<PAGE>



          UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                      Washington, DC   20549

                            FORM 10-Q

     (X)  Quarterly Report Pursuant to Section 13 or 15(d) of
          the Securities Exchange Act of 1934

          For the quarterly period ended June 30, 1998

                                or

     ( )  Transition Report Pursuant to Section 13 or 15(d)
          of the Securities Exchange Act of 1934

                  Commission File Number 0-12194

                         ZITEL CORPORATION
     (Exact name of Registrant as specified in its charter)



           California                        94-2566313
   (State or other jurisdiction of       (I.R.S. Employer
   incorporation or organization)       Identification No.)

     47211 Bayside Parkway                   94538-6517
      Fremont, California                    (Zip Code)
(Address of principal executive offices)


Registrant's telephone number, including area code:  (510) 440-9600


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 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 _____

The number of shares of the Registrant's Common Stock outstanding as of June 30,
1998, was 17,766,606.



<PAGE>
              ZITEL CORPORATION AND SUBSIDIARIES


                             INDEX


<TABLE>
<CAPTION>

                                                            Page
                                                           Number
<S>                                                        <C>
PART I.   Financial Information

  Item 1.  Financial Statements

     Condensed Consolidated Balance Sheets
       June 30, 1998 (unaudited) and September 30, 1997 .....  3

     Condensed Consolidated Statements of
       Operations (unaudited) - Three and Nine Months
        Ended June 30, 1998 and 1997 ........................  4

     Condensed Consolidated Statements of
       Cash Flows (unaudited) - Nine Months Ended
       June 30, 1998 and 1997 ...............................  5

     Notes to Condensed Consolidated
       Financial Statements .................................  7

  Item 2.   Management's Discussion and Analysis of
            Financial Condition and Results
              of Operations ................................. 13

PART II.   Other Information

  Item 5.  Other Information ................................ 18

  Item 6.  Exhibits and Reports on Form 8-K ................. 27

</TABLE>


                                   Page 2

<PAGE>

                  ZITEL CORPORATION AND SUBSIDIARIES
                CONDENSED CONSOLIDATED BALANCE SHEETS
                           ($000's)

<TABLE>
<CAPTION>

                                      (UNAUDITED)
                                        June 30,  September 30,
                                         1998         1997
                                      ----------- -------------
<S>                                   <C>         <C>
     ASSETS
Current assets:
  Cash and cash equivalents            $ 11,751      $  4,224
  Short-term investments                      0         9,596
  Accounts receivable, net                3,762         6,547
  Inventories                               207         3,050
  Deferred and refundable taxes             208         3,540
  Other current assets                    1,935           993
                                       --------      --------
    Total current assets                 17,863        27,950

Fixed assets, net                         1,442         3,700
Intangible assets, net                    4,581         5,846
Other assets, net                         9,396        11,798
                                       --------      --------
  Total assets                         $ 33,282      $ 49,294
                                       ========      ========

     LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable                     $  4,200      $  4,768
  Accrued liabilities                     4,523         4,419
                                       --------      --------
    Total current liabilities             8,723         9,187
Convertible subordinated debt            15,372        24,161
                                       --------      --------
    Total liabilities                    24,095        33,348
                                       --------      --------
Shareholders' equity:
  Common stock                           48,835        27,081
  Accumulated deficit                   (39,648)      (11,135)
                                       --------      --------
  Total shareholders' equity              9,187        15,946
                                       --------      --------
  Total liabilities and 
    shareholders' equity               $ 33,282      $ 49,294
                                       ========      ========

</TABLE>

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

                             Page 3
<PAGE>

               ZITEL CORPORATION AND SUBSIDIARIES
         CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                          (UNAUDITED)
                (In thousands except per share data)


<TABLE>
<CAPTION>
                          Three Months Ended   Nine Months Ended
                               June 30,            June 30,
                          ------------------  ------------------
                            1998      1997      1998      1997
                          --------  --------  --------  --------
<S>                       <C>       <C>       <C>       <C>
Net sales                 $  4,591  $  2,215  $ 16,137  $  7,057
Royalty revenue                749     1,137     1,541     4,651
                          --------  --------  --------  --------
  Total revenue              5,340     3,352    17,678    11,708
Cost of goods sold           4,445     1,707    10,240     6,243
Research and development 
  expenses                   1,616     1,671     5,567     4,906
Selling, general & 
  administrative expenses    7,614     3,291    19,474     8,789
Loss on impairment
  of assets                  1,956         0     1,956         0
Acquisition of 
  in-process R&D                 0     6,600         0     6,600
                          --------  --------  --------  --------
  Operating loss           (10,291)   (9,917)  (19,559)  (14,830)

Interest expense             1,401     1,397     2,409     1,397
Other (income) expense         288      (234)       (2)   (1,269)
                          --------  --------  --------  --------
Loss before income taxes   (11,980)  (11,080)  (21,966)  (14,958)
Provision for (benefit 
  from) income taxes         6,547    (3,107)    6,547    (4,503)
                          --------  --------  --------  --------
Net loss                  $(18,527) $ (7,973) $(28,513) $(10,455)
                          ========  ========  ========  ========

Basic and diluted loss 
  per share               $  (1.07) $   (.52) $  (1.73) $   (.69)
                          ========  ========  ========  ========

Number of shares used in 
  basic and diluted loss 
  per share calculations    17,235    15,280    16,528    15,157
                          ========  ========  ========  ========

</TABLE>

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

                                Page 4
<PAGE>

              ZITEL CORPORATION AND SUBSIDIARIES
        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                            ($000's)

<TABLE>
<CAPTION>
                                                      (UNAUDITED)
                                                  Nine Months Ended
                                                        June 30,
                                                    1998      1997
                                                  --------  --------
<S>                                               <C>       <C>
Cash flows provided by (used in) operating 
  activities:
  Net loss                                        $(28,513) $(10,455)
  Adjustments to reconcile net loss to net cash
   provided by (used in) operating activities:
    Acquisition of in-process R&D                        0     6,600
    Decrease (increase) in deferred and
     refundable taxes                                6,509    (4,745)
    Loss on impairment of assets                     1,956         0
    Writedown of inventory                             888         0
    Writeoff of patents                                387         0
    Adjustment of goodwill and purchased technology    658         0
    Discount amortization on subordinated debentures 1,111     1,204
    Amortization of capitalized financing costs        672         0
    Depreciation and amortization                    2,338       923
    Provision for doubtful accounts                    155       147
    Provision for inventory allowances                 160       360
    Gain on sale of trading securities                   0      (777)
    Equity in loss of unconsolidated company           410         0
    Change in operating assets and liabilities:
    Decrease (increase) in accounts receivable       2,630    (1,642)
    Decrease in inventories                          1,795       469
    Increase in other current assets                  (942)     (192)
    Increase (decrease) in accounts payable           (568)    2,000
    Increase in accrued liabilities                    719     1,764
                                                  --------  --------
 Net cash used in operating activities              (9,635)   (4,344)
                                                  --------  --------
Cash flows provided by (used in) investing activities:
    Purchase of fixed assets                          (549)   (1,980)
    Purchase of other assets                        (1,180)     (618)
    Investment in unconsolidated company            (1,510)   (2,024)
    Proceeds from sale of marketable securities      9,596     3,159
    Purchase of companies, net of cash acquired          0   (11,062)
                                                  --------  --------
 Net cash provided by (used in) 
  investing activities                               6,357   (12,525)
                                                  --------  --------

</TABLE>

                                Page 5
<PAGE>

              ZITEL CORPORATION AND SUBSIDIARIES
        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                          (continued)
                            ($000's)

<TABLE>
<CAPTION>
                                                      (UNAUDITED)
                                                  Nine Months Ended
                                                        June 30,
                                                    1998       1997
                                                  --------   -------
<S>                                               <C>        <C>
Cash flows provided by financing activities:
   Issuance of common stock                        $ 1,238   $ 1,200
   Issuance of subordinated debentures               9,567    23,795
                                                   -------   -------
 Net cash provided by financing activities          10,805    24,995
                                                   -------   -------
 Net increase in cash                                7,527     8,126
Cash and cash equivalents, beginning of year         4,224     9,216
                                                   -------   -------
Cash and cash equivalents, end of period           $11,751   $17,342
                                                   =======   =======

Supplemental non-cash investing and financing activities:

  Issuance of common stock in business combination $     0   $ 1,200
                                                   =======   =======

  Professional costs incurred in placement of
    subordinated debentures                        $   558   $ 1,205
                                                   =======   =======

  Conversion of 5% subordinated debt and
    accrued interest                               $18,791   $     0
                                                   =======   =======

  Common stock purchase warrants                   $   614   $     0
                                                   =======   =======
</TABLE>

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



                             Page 6
<PAGE>

               ZITEL CORPORATION AND SUBSIDIARIES

       NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                           (UNAUDITED)
            (Amounts in thousands except per share data)

1.  The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission and should be read in conjunction with
the audited financial statements of the Company.  Certain information and
footnote disclosures, normally included in financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted although the Company believes the disclosures which are made are
adequate to make the information presented not misleading.  Further, the
condensed consolidated financial statements reflect, in the opinion of
management, all adjustments necessary to present fairly the financial position
and results of operations as of and for the periods indicated.  The results of
operations for the period ended June 30, 1998 are not necessarily indicative of
the results expected for the full year.  The Company has sustained recurring
losses related primarily to lower than anticipated revenues.

2.  Recent Accounting Pronouncements:
    In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income".  SFAS No. 130 establishes standards for the reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements.  Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources.  The impact of adopting SFAS
No. 130, which is effective for the Company in fiscal year 1999, has not been
determined.

    In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information".  SFAS No. 131 requires publicly-held
companies to report financial and other information about key revenue-producing
segments of the entity for which such information is available and is utilized
by the chief operations decision maker.  Specific information to be reported for
individual segments includes profit or loss, certain revenue and expense items
and total assets.  A reconciliation of

                             Page 7
<PAGE>

segment financial information to amounts reported in the financial statements
would be provided.  SFAS No. 131 is effective for the Company in fiscal year
1999 and the impact of adoption has not been determined.

    On October 27, 1997, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 97-2, "Software Revenue Recognition".
SOP 97-2 establishes the standard for the appropriate recognition of software
revenue, effective for the Company in fiscal year 1999.  The effect of the new
SOP 97-2 has yet to be determined.

3.  Inventories:

<TABLE>
<CAPTION>

                               June 30,        September 30,
                                1998               1997
                            ------------       -------------
     <S>                    <C>                <C>
     Raw materials             $    0             $  953
     Work in process                0                576
     Finished goods               207              1,521
                               ------             ------
                               $  207             $3,050
                               ======             ======
</TABLE>

    Inventory at June 30, 1998, consists primarily of finished goods inventory
related to the Company's Year 2000 Services business.  During the quarter, the
Company wrote inventory down to its net realizable value and incurred a related
write-off of $888 thousand.

4.  Intangible Assets:
    Intangible assets include goodwill and purchased technology, recorded in
connection with the acquisition of the three software companies, which were
being amortized on a straight-line basis over seven and five years,
respectively.  The Company periodically assesses the recoverability of the
intangible assets by determining whether the amortization of the asset balance
over its remaining life can be recovered through undiscounted future operating
cash flows of the acquired operation.  The amount of impairment, if any, is
measured based on projected discounted future operating cash flows and is
recognized as a write down of the asset to net realizable value.  At June 30,
1998, a write-down of a combined total of $658 thousand was made to goodwill and
purchased technology.  In addition, the amortization period of goodwill was
adjusted to five years from seven years.  As of June 30, 1998, intangible assets
consist of the following:

                             Page 8

<PAGE>

<TABLE>

                                       June 30,     September 30,
                                        1998            1997
                                       --------     -------------
    <S>                                <C>          <C>
    Goodwill                            $3,018          $3,242
    Purchased technology                 2,588           2,862
    Less accumulated amortization       (1,025)           (258)
                                        ------          ------
                                        $4,581          $5,846
                                        ======          ======
</TABLE>

5.  Deferred Software Implementation Costs:
    The Company capitalizes substantially all costs related to the purchase of
software and its implementation which includes purchased software, consulting
fees and the use of certain specified Company resources, and are being amortized
on a straight-line basis over the estimated life of the computer software, which
is five years.  In June 1998, the Company wrote down the cost of amounts
capitalized in the amount of $742 thousand and the related accumulated
amortization of $192 thousand.  As of June 30, 1998, $351 thousand in costs
remains unamortized and are included in other long-term assets.  Amortization in
the amount of $170 thousand has been charged to expense during the nine-month
period in fiscal 1998.  Amortization of $111 thousand had been charged to
expense in fiscal year 1997.

6.  Investment in Unconsolidated Company:
    During the quarter ended December 31, 1997, Zitel invested an additional
$1.5 million in MatriDigm Corporation in exchange for a convertible promissory
note.  The note was converted into 1,050 thousand shares of common stock in May
1998.  As of June 30, 1998, the Company's investment in MatriDigm Corporation
amounted to $7.4 million, consisting of 10.6 million shares of preferred stock
and approximately 1.6 million shares of common stock.  The Company recorded $410
thousand equity in losses of the unconsolidated company during the quarter ended
June 30, 1998.  The Company also guaranteed a bank loan in the amount of $1
million, which is classified in other current assets.

7.  Line of Credit:
    In April 1998, the Company obtained a $1.5 million secured bank line of
credit.  The line of credit expires on September 30, 1998.  Advances bear
interest at the bank's prime rate plus 1% (9.5% at June 30, 1998).  Under terms
of the agreement, the borrowing base is 75% of eligible domestic and foreign
insured accounts receivable.  Payment of interest is on a monthly basis, with
principal limited to the borrowing base and is due upon 

                             Page 9
<PAGE>

maturity.  In addition, the Company is required to maintain certain specified
financial ratios.  During the quarter ended June 30, 1998, the Company was in
violation of certain covenants, which were waived by the bank.  During the
quarter ended June 30, 1998, the line of credit was not utilized.

8.  Convertible Subordinated Debentures:
    The current quarter includes a charge to interest expense in 
the amount of $169 thousand related to the amortization of the capitalized
financing costs on the 5% convertible subordinated debentures.  For the nine
months ended June 30, 1998, approximately $18.8 million was converted into 1.9
million shares of common stock at an average price of $10.068 per share.

    On June 16, 1998, the Company issued $10,000,000 principal amount of 3%
Convertible Subordinated Debentures (the "Debentures") which are due June 15,
1999, and five-year common stock purchase warrants totalling 150,000 shares of
the Company's common stock.  The Debentures include a 10% discount of
$1,111,000, which was charged to interest expense in the current quarter.  The
Debentures accrue interest at the rate of 3% per annum and principal and accrued
interest are convertible into common stock of the Company at a price of
$3.92625.  The warrants were valued at $5.1041 and will be amortized over the
life of the Debentures.  Any Debentures outstanding on June 15, 1999, will be
automatically converted into common stock.  The Debentures restrict
distributions and repurchases of capital stock.  Reference is made to the
Company's current report on Form 8-K dated June 25, 1998 for additional
information about the Debentures.

9.  Earnings Per Share (EPS):
    The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("SFAS 128"), effective December 31,
1997.  SFAS 128 requires the presentation of basic and diluted earnings per
share.  Basic EPS is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period.  Diluted EPS is computed giving effect to all dilutive potential common
shares that were outstanding during the period.  Dilutive potential common
shares consist of the incremental common shares issuable upon the conversion of
convertible subordinated debt (using the "if converted" method) and exercise of
stock options and warrants for all periods.  All prior period earnings per share
amounts have been restated to comply with the SFAS 128.

                             Page 10
<PAGE>

    In accordance with the disclosure requirements of SFAS 128, a reconciliation
of the numerator and denominator of basic and diluted EPS is provided as follow
(in thousands, except per share amounts):

<TABLE>
<CAPTION>

                                      Three Months Ended  Nine Months Ended
                                           June 30,            June 30,
                                      ------------------  ------------------
                                        l998      1997      1998     1997
                                      --------  --------  --------  --------
<S>                                   <C>       <C>       <C>       <C>
Numerator - Basic and Diluted EPS
  Net loss                            $(18,527) $ (7,973) $(28,513) $(10,455)
                                      ========  ========  ========  ========
Denominator - Basic EPS
  Common stock outstanding              17,235    15,280    16,528    15,157
  Common equivalent stock                    0         0         0         0
                                      --------  --------  --------  --------
                                        17,235    15,280    16,528    15,157
                                      --------  --------  --------  --------
Basic loss per share                  $  (1.07) $   (.52) $  (1.73) $   (.69)
                                      ========  ========  ========  ========

Denominator - Diluted EPS
  Denominator - Basic EPS               17,235    15,280    16,528    15,157
  Effect of Dilutive Securities:
    Common stock options                     0         0         0         0
    Convertible preferred stock              0         0         0         0
                                      --------  --------  --------  --------
                                        17,235    15,280    16,528    15,157
                                      --------  --------  --------  --------
Diluted loss per share                $  (1.07) $   (.52) $  (1.73) $   (.69)
                                      ========  ========  ========  ========
</TABLE>

    For the quarter and nine-month period ended June 30, 1998, options to
purchase 459 thousand and 649 thousand shares, respectively, were not included
in the computation of diluted EPS because of the anti-dilutive effect of
including these shares in the calculation for both periods.  For the quarter and
nine-month period ended June 30, 1997, options to purchase 1,061 thousand and
1,302 thousand shares, respectively, were not 
included in the computation of diluted EPS because of the anti-dilutive effect
of including these shares in the calculation for both periods.  In addition, had
the subordinated debt been converted, it would have resulted in approximately
4,129 thousand and 499 thousand shares for the three months ended and 2,482
thousand and 499 thousand shares for the nine months ended June 30, 1998 and
1997, respectively.  These shares were not included in the computation due to
their anti-dilutive effect.

10. Sale of Storage Business Unit:
    On July 24, 1998, the Company completed the sale of the 

                             Page 11
<PAGE>

storage business unit for cash and a note totalling $1,000,000 and royalties of
up to $4,000,000 payable over four years based on the sales performance of the
new company.  Included in the current quarter are costs related to the operation
of the storage business unit of approximately $1.4 million, severance costs of
$1.0 million, excess capacity of the Fremont facility of $750 thousand, and the
write-off of assets of the storage business unit in the amount of $4.0 million.

11. Deferred Taxes:
    Due to the uncertainty surrounding the realization of the NOL and credit
carryforwards in future tax years, the Company has established a 100% valuation
allowance against its deferred tax assets to the extent it is more likely than
not that this asset will not be realized.  The valuation allowance has increased
approximately $6.5 million for the three months ended June 30, 1998.































                             Page 12
<PAGE>

        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

              CONDITION AND RESULTS OF OPERATIONS

Results of Operations

The Company recorded a net loss of $18,527,000 ($1.07 per share) for the quarter
ended June 30, 1998, compared with a net loss of $7,973,000 ($0.52 per share)
for the same quarter of the prior year.  Included in the current quarter results
were a loss of approximately $1,400,000 related to the operation of the
Company's storage business unit, excess capacity of the Fremont facility of
$750,000, severance costs of the storage business unit of approximately
$1,000,000, write-off of assets specific to the storage business unit of
approximately $4,000,000, a discount charge of approximately $1,111,000 related
to the $10,000,000 convertible subordinated debentures issued in June 1998, and
a charge to operations of approximately $658,000 for revaluation of goodwill and
intangible assets.  A loss of approximately $410,000 was recorded which related
to the Company's minority share of an unconsolidated investment.  In addition,
the Company wrote down its deferred tax assets by $6,547,000 (55% of income
before income taxes).  Results for the quarter of the previous year included a
one-time write off of in-process research and development in connection with the
acquisition of software companies in June 1997.  The prior year's quarter also
included a discount charge of approximately $1,204,000 related to the
$25,000,000 convertible subordinated debentures issued in May 1997 and a tax
benefit of $1,077,000 (36% of income before income taxes).  Weighted average
shares outstanding for the current quarter were 17,235,000 compared to
15,280,000 for the same quarter of the prior year.

For the nine months ended June 30, 1998, the net loss was $28,513,000 ($1.73 per
share) compared with a net loss of $10,455,000 ($0.69 per share) for the same
period a year earlier.  Weighted average shares outstanding in the first nine
months of fiscal 1998 were 16,528,000 compared to 15,157,000 for the same period
of fiscal 1997.

Total revenue for the current quarter was $5,340,000 compared with total revenue
of $3,352,000 for the same quarter of the prior year, an increase of $1,988,000.
The increase in revenue is directly attributable to an increase in net sales,
partially offset by a decrease in royalty revenue.  Net sales for the current
quarter were $4,591,000 versus $2,215,000 for the same quarter of the prior
year, an increase of $2,376,000.  The 

                             Page 13
<PAGE>

increase in net sales is attributable to the net sales generated by the
Company's software business unit (which was acquired June 30, 1997) of
$3,510,000, which was partially offset by a decrease of $1,318,000 in net sales
of the storage business unit.  Royalty revenue for the current quarter was
$749,000 versus $1,137,000 for the same quarter of the prior year.  During the
quarter, the Company negotiated and received the final payment for all royalty
obligations from IBM Corporation.  In addition, the solution services business
unit recognized net sales on its first remediation contract, approximately
$328,000.

For the nine months ended June 30, 1998, total revenue was $17,678,000 versus
total revenue of $11,708,000 for the same period of the prior year, an increase
of $5,970,000.  The increase in revenue is directly attributable to an increase
in net sales, partially offset by a decrease in royalty revenue.  For the nine
months just ended, net sales were $16,137,000 versus $7,057,000 for the same
period of the prior year, an increase of $9,080,000.  The increase in net sales
is directly attributable to the net sales generated by the Company's software
business unit of $10,653,000, partially offset by a decrease of $1,350,000 in
net sales of the storage business unit.  Royalty revenue was $1,541,000 for the
nine-month period just ended compared with $4,651,000 for the same period of the
prior year.

Gross margin as a percent of net sales was 3% for the quarter ended June 30,
1998 compared to 23% for the same quarter of the prior year.  For the nine-month
period ended June 30, 1998, gross margin was 37% versus 12% for the same period
a year earlier.  The decrease in gross margin percentage during the current
quarter is primarily attributable to the write-down of inventory and related
reserves of the Company's storage business unit.  The increase in the gross
margin percentage for the nine-month period is primarily the result of product
mix as a result of net sales generated by the software business unit.

On July 24, 1998, the Company finalized the sale of its storage business unit
for proceeds of approximately $1,000,000 with an additional $4,000,000 royalty
potential based on the new company's net sales of the storage product.  The
transaction involved the sale of the assets and liabilities of this business
unit.  Included in the current quarter are losses of approximately $1,400,000
related to the operation of this business unit.  Additionally, costs related to
the storage business unit during the quarter were severance costs in the amount
of $1,000,000, excess capacity of the Fremont facility of $750,000, and the
write-off of assets specific to the business 

                             Page 14
<PAGE>

unit of approximately $4,000,000.  In addition, it is anticipated that
approximately $800,000 in personnel-related costs of the storage business unit
will be incurred in the fourth quarter of the current fiscal year.

Research and development expenses for the quarter ended June 30, 1998, were 30%
of total revenue compared with 50% for the same quarter of the prior year. 
Actual dollars decreased $55,000.  With the sale of the storage business unit,
it is anticipated that research and development spending will decrease
significantly in actual dollars.

Selling, general and administrative (SG&A) expenses were 143% of total revenue
for the current quarter versus 98% for the same quarter of the prior year. 
Actual spending increased $4,323,000.  The increase in spending is attributable
to the added SG&A expenses of the acquired software companies of approximately
$2,464,000, an increase of $637,000 in legal costs, $975,000 for severance for
the storage business unit personnel, and $750,000 estimated loss on excess
capacity at the Fremont facility due to the sale of the storage business unit.

For the nine-month period just ended, SG&A expenses were 110% of total revenue
compared to 75% for the same period of the prior year.  Actual spending
increased $10,685,000.  The increase in spending is attributable to the
additional SG&A expenses of the acquired software companies in the amount of
$6,940,000; an increase in SG&A spending of the solution services business unit
of $866,000; and the severance and facilities items indicated above.  Management
continues to reduce operating expenses to bring them in line with the current
business operations.

Interest expense was $1,401,000 for the quarter just ended versus interest
expense of $1,397,000 in the same quarter of the prior year.  For the current
quarter, interest expense included the amortization of the discount on the 3%
convertible subordinated debentures of $1,111,000 and, in the prior year, the
amortization of the discount on the 5% convertible subordinated debentures was
$1,204,000.  In addition, interest expense included $290,000 interest expense
related to the convertible subordinated debentures in the current year compared
to $193,00 in the prior year.

For the nine months just ended, interest expense was $2,409,000 compared to
$1,397,000 in the prior year.  Included in the current year is interest expense
in the amount of $1,296,000, which relates to the convertible subordinated
debentures.

                             Page 15
<PAGE>

Other expense for the quarter just ended was $288,000 compared to income of
$234,000 in the prior year.  The current quarter included $410,000 expense
related to the equity in losses of MatriDigm Corporation, an unconsolidated
company.  Interest income in the current quarter is $100,000 compared to
$250,000 in the prior year.

For the nine months ended June 30, 1998, other income was $2,000 compared to
income of $1,269,000 in the prior year.  Included in other income in the prior
year is $777,000 of realized gains from the sale of marketable securities. 
Interest income in the current year is $395,000 compared to $516,000 in the
prior year.

Liquidity and Capital Resources

During the nine-month period ended June 30, 1998, working capital decreased
$9,623,000 and cash flow utilized by operating activities was $9,635,000.  The
utilization of cash in operating activities resulted primarily from the net loss
of $28,513,000.  This was partially offset by the reduction in deferred and
refundable taxes of $6,509,000, a decrease in accounts receivable of $2,630,000,
a decrease in inventory of $1,795,000, a loss on impairment of assets in the
amount of $1,956,000, and depreciation and amortization in the amount of
$2,338,000.

During the current year, net cash provided by investing activities was
$6,357,000.  $9,596,000 was generated from the sale of marketable securities. 
This was partially offset by the Company's investment of $1,510,000 in MatriDigm
Corporation, an unconsolidated company, the purchase of fixed assets in the
amount of $549,000, and the purchase of other assets of $1,180,000.

Net cash provided by financing activities was $10,805,000 which included
$9,567,000 which was raised from the issuance of 3% convertible subordinated
debentures and $1,238,000 from the exercise of employee stock options and from
the sale of stock under the Company's employee stock purchase plan.  The Company
has an unutilized $1,500,000 bank line of credit.  The line expires on September
30, 1998.

Management believes that the Company will meet its cash requirements during the
next twelve months from current cash on hand, other working capital, cash flow
from operations, the available bank line of credit, and the additional
$10,000,000 debentures potentially available to the Company within six months of
the June 1998 private placement.

                             Page 16
<PAGE>

Recent Accounting Pronouncements

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income",
and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information".  In October 1997, the AICPA issued SOP 97-2, "Software Revenue
Recognition".  Readers are referred to the "Recent Accounting Pronouncements"
section of the Notes to the Consolidated Financial Statements for further
discussion.



















========================================================================
This report contains forward-looking statements which are subject to
uncertainties, including those contained in the Company's annual report on Form
10-K for the fiscal year ended September 30, 1997.




------------------------------------------------------------------------
Zitel is a registered trademark of Zitel Corporation.
All other product names and brand names are trademarks or registered trademarks
of their respective holders.



                             Page 17
<PAGE>

PART II.  OTHER INFORMATION

Item 5.   Other Information

                 NOTICE OF STOCKHOLDER PROPOSALS

Pursuant to recent changes to the proxy rules, unless a stockholder who wishes
to bring a matter before the stockholders at the Company's 1999 annual meeting
of stockholders notifies the Company of such matter prior to November 12, 1998,
management will have discretionary authority to vote all shares for which it has
proxies in opposition to such matter.

                             RISK FACTORS

Significant Losses

During the first three quarters of the Company's 1998 fiscal year the Company
has reported net losses of $4,496,000, $5,490,000 and $18,527,000.  The Company
reported a total net loss of $17,501,000 in fiscal 1997 (including royalty
revenue of $5,340,000) and total net income of $4,049,000 in fiscal 1996
(including royalty revenue of $14,473,000).  During the first three quarters of
fiscal 1998, the Company received royalty revenue of $1,541,000, and no
additional royalty revenue will be received from IBM Corporation.

While the Company has taken a number of steps to attempt to return to
profitability, there is no assurance that it will be successful.  As the
majority of the recent losses were caused by the operations of the Company's
former storage systems business unit, in July 1998, the Company sold that
business unit.  The Company will record personnel related costs of approximately
$800,000 with respect to the storage business unit during the fourth quarter of
fiscal 1998 but should not have any additional costs with respect to that
business unit thereafter.  The Company is in the process of attempting to
terminate its lease or sublease its Fremont, California headquarters and move to
substantially smaller and less costly premises.  There is no assurance that the
Company will not incur significant costs in addition to $750,000 reserved in the
third quarter of fiscal year 1998.

The Company is taking other actions to reduce its costs in an effort to bring
costs into line with anticipated revenues.  There can be no assurance that the
Company will be successful in this effort and remain a viable operating entity.

                             Page 18

<PAGE>

Change of Nature of Business

From its organization in 1979 until the acquisition of the Datametrics
businesses in June 1997, substantially all of the Company's net sales were
generated from the design, manufacture and sale of electronic data storage
systems.  In June 1997, the Company acquired the business of Datametrics Systems
Corporation and certain related businesses which were engaged in the
development, marketing and sales of software products.  In fiscal 1997, the
Company commenced offering Year 2000 conversion services; the first remediation
revenue from the Year 2000 business unit was recorded in the third quarter of
1998.  With the sale of the Company's storage business unit, substantially all
of its operations are in businesses in which it has limited experience. 
Accordingly, the Company must quickly develop increased management skills
necessary to survive and realize net income in these new businesses.  There is
no assurance that it will be successful in developing these skills or realizing
net income in the future.

Fluctuations in Quarterly Results

The Company's quarterly operating results have in the past varied and may in the
future vary significantly depending on a number of factors, including: the level
of competition, the size, timing, cancellation or rescheduling of significant
orders; market acceptance of new products and product enhancements; new product
announcements or introductions by the Company's competitors; deferrals of
customer orders in anticipation of new products or product enhancements; changes
in pricing by the Company or its competitors; the ability of the Company to
develop, introduce and market new products and product enhancements on a timely
basis; the Company's success in expanding its industry partner programs;
technological changes in the market for the Company's products; product mix and
the mix of sales among the Company's sales channels; levels of expenditures on
research and development; changes in the Company's strategy; personnel changes;
and general economic trends and other factors.

Sales for any quarter have not been predictable with any significant degree of
certainty.  Sales to a single customer in a quarter have affected and may affect
net sales and operating margins.  Sales in any quarter are generally dependent
on orders booked and shipped in that quarter.  Any significant deferral of sales
could have a material adverse effect on the Company's results of operations in
any particular quarter.  To the extent that the Company completes significant
sales earlier than 

                             Page 19
<PAGE>

expected, operating results for subsequent quarters may be adversely affected. 
The Company's expense levels are based, in part, on its expectations as to
future sales.  As a result, if sales levels are below expectations, net income
may be disproportionately affected.

The mix of the products marketed by the Company has changed over the last year. 
The Company is now offering software products and also Year 2000 conversion
services; the Company is no longer offering electronic data storage products. 
Due to all of the foregoing factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as an indicator of future performance.  It is possible
that in some future quarter the Company's operating results may be below the
expectations of public market analysts and investors.  In such event, the price
of the Company's Common Stock would likely be materially and adversely affected.

Investment in MatriDigm Corporation

At June 30, 1998, the Company had invested approximately $7,400,000 and
guaranteed a bank loan of $1,000,000 to acquire approximately 33% interest in
MatriDigm Corporation, a private company organized to provide software
maintenance and re-engineering services for users of IBM mainframe computer
systems. The initial focus of MatriDigm has been development of technology to
automate the conversion of legacy software code which could not recognize or
utilize dates after the year 1999 (the "Year 2000 Problem") into code which is
able to recognize and utilize dates into the next century.  MatriDigm has
devoted substantially all of its engineering resources to development of such
technology.  In May 1997, MatriDigm announced the commercial availability of its
MAP2000 windowing process for programs written in ANSI COBOL 85.  MatriDigm has
subsequently extended the capability of MAP2000 to cover COBOL ANSI 68 and 74,
with support for CICS and IMS/DC transactions and VSAM, IMS/DB SQL and DB2
databases and file systems.  MARC2000, introduced June 1998, provides an
independent audit to confirm the accuracy and completeness of COBOL Year 2000
code conversions.  It provides extensive reports identifying faulty and
potentially faulty code and helps the customer to record the activities needed
to demonstrate due diligence in auditing COBOL Year 2000 renovation projects. 
MatriDigm intends to continue to refine its current toolset and to extend its
toolset.



                             Page 20
<PAGE>

Substantially all software programs written assume that the first two digits of
any date are "19" and cannot recognize or utilize dates commencing with the year
2000.  Estimates of the cost and available market for conversion of existing
code to eliminate this problem are substantial and vary widely.  The alternative
solutions available to a company with a Year 2000 Problem include migration to
new programs, elimination of code with a Year 2000 Problem, use of internal
resources to convert existing code, or procurement of conversion services from
outside providers such as the Company and MatriDigm.

A large number of companies, many of which have substantially greater resources
than MatriDigm, are offering conversion services or are developing systems to
provide such services, and competition is intense among the providers of such
services.  However, the demand for Year 2000 conversion services has emerged at
a slower pace than originally anticipated and there is no assurance that it can
successfully market its automated toolset, develop extensions for other computer
languages or generate substantial revenue and profits.  During the course of
development, the Company has made additional investments in MatriDigm and
continues to make additional investments.  To the extent other investors are
unable or unwilling to continue to make investments in MatriDigm, the Company
may be required to make a disproportionate share of such investments.

Volatility of Stock Price

The price of the Company's Common Stock has been subject to extreme volatility
during fiscal 1997 and fiscal 1998.  The Company believes that the principal
reasons for this volatility are rumored progress of and rumored problems in the
product development program and marketing efforts of MatriDigm.  MatriDigm is a
private company and the principal vehicle for public participation in ownership
of MatriDigm is indirectly through ownership of Common Stock of the Company. 
MatriDigm has been unable or unwilling to provide public information on a
regular basis about the status of its development and marketing efforts and, as
a result, an opportunity is presented for third parties to initiate rumors which
result in significant swings in the price of the Company's Common Stock.  Until
MatriDigm discloses the generation of significant sustained revenue, it will
remain difficult for investors to apply standard methods of analysis to the
value of the Company's investment in MatriDigm and the prospects for the
Company's Year 2000 services and the pattern of volatility may continue.


                             Page 21
<PAGE>

Competition

The market for Year 2000 conversion services through outside providers is
intensely competitive, with services being provided by a substantial number of
national, regional and local firms, many of which have existing relationships
and contractual arrangements with customers.  Many of these competitors have
substantially greater financial, technical and marketing resources than the
Company and MatriDigm.  The ability of the Company and MatriDigm to compete in
this market will depend on the ability of MatriDigm to successfully market its
automated solution.

The market for system management tools in which the Company's software products
division competes is intensely competitive.  Many of the companies with which
the Company competes, such as Computer Associates and BGS, Inc., have
substantially larger installed bases and greater financial resources than the
Company.  There can be no assurance that the Company's competitors will not
develop products comparable or superior to those developed by the Company or
adapt more quickly than the Company to new technologies, evolving industry
standards, new product introductions, or changing customer requirements.

Dependence on New Products; Rapid Technological Change

The markets in which the Company operates are characterized by rapid
technological change, changing customer needs, frequent new product
introductions, and evolving industry standards.  The introduction of products
embodying new technologies and/or the emergence of new industry standards could
render the Company's existing products and services obsolete and unmarketable. 
The Company's future success will depend upon its ability to develop and to
introduce new products and services on a timely basis that keep pace with
technological developments and emerging industry standards and address the
increasingly sophisticated needs of its customers.  There can be no assurance
that the Company will be successful in developing and marketing products or
services that respond to technological changes or evolving industry standards,
that the Company will not experience difficulties that could delay or prevent
the successful development, introduction and marketing of new products or
services, or that its new products or services will adequately meet the
requirements of the marketplace and achieve market acceptance.  If the Company
is unable, for technological or other reasons, to develop and introduce new
products or services in a timely manner in response 


                             Page 22
<PAGE>

to changing market conditions or customer requirements, the Company's business,
operating results and financial condition will be materially and adversely
affected.

Product Liability

The Company's agreements with its customers typically contain provisions
intended to limit the Company's exposure to potential product liability claims. 
It is possible that the limitation of liability provisions contained in the
Company's agreements may not be effective.  Although the Company has not
received any product liability claims to date, the sale and support of products
by the Company and the incorporation of products from other companies may entail
the risk of such claims.  A successful product liability claim against the
Company could have a material adverse effect on the Company's business,
operating results and financial condition.

The market for Year 2000 conversion services is not fully developed and service
warranty standards have not as yet been fully defined.  The extent to which the
solution services division must provide warranty protection to its customers in
order to be competitive remains uncertain.  To the extent that future warranty
obligations shift risks to the Company that are in excess of the warranty
protection provided to the Company by MatriDigm and other toolset providers, a
successful claim against the Company could have a material adverse effect on the
Company's business, operating results and financial condition.

Dependence on Proprietary Technology

The Company's success depends significantly upon its proprietary technology. 
The Company currently relies on a combination of copyright and trademark laws,
trade secrets, confidentiality agreements, and contractual provisions to protect
its proprietary rights.  The Company seeks to protect its software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection.  The Company has registered its Zitel and
Datametrics trademarks and will continue to evaluate the registration of
additional trademarks as appropriate.  The Company generally enters into
confidentiality agreements with its employees and with key vendors and
suppliers.  The Company believes that the rapidly changing technology in the
computer industry makes the Company's success depend more on the technical
competence and creative skills of its personnel than on proprietary technology.


                             Page 23
<PAGE>

There has also been substantial litigation in the computer industry regarding
intellectual property rights.  The Company has not received significant claims
that it is infringing third parties' intellectual property rights, but there can
be no assurance that third parties will not, in the future, claim infringement
by the Company with respect to current or future products, trademarks or other
proprietary rights.

Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or to obtain and
use information that the Company regards as proprietary.  There can be no
assurance that the Company's means of protecting its proprietary rights will be
adequate or that the Company's competitors will not independently develop
similar technology, duplicate the Company's products or design around patents
issued to the Company or other intellectual property rights of the Company.

The Company's solution services division relies primarily on proprietary
technology developed and owned by MatriDigm Corporation and the prospects for
the division are dependent on the ability of MatriDigm to maintain and expand a
toolset which provides a relative advantage over competing Year 2000 conversion
service providers for IBM COBOL.  In the event that the MatriDigm toolset does
not achieve significant market acceptance, the business of the solution services
division would be materially and adversely affected.

International Sales and Operations

Sales to customers outside the United States have accounted for significant
portions of the Company's net sales.  International sales pose certain risks not
faced by companies that limit themselves to domestic sales.  Fluctuations in the
value of foreign currencies relative to the U.S. Dollar, for example, could make
the Company's products less price competitive.  Some of the Company's sales are
denominated in foreign currencies and this could result in losses from foreign
currency transactions.  International sales also could be adversely affected by
factors beyond the Company's control including the imposition of government
controls, export license requirements, restrictions on technology exports,
changes in tariffs and taxes, and general economic and political conditions. 
The laws of some countries do not protect the Company's intellectual property
rights to the same extent as the laws of the United States.



                             Page 24
<PAGE>
Dependence on Key Personnel

The Company's future performance depends, in significant part, upon the
continued service of its key technical and senior management personnel.  The
Company provides incentives such as salary, benefits and option grants (which
are typically subject to vesting over four years) to attract and retain
qualified employees.  The loss of the services of one or more of the Company's
officers or other key employees could have a material adverse effect on the
Company's business, operating results and financial condition.  The Company's
future success also depends on its continuing ability to attract and retain
highly qualified technical and management personnel.  Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its key technical and management employees or that it can attract, assimilate
and retain other highly qualified technical and management personnel in the
future.

The future success of the Company's solution services division, in particular,
will depend, to a significant extent, on its ability to attract, train,
motivate, and retain highly skilled software development professionals,
particularly project managers, software engineers and other senior technical
personnel.  The Company believes that, in the United States, and elsewhere,
there is a shortage of, and significant competition for, software development
professionals with the advanced technological skills necessary to perform the
services offered by the solution services division.  The increasing recognition
of the scope and significance of the Year 2000 Problem has materially increased
the competition for personnel with appropriate skills and salary requirements
have increased as availability of such personnel has declined precipitously. 
The Company's ability to maintain and renew existing relationships and obtain
new business depends, in large part, on its ability to hire and retain technical
personnel.  An inability to hire such additional qualified personnel could
impair the ability of the solution services division to manage and complete its
existing projects and to bid for or obtain new projects.

Anti-Takeover Provisions

Certain provisions of the Company's Certificate of Incorporation, as amended and
restated, and Bylaws, as amended, California law and the Company's
indemnification agreements with certain officers and directors of the Company
may be deemed to have an anti-takeover effect.  Such provisions may delay, defer
or prevent a tender offer or takeover attempt that a stockholder 

                             Page 25
<PAGE>

might consider to be in that stockholder's best interests, including attempts
that might result in a premium over the market price for the shares held by
stockholders.

The Company's Board of Directors may issue additional shares of Common Stock or
establish one or more classes or series of Preferred Stock, having the number of
shares designations, relative voting rights, dividend rates, liquidation and
other rights, preferences and limitations, as determined by the Board of
Directors, without stockholder approval.

The Board of Directors of the Company has approved the adoption of a Preferred
Share Purchase Rights Plan (the "Rights Plan").  Terms of the Rights Plan
provide for a dividend distribution of one preferred share purchase right (a
"Right") for each outstanding share of common stock, no par value per share (the
"Common Shares"), of the Company.  Each Right entitles the registered holder to
purchase from the Company one one-hundredth of a share of Series A Junior
Participating Preferred Stock, no par value (the "Preferred Stock"), at an
exercise price of $69.50 per one one-hundredth of a Preferred Share (the
"Purchase Price"), subject to adjustment, and a redemption price of $.01 per
Right.  Each one one-hundredth of a share of Preferred Stock has designations
and the powers, preferences and rights, and the qualifications, limitations and
restrictions which make its value approximately equal to the value of a Common
Share.

The Rights are not exercisable until the earlier to occur of (i) 10 days
following a public announcement that a person, entity or group of affiliated or
associated persons (an "Acquiring Person") have acquired beneficial ownership of
15% or more of the outstanding Common Shares or (ii) 10 business days (or such
later date as may be determined by action of the Board of Directors prior to
such time as any person or entity becomes an Acquiring Person) following the
commencement of, or announcement of an intention to make, a tender offer or
exchange offer the consummation of which would result in the beneficial
ownership by a person or group of 15% or more of such outstanding Common Shares.

The Rights have certain anti-takeover effects, as they would cause substantial
dilution to a person or group that attempted to acquire the Company on terms not
approved by the Company's Board of Directors.  The Rights should not interfere
with any merger or other business combination approved by the Board of
Directors, since the Rights may be redeemed by the Company at $.01 per Right
prior to the earliest of (i) the twentieth day following the time 

                             Page 26
<PAGE>

that a person or group has acquired beneficial ownership of 15% or more of the
Common Shares (unless extended for one or more 10 day periods by the Board of
Directors), (ii) a change of control, or (iii) the final expiration date of the
rights.

Item 6.  Exhibits and Reports on Form 8-K

           (a)  Exhibits

                Exhibit 27 - Financial Data Schedule

           (b)  Reports on Form 8-K 

                During the period from April 1, 1998 through
                June 30, 1998, the Company filed the following
                current report on Form 8-K:

                Date of Report - Item(s) Reported:
                June 25, 1998 - Placement of 3% Convertible
                Subordinated Debentures.




























                             Page 27
<PAGE>
                            SIGNATURES


Pursuant to the requirements 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.


                                  ZITEL CORPORATION


Date:  August 12, 1998            /s/ Larry B. Schlenoff
                                  ----------------------------------
                                  Larry B. Schlenoff
                                  Vice President, Finance &
                                  Administration
                                  (Chief Financial Officer and
                                  Secretary)































                             Page 28