   0.02
Diluted income (loss) per share                       $   0.33             $   0.22                ($1.01)             $   0.02

<FN>
(1)  Results   for  the  second   quarter  of  1998   included  a   $187,768,000
     restructuring  charge which primarily related to an asset impairment charge
     of $175,000,000.  The asset  impairment  charge  effectively  reduced asset
     valuations  to reflect the economic  effect of industry  price  erosion for
     disk  media and  projected  underutilization  of the  Company's  production
     equipment and  facilities.  Based on analysis of the  Company's  production
     capacity and its  expectations  of the media market over the remaining life
     of the Company's fixed assets,  the Company  concluded that it would not be
     able to recover the book value of those assets.

(2)  Results for the third quarter of 1997 included a $52,157,000  restructuring
     charge to consolidate the Company's U.S. manufacturing operations.
</FN>
</TABLE>
NOTE 16.  SUBSEQUENT EVENT (UNAUDITED)

     In February 1999, the Company and Western Digital  announced the signing of
a letter of intent under which the Company will acquire  Western  Digital's disk
media  business  for  approximately  $80 million of the  Company's  Common Stock
(based on the market value of the Company's  Common Stock at the time the letter
of intent was signed). In addition, the Company will assume certain liabilities,
mainly lease obligations related to production  equipment and facilities.  Terms
of the strategic  relationship  include a three-year  volume purchase  agreement
under which Western Digital will buy a substantial portion of its media from the
Company.  The Company plans to combine  Western  Digital's  media group with its
manufacturing  operations  over the next 18 months.  Such action will relocate a
portion of Western  Digital's  production  equipment to the  Company's  offshore
locations,   thus  more  fully  utilizing  the  Company's  lower-cost  Malaysian
operations.  At the time of this filing the Company  and  Western  Digital  were
continuing to negotiate terms of the acquisition.

                                       63
<PAGE>

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

         Not Applicable.

                                    PART III

ITEMS 10, 11, 12 and 13.
<TABLE>
         Items  10  through  13 of Part  III  will be  contained  in the  Komag,
Incorporated  Proxy  Statement for the Annual Meeting of Stockholders to be held
May 25,  1999  (the  "1999  Proxy  Statement"),  which  will be  filed  with the
Securities  and  Exchange  Commission  no later  than May 5,  1999.  The  cross-
reference table below sets forth the captions under which the responses to these
items are found:
<CAPTION>
10-K Item     Description                                 Caption in 1999 Proxy Statement
---------     -----------                                 -------------------------------

<S>           <C>                                         <C>
10            Directors and Executive Officers            "Item No. 1--Election of Directors:
                                                                Nominees; Business
                                                                Experience of Directors and
                                                                Nominees" and "Additional
                                                                Information: Certain
                                                                Relationships and Related
                                                                Transactions; Other Matters"

11            Executive Compensation                      "Additional Information: Executive
                                                                Compensation and Related
                                                                Information"

12            Security Ownership of Certain Beneficial    "Additional Information: Principal
                  Owners and Management                         Stockholders"

13            Certain Relationships and Related           "Additional Information: Certain
                  Transactions                                  Relationships and Related
                                                                Transactions"
</TABLE>

         The information set forth under the captions listed above, contained in
the 1999  Proxy  Statement,  are  hereby  incorporated  herein by  reference  in
response to Items 10 through 13 of this Report on Form 10-K.

                                       64
<PAGE>

                                     PART IV

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

         (a) List of Documents filed as part of this Report.

         1.  Financial Statements.

         The following consolidated financial statements of Komag,  Incorporated
are filed in Part II, Item 8 of this Report on Form 10-K:

Consolidated  Statements  of  Operations--Fiscal   Years  1998,  1997  and  1996
Consolidated Balance  Sheets--January 3, 1999 and December 28, 1997 Consolidated
Statements  of  Cash  Flows--Fiscal  Years  1998,  1997  and  1996  Consolidated
Statements of  Stockholders'  Equity--Fiscal  Years 1998, 1997 and 1996 Notes to
Consolidated Financial Statements



         2.  Financial Statement Schedules.

         The following  financial  statement schedule of Komag,  Incorporated is
filed in Part IV, Item 14(d) of this report on Form 10-K:

Schedule II--Valuation and Qualifying Accounts

Report of Other Auditor
     --Report of Chuo Audit Corporation on Asahi Komag Co., Ltd.

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

                                       65
<PAGE>

    3.  Exhibits.

3.1       Amended and Restated  Certificate of  Incorporation  (incorporated  by
          reference from a similarly  numbered  exhibit filed with the Company's
          report on Form 10-Q for the quarter ended September 27, 1998).

3.2       Bylaws  (incorporated  by  reference  from  Exhibit 3.3 filed with the
          Company's report on Form 10-K for the year ended December 30, 1990).

4.2       Specimen Stock Certificate (incorporated by reference from a similarly
          numbered  exhibit  filed  with  Amendment  No.  1 to the  Registration
          Statement).

10.1.1    Lease  Agreement  dated May 24,  1991  between  Milpitas-Hillview  and
          Komag,  Incorporated  (incorporated  by reference  from Exhibit 10.1.2
          filed  with the  Company's  report  on Form  10-K  for the year  ended
          December 29, 1991).

10.1.3    Lease  Agreement  dated July 29, 1988 by and between Brokaw  Interests
          and Komag, Incorporated (incorporated by reference from Exhibit 10.1.6
          filed  with the  Company's  report  on Form  10-K  for the year  ended
          January 1, 1989).

10.1.4    Lease  Agreement  dated  May  2,  1989  by  and  between  Stony  Point
          Associates I and Komag  Material  Technology,  Inc.  (incorporated  by
          reference from Exhibit 10.1.6 filed with the Company's  report on Form
          10-K for the year ended December 31, 1989).

10.1.6    Second  Amendment  to Lease  dated  December  28,  1990 by and between
          Milpitas- Hillview and Komag, Incorporated  (incorporated by reference
          from Exhibit 10.1.12 filed with the Company's  report on Form 10-K for
          the year ended December 30, 1990).

10.1.7    First  Amendment to Lease dated  November 1, 1993 by and between Wells
          Fargo Bank et al and Komag Material Technology,  Inc. (incorporated by
          reference from Exhibit 10.1.14 filed with the Company's report on Form
          10-K for the year ended January 2, 1994).

10.1.9    Lease  Agreement  dated  August  4,  1995 by and  between  Great  Oaks
          Interests  and Komag,  Incorporated  (incorporated  by reference  from
          Exhibit  10.1.12 filed with the Company's  report on Form 10-Q for the
          quarter ended October 1, 1995).

10.1.10   First  Amendment to Lease dated  November 3, 1995 by and between Great
          Oaks Interests and Komag, Incorporated (incorporated by reference from
          Exhibit  10.1.10 filed with the Company's  report on Form 10-K for the
          year ended December 29, 1996).

10.1.11   Lease Agreement  (B10) dated May 24, 1996 between Sobrato  Development
          Companies #871 and Komag, Incorporated (incorporated by reference from
          Exhibit  10.1.11 filed with the Company's  report on Form 10-K for the
          year ended December 29, 1996).

10.1.12   Lease Agreement  (B11) dated May 24, 1996 between Sobrato  Development
          Companies #871 and Komag, Incorporated (incorporated by reference from
          Exhibit  10.1.12 filed with the Company's  report on Form 10-K for the
          year ended December 29, 1996).

10.2      Form  of  Directors'   Indemnification   Agreement   (incorporated  by
          reference  from Exhibit 10.9 filed with the  Company's  report on Form
          10-K for the year ended December 30, 1990).

                                       66
<PAGE>

10.3.1    Joint  Venture  Agreement by and among Komag,  Inc.;  Asahi Glass Co.,
          Ltd.;  and Vacuum  Metallurgical  Company  dated  November 9, 1986, as
          amended  January  7,  1987  and  January  27,  1987  (incorporated  by
          reference from Exhibit 10.10.1 filed with the  Registration  Statement
          on Form S-1--File No. 33-13663) (confidential treatment obtained as to
          certain portions).

10.3.2    General  Partnership  Agreement for Komag  Technology  Partners  dated
          January 7, 1987  (incorporated by reference from Exhibit 10.10.2 filed
          with the Registration Statement on Form S-1--File No. 33-13663).

10.3.3    Technology Contribution Agreement dated January 7, 1987 by and between
          Komag,  Incorporated  and Komag Technology  Partners  (incorporated by
          reference from Exhibit 10.10.3 filed with the  Registration  Statement
          on Form S-1--File No. 33-13663) (confidential treatment obtained as to
          certain portions).

10.3.4    Technical  Cooperation  Agreement dated January 7, 1986 by and between
          Asahi Glass Company,  Ltd. and Komag,  Incorporated  (incorporated  by
          reference from Exhibit 10.10.4 filed with the  Registration  Statement
          on Form S-1--File No. 33-13663).

10.3.5    Third Amendment to Joint Venture  Agreement by and among Komag,  Inc.;
          Asahi Glass Co., Ltd.; Vacuum Metallurgical Company; et al dated March
          21, 1990  (incorporated  by reference from Exhibit  10.10.5 filed with
          the  Company's  report on Form 10-K for the year  ended  December  31,
          1989).

10.3.6    Fourth Amendment to Joint Venture Agreement by and among Komag,  Inc.;
          Asahi Glass Co., Ltd.; Vacuum  Metallurgical  Company; et al dated May
          24, 1990  (incorporated  by reference from Exhibit 10.10.11 filed with
          the Company's report on Form 10-K for the year ended January 1, 1995).

10.3.7    Fifth Amendment to Joint Venture  Agreement by and among Komag,  Inc.,
          Asahi  Glass Co.,  Ltd.;  Vacuum  Metallurgical  Company;  et al dated
          November 4, 1994  (incorporated  by reference  from  Exhibit  10.10.12
          filed  with the  Company's  report  on Form  10-K  for the year  ended
          January 1, 1995).

10.3.8    Joint  Venture  Agreement  dated March 6, 1989 by and  between  Komag,
          Incorporated;  Komag  Material  Technology,  Inc.;  and Kobe Steel USA
          Holdings Inc.  (incorporated  by reference from Exhibit  10.10.6 filed
          with the Company's report on Form 10-K for the year ended December 31,
          1989) (confidential treatment obtained as to certain portions).

10.3.9    Joint Development and Cross-License  Agreement dated March 10, 1989 by
          and between Komag, Incorporated;  Kobe Steel, Ltd.; and Komag Material
          Technology, Inc. (incorporated by reference from Exhibit 10.10.7 filed
          with the Company's report on Form 10-K for the year ended December 31,
          1989).

10.3.10   Blank Sales  Agreement  dated  March 10,  1989 by and  between  Komag,
          Incorporated;  Kobe Steel, Ltd.; and Komag Material  Technology,  Inc.
          (incorporated  by reference  from a similarly  numbered  exhibit filed
          with the Company's report on Form 10-K for the year ended December 31,
          1989).

10.3.11   Finished  Substrate  Agreement  dated  March 10,  1989 by and  between
          Komag, Incorporated;  Kobe Steel, Ltd.; and Komag Material Technology,
          Inc.  (incorporated  by reference from Exhibit  10.10.9 filed with the
          Company's  report on Form 10-K for the year ended  December  31, 1989)
          (confidential treatment obtained as to certain portions).

                                       67
<PAGE>

10.3.12   Stock Purchase  Agreement  between Komag,  Incorporated and Kobe Steel
          USA Holdings Inc. dated November 17, 1995  (incorporated  by reference
          from a similarly  numbered  exhibit filed with the Company's report on
          Form 10-K for the year ended December 31, 1995).

10.3.13   Substrate  Agreement  by and  between  Kobe  Steel,  Ltd.  and  Komag,
          Incorporated dated November 17, 1995 (incorporated by reference from a
          similarly  numbered  exhibit filed with the  Company's  report on Form
          10-K for the year ended  December  31, 1995)  (confidential  treatment
          obtained as to certain portions).

10.3.14   License Amendment Agreement among Komag, Incorporated;  Komag Material
          Technology,  Inc.;  and Kobe  Steel,  Ltd.  dated  November  17,  1995
          (incorporated  by reference  from a similarly  numbered  exhibit filed
          with the Company's report on Form 10-K for the year ended December 31,
          1995).

10.3.15   Substrate Sales Amendment Agreement among Komag,  Incorporated;  Komag
          Material  Technology,  Inc.;  and Kobe Steel,  Ltd. dated November 17,
          1995  (incorporated  by reference  from a similarly  numbered  exhibit
          filed  with the  Company's  report  on Form  10-K  for the year  ended
          December 31, 1995).

10.3.16   Joint Venture  Amendment  Agreement among Komag,  Incorporated;  Komag
          Material  Technology,  Inc.;  and Kobe Steel USA Holdings  Inc.  dated
          November 17, 1995 (incorporated by reference from a similarly numbered
          exhibit  filed  with the  Company's  report  on Form 10-K for the year
          ended  December  31,  1995)  (confidential  treatment  obtained  as to
          certain portions).

10.4.1    Restated 1987 Stock Option Plan,  effective January 31, 1996 and forms
          of agreement  thereunder  (incorporated  by reference from a similarly
          numbered  exhibit filed with the Company's report on Form 10-Q for the
          quarter ended June 30, 1996).

10.4.2    Komag,  Incorporated  Management  Bonus Plan As Amended  and  Restated
          January 22, 1997.

10.4.3    1988 Employee Stock Purchase Plan Joinder Agreement dated July 1, 1993
          between   Komag,   Incorporated   and   Komag  USA   (Malaysia)   Sdn.
          (incorporated  by  reference  from  Exhibit  10.11.11  filed  with the
          Company's report on Form 10-K for the year ended January 2, 1994).

10.4.4    Komag,   Incorporated   Discretionary   Bonus  Plan  (incorporated  by
          reference from Exhibit 10.4.4 filed with the Company's  report on Form
          10-K for the year ended December 29, 1996).

10.4.5    Komag,  Incorporated 1997 Supplemental  Stock Option Plan Amended June
          12, 1998.

10.5.1    Komag,   Incorporated  Deferred  Compensation  Plan  (incorporated  by
          reference from a similarly  numbered  exhibit filed with the Company's
          report on Form 10-K for the year ended January 1, 1995).

10.5.2    Amendment  No. 1 to Komag,  Incorporated  Deferred  Compensation  Plan
          dated January 1, 1997  (incorporated  by reference from Exhibit 10.5.2
          filed  with the  Company's  report  on Form  10-K  for the year  ended
          December 29, 1996).

                                       68
<PAGE>

10.5.3    Komag Material  Technology,  Inc. 1995 Stock Option Plan (incorporated
          by reference from Exhibit  10.11.12 filed with the Company's report on
          Form 10-Q for the Quarter ended October 1, 1995).

10.6      Common Stock Purchase  Agreement dated December 9, 1988 by and between
          Komag,  Incorporated  and  Asahi  Glass  Co.,  Ltd.  (incorporated  by
          reference  from Exhibit 1 filed with the Company's  report on Form 8-K
          filed with the  Securities  and  Exchange  Commission  on December 20,
          1988).

10.7      Common Stock Purchase  Agreement dated February 6, 1990 by and between
          Komag,  Incorporated and Kobe Steel USA Holdings Inc. (incorporated by
          reference  from Exhibit 10.17 filed with the Company's  report on Form
          10-K for the year ended December 31, 1989).

10.8      Registration  Rights  Agreement  dated  March 21,  1990 by and between
          Komag,  Incorporated and Kobe Steel USA Holdings Inc. (incorporated by
          reference  from Exhibit 10.18 filed with the Company's  report on Form
          10-K for the year ended December 31, 1989).

10.9      Amendment  No. 1 to Common Stock  Purchase  Agreement  dated March 21,
          1990 by and between  Komag,  Incorporated  and Asahi  Glass Co.,  Ltd.
          (incorporated by reference from Exhibit 10.19 filed with Amendment No.
          1 to the Registration Statement filed with the Securities and Exchange
          Commission on May 26, 1987).

10.10     Amended and Restated  Registration  Rights  Agreement  dated March 21,
          1990 by and between  Komag,  Incorporated  and Asahi  Glass Co.,  Ltd.
          (incorporated by reference from Exhibit 10.20 filed with Amendment No.
          1 to the Registration Statement filed with the Securities and Exchange
          Commission on May 26, 1987).

10.11     Letter  dated   February  10,  1992  from  the  Malaysian   Industrial
          Development Authority addressed to Komag,  Incorporated  approving the
          "Pioneer Status" of the Company's  thin-film media venture in Malaysia
          (incorporated by reference from Exhibit 10.28 filed with the Company's
          report on Form 10-K for the year ended January 3, 1993).

10.12     Credit Agreement  between Komag,  Incorporated and The Industrial Bank
          of Japan,  Limited,  San  Francisco  Agency  dated  December  15, 1995
          (incorporated by reference from Exhibit 10.16 filed with the Company's
          report on Form 10-K for the year ended December 31, 1995).

10.13     First Amendment to Credit Agreement by and between Komag, Incorporated
          and The Industrial Bank of Japan,  Limited, San Francisco Agency dated
          November 19, 1996  (incorporated  by reference to Exhibit  10.17 filed
          with the Company's report on Form 10-K for the year ended December 29,
          1996).

10.14     Second   Amendment  to  Credit   Agreement   by  and  between   Komag,
          Incorporated and The Industrial Bank of Japan,  Limited, San Francisco
          Agency dated  January 31, 1997  (incorporated  by reference to Exhibit
          10.18 filed with the Company's  report on Form 10-K for the year ended
          December 29, 1996).

10.15     Credit Agreement  between Komag,  Incorporated and The Dai-Ichi Kangyo
          Bank,   Limited,   San   Francisco   Agency  dated   October  7,  1996
          (incorporated  by reference to Exhibit  10.19 filed with the Company's
          report on Form 10-K for the year ended December 29, 1996).

                                       69
<PAGE>

10.16     First Amendment to Credit  Agreement  between Komag,  Incorporated and
          The Dai-Ichi Kangyo Bank, Limited, San Francisco Agency dated November
          25, 1996  (incorporated  by reference to Exhibit  10.20 filed with the
          Company's report on Form 10-K for the year ended December 29, 1996).

10.17     Credit   Agreement   dated  as  of  February  7,  1997  among   Komag,
          Incorporated,  institutional lenders and The Industrial Bank of Japan,
          Limited,  San Francisco Agency, as agent for the  lenders(incorporated
          by reference to Exhibit 10.22 filed with the Company's  report on Form
          10-K for the year ended December 29, 1996).

10.18     Amended and Restated Credit  Agreement Among Komag,  Incorporated  and
          BankBoston,  N.A. as agent  (incorporated  by  reference  from Exhibit
          10.23  filed with the  Company's  report on Form 10-Q for the  quarter
          ended June 29, 1997).

10.19     First Amendment to Amended and Restated Credit Agreement dated October
          9, 1997  among  Komag,  Incorporated  and  BankBoston,  N.A.  as agent
          (incorporated by reference from Exhibit 10.24 filed with the Company's
          report on Form 10-Q for the quarter ended September 28, 1997).

10.20     Second  Amendment to Amended and Restated Credit Agreement dated March
          23,  1998 among  Komag,  Incorporated  and  BankBoston,  N.A. as agent
          (incorporated by reference from Exhibit 10.20 filed with the Company's
          report on Form 10-Q for the quarter ended March 29, 1998).

21        List of Subsidiaries.

23.1      Consent of Ernst & Young LLP.

23.2      Consent of Chuo Audit Corporation.

24        Power of Attorney.  Reference is made to the  signature  pages of this
          Report.

27        Financial Data Schedule.

-----------------
The  Company  agrees to furnish  to the  Commission  upon  request a copy of any
instrument  with respect to long-term  debt where the total amount of securities
authorized thereunder does not exceed 10% of the total assets of the Company.

 (b) Reports on Form 8-K.

         Not Applicable


                                       70
<PAGE>

Undertaking

         For  the  purposes  of  complying  with  the  amendments  to the  rules
governing Form S-8  (effective  July 13, 1990) under the Securities Act of 1933,
the undersigned registrant hereby undertakes as follows:

         Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors,  officers or  controlling  persons of
the  registrant  pursuant  to  the  foregoing  provisions,   or  otherwise,  the
registrant  has been advised that in the opinion of the  Securities and Exchange
Commission  such  indemnification  is against  public policy as expressed in the
1933  Act  and is,  therefore,  unenforceable.  In the  event  that a claim  for
indemnification  against  such  liabilities  (other  than  the  payment  by  the
registrant of expenses  incurred or paid by a director,  officer or  controlling
person of the  registrant  in the  successful  defense  of any  action,  suit or
proceeding)  is  asserted by such  director,  officer or  controlling  person in
connection  with the  securities  being  registered  on the Form S-8  identified
below, the registrant will,  unless in the opinion of its counsel the matter has
been  settled  by  controlling  precedent,  submit  to a  court  of  appropriate
jurisdiction the question whether such  indemnification  by it is against public
policy  as  expressed  in the  1933  Act  and  will  be  governed  by the  final
adjudication of such issue.

         The  preceding  undertaking  shall be  incorporated  by reference  into
registrant's Registration Statements on Form S-8 Nos. 33-16625 (filed August 19,
1987),  33-19851  (filed January 28, 1988),  33-25230  (filed October 28, 1988),
33-41945  (filed July 29, 1991),  33-45469  (filed  February 3, 1992),  33-53432
(filed  October 16,  1992),  33-80594  (filed June 22,  1994),  33-62543  (filed
September 12, 1995), 333-06081 (filed June 14, 1996), 333-23095 (filed March 11,
1997), 333-31297 (filed July 15, 1997) and 333-48867 (filed March 30, 1998).

                                       71
<PAGE>

SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in San Jose, California on
this 31st day of March, 1999.

                               Komag, Incorporated

                                          By  /s/ Stephen C. Johnson
                                              ----------------------
                                                  Stephen C. Johnson
                                          President and Chief Executive Officer







                                POWER OF ATTORNEY

         KNOW ALL PERSONS BY THESE  PRESENTS,  that each person whose  signature
appears herein constitutes and appoints Stephen C. Johnson and William L. Potts,
Jr., and each of them, as his true and lawful attorneys-in-fact and agents, with
full power of substitution  and  resubstitution,  for him and in his name, place
and stead,  in any and all  capacities,  to sign any and all  amendments to this
Report on Form 10-K, and to file the same, with all exhibits thereto,  and other
documents in connection therewith,  with the Securities and Exchange Commission,
granting unto said  attorneys-in-fact  and agents,  and each of them, full power
and  authority  to do and  perform  each and every act and thing  requisite  and
necessary  to be done in  connection  therewith,  as  fully to all  intents  and
purposes as he might or could do in person,  hereby ratifying and confirming all
that  said  attorneys-in-fact  and  agents,  or any of  them,  or  their  or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.


                                       72
<PAGE>

<TABLE>
         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this report has been signed by the following  persons in the  capacities  and on
the dates indicated:
<CAPTION>

         Name                            Title                                       Date
<S>                                <C>                                         <C>
  TU CHEN                          Chairman of the Board                       March 31, 1999
-----------------------              and Director
 (Tu Chen)


  STEPHEN C. JOHNSON               President and Chief Executive
----------------------                Officer
 (Stephen C. Johnson)                                                          March 31, 1999


  WILLIAM L. POTTS, JR.            Senior Vice President, Chief                March 31, 1999
------------------------             Financial Officer and Secretary 
 (William L. Potts, Jr.)            (Principal Financial and         
                                     Accounting Officer)             


  CRAIG R. BARRETT                 Director                                    March 31, 1999
--------------------
 (Craig R. Barrett)


  CHRIS A. EYRE                    Director                                    March 31, 1999
-----------------
 (Chris A. Eyre)


  IRWIN FEDERMAN                   Director                                    March 31, 1999
-----------------
 (Irwin Federman)


  GEORGE A. NEIL                   Director                                    March 31, 1999
-----------------
 (George A. Neil)


  MAX PALEVSKY                     Director                                    March 31, 1999
---------------
 (Max Palevsky)


  ANTHONY SUN                      Director                                    March 31, 1999
--------------
 (Anthony Sun)


  MASAYOSHI TAKEBAYASHI            Director                                    March 31, 1999
------------------------
 (Masayoshi Takebayashi)


*By WILLIAM L. POTTS, JR.
   ----------------------
   (William L. Potts, Jr.,
     Attorney-in-Fact)

</TABLE>

                                       73
<PAGE>

ITEM 14(d) FINANCIAL STATEMENT SCHEDULES
<TABLE>
                                                    KOMAG, INCORPORATED
                                      Schedule II--VALUATION AND QUALIFYING ACCOUNTS
                                                      (in thousands)
<CAPTION>

Col. A                                                      Col. B          Col. C          Col. D           Col. E
------                                                      ------          ------          ------           ------
                                                                            Additions
                                                            Balance at      Charged to                       Balance
                                                            Beginning       Costs and                        at End
Description                                                 of Period       Expenses        Deductions       of Period
-----------                                                 ---------       --------        ----------       ---------
<S>                                                           <C>           <C>             <C>                <C>
Year ended December 29, 1996
        Allowance for doubtful accounts                       $3,006        $(1,011)        $     11           $ 1,984
        Allowance for sales returns                            1,273          3,528(1)         3,698(2)          1,103
                                                          -------------   --------------  --------------- -----------------
                                                              $4,279        $ 2,517         $  3,709           $ 3,087
                                                          =============   ==============  =============== =================
                                                                       
Year ended December 28, 1997                                           
        Allowance for doubtful accounts                       $1,984        $ 1,286             ($28)          $ 3,298
        Allowance for sales returns                            1,103          7,145(1)         7,122(2)          1,126
                                                          -------------   --------------  --------------- -----------------
           Sub total                                           3,087          8,431            7,094             4,424
        Restructuring liability                                    -         52,157(3)        40,904(4)         11,253
                                                          -------------   --------------  --------------- -----------------
                                                              $3,087        $60,588         $ 47,998           $15,677
                                                          =============   ==============  =============== =================
                                                                       
Year ended January 3, 1999                                             
        Allowance for doubtful accounts                       $3,298        ($1,125)        $      8           $ 2,165
        Allowance for sales returns                            1,126          7,654(1)         8,098(2)            682
                                                          -------------   --------------  --------------- -----------------
           Sub total                                           4,424          6,529            8,106             2,847
        Restructuring liability                               11,253        187,768(5)       194,893(6)          4,128
                                                          -------------   --------------  --------------- -----------------
                                                             $15,677       $194,297         $202,999           $ 6,975
                                                          =============   ==============  =============== =================
<FN>
(1)  Additions to the allowance for sales returns are netted against sales.
(2)  Actual sales returns of subsequently  scrapped product were charged against
     the allowance for sales  returns.  Actual sales returns of product that was
     subsequently  tested and shipped to another  customer were netted  directly
     against sales.
(3)  The Company  recorded a restructuring  charge of $52,157,000 to consolidate
     its U.S. manufacturing operations
(4)  Charges against the  restructuring  liability  included non-cash charges of
     $33,013,000  for the  write-off  of the net  book  value of  equipment  and
     leaseholds,  and cash charges of approximately $7,891,000 for severance and
     equipment related costs.
(5)  The Company recorded a restructuring charge of $187,768,000 which primarily
     related to an asset  impairment  charge due to industry  price  erosion for
     disk media and the projected  underutilization of the Company's  production
     equipment and facilities.
(6)  Charges against the  restructuring  liability  included non-cash charges of
     $175,000,000  for  the  asset   impairment   charge  and  cash  charges  of
     approximately $19,893,000 for severance and equipment related costs.
</FN>
</TABLE>

                                       74
<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors
Asahi Komag Co., Ltd.

     We have audited the accompanying consolidated balance sheets of Asahi Komag
Co., Ltd. and its subsidiary  (the  "Company") as of December 31, 1998 and 1997,
and the consolidated statements of income, cash flows, and changes in equity for
the years ended December 31, 1998, 1997 and 1996. 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  auditing  standards  generally
accepted in the United States of America.  These 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,  based on our audit, the financial  statements  referred to
above present  fairly,  in all material  respects,  the  consolidated  financial
position of the Company as of December 31, 1998 and 1997,  and the  consolidated
results of its  operations  and its cash flows for the years ended  December 31,
1998, 1997 and 1996 in conformity with generally accepted accounting  principles
applicable in the United States of America.

     The consolidated financial statements as of and for the year ended December
31,  1998 have  been  translated  into  United  States  Dollars  solely  for the
convenience  of the  reader.  Our audit  included  the  translation,  and in our
opinion such  translation  has been made in accordance  with the basis stated in
note 2h to the consolidated financial statements.

                             CHUO AUDIT CORPORATION

Tokyo, Japan

January 22, 1999


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<PAGE>



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