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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the transition period from _______________ to _______________

Commission file number 0-23418

MTI TECHNOLOGY CORPORATION

4905 East La Palma Avenue
Anaheim, California 92807
(Address of principal executive offices, zip code)

Registrant’s telephone number, including area code: (714) 970-0300

     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   _____   

     The number of shares outstanding of the issuer’s common stock, $.001 par value, as of November 8, 2002 was 32,911,994.

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MTI TECHNOLOGY CORPORATION

INDEX

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PART I

FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS

MTI TECHNOLOGY CORPORATION

See accompanying notes to condensed consolidated financial statements.

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MTI TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

See accompanying notes to condensed consolidated financial statements.

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MTI TECHNOLOGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

See accompanying notes to condensed consolidated financial statements.

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MTI TECHNOLOGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.		Overview
		The interim condensed consolidated financial statements included herein have been prepared by MTI Technology Corporation (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been omitted pursuant to such SEC rules and regulations; nevertheless, the management of the Company believes that the disclosures herein are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 6, 2002. In the opinion of management, the condensed consolidated financial statements included herein reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the condensed consolidated financial position of the Company as of October 5, 2002 and April 6, 2002, the condensed consolidated results of operations for the three and six month periods ended October 5, 2002 and October 6, 2001, and cash flows for the six months ended October 5, 2002 and October 6, 2001. The results of operations for the interim periods are not necessarily indicative of the results of operations for the full year.
		References to amounts are in thousands, except per share data, unless otherwise specified. Certain prior year amounts have been reclassified to conform with the fiscal 2003 presentation.
2.		Restructuring
		During the first quarter of fiscal year 2003, the Company recorded a restructuring charge of $1,046 which consisted of charges of $545 related to a headcount reduction of 39 employees, or 15% of the Company’s workforce, and $501 related to the disposal or abandonment of fixed assets. Of the 39 employees terminated, 14, 3, 6, 1, 14, and 1 were from the Sales, Marketing, General and Administrative, Field Services, Research and Development, and Manufacturing departments, respectively. The expected cash impact of the restructuring charge is $545 related to severance, of which none and $396 was paid in the first and second quarters of fiscal year 2003, respectively. The remaining amount is expected to be paid during the third and fourth quarters of fiscal year 2003. The Company completed consolidating its manufacturing facility to Dublin, Ireland, in July 2002.
		The amount accrued for restructuring activities as of October 5, 2002, was as follows:

3.		Inventories
		Inventories consist of the following:

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4.		Line of Credit
		In February 2002, the Canopy Group, Inc. (“Canopy”), the Company’s largest stockholder, lent $1,900 to the Company. The Company then entered into a Loan Agreement (the “Canopy Loan Agreement”) with Canopy on June 27, 2002, allowing the Company, subject to certain conditions, to borrow up to an aggregate of $7,000 under a revolving line of credit. During the second quarter of fiscal year 2003, the outstanding $1,900 loan was paid-off and $1,900 was borrowed against this line of credit. The line will mature on June 30, 2003, bearing an interest rate of nine percent per annum and is secured by a security interest in substantially all of the Company’s assets. The Canopy Loan Agreement contains negative covenants placing certain restrictions on the Company’s ability to repurchase capital stock, pay dividends or make distributions, purchase or sell assets, incur liens on its assets, incur additional debt, merge with another entity, make loans or investments, amend its charter Certificate of Incorporation or bylaws or issue stock. Although the Company is currently in compliance with all of the terms of the Canopy Loan Agreement, and believes that it will remain in compliance, there can be no assurance that it will be able to borrow under the Canopy Loan Agreement. Canopy may terminate the Canopy Loan Agreement and declare all amounts outstanding immediately due and payable upon an event of default, including upon 30 days notice in the event that Canopy in good faith deems its interest in the Company to be insecure, the value of the collateral to have significantly declined, or the prospect of timely payment or performance to be impaired. Ralph J. Yarro, III, one of our Directors, is also a Director, President and Chief Executive Officer of Canopy. Darcy G. Mott, one of our Directors, is also a Vice President, Treasurer and Chief Financial Officer of Canopy. Canopy beneficially owns approximately 45% of our outstanding common stock.
		In November 2002, the Company entered into an agreement with Comerica Bank for a line of credit up to $7.0 million at an interest rate equal to prime. The line of credit is secured by a Letter of Credit which is guaranteed by Canopy.
5.		Net Income (Loss) per Share
		The following table sets forth the computation of basic and diluted net income (loss) per share:

		Options and warrants to purchase 11,741 shares of common stock were outstanding at October 5, 2002, but were not included in the computation of diluted net loss per share for the three months ended October 5, 2002, because the effect would be antidilutive.
		Options and warrants to purchase 11,755 shares of common stock were outstanding at October 5, 2002, but were not included in the computation of diluted net loss per share for the six months ended October 5, 2002, because the effect would be antidilutive.
		Options and warrants to purchase 12,191 shares of common stock were outstanding at October 6, 2001, but were not included in the computation of diluted net loss per share for the three and six months ended October 6, 2001, as the effect would be antidilutive.

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6.		Business Segment Information
		The Company is engaged in the design, manufacture, sale, and service of high-performance storage systems, software, and related products. The Company’s reportable business segments are based upon geographic areas. The Company’s operations are structured to achieve consolidated objectives. As a result, significant interdependence and overlap exists among the Company’s geographic areas. Accordingly, revenue, operating loss and identifiable assets shown for each geographic area may not be the amounts which would have been reported if the geographic areas were independent of one another.
		Revenue and transfers between geographic areas are generally priced to recover cost, plus an appropriate mark-up for profit. Operating loss is revenue less cost of revenues and direct operating expenses.
		A summary of the Company’s operations by geographic area is presented below:

7.		New Accounting Pronouncements
		On October 3, 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. (“Statement”) 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes Statement 121. Statement 144 retains many of the fundamental provisions of Statement 121. Statement 144 also supersedes the accounting and reporting provisions of Accounting Principle Board Opinion 30, Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (“APB 30”), for the disposal of a segment of a business. However, it retains the requirement in APB 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. Statement 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company adopted Statement 144 at the beginning of the first quarter of fiscal year 2003. The adoption did not have a material impact on the Company’s results of operations or financial position.
		On April 30, 2002, the FASB issued Statement 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement updates, clarifies and simplifies existing accounting pronouncements. Statement 145 rescinds Statement 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion 30 will now be used to classify those gains and losses. Statement 64 amended Statement 4, and is no longer necessary because Statement 4 has been rescinded.

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		Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. Because the transition has been completed, Statement 44 is no longer necessary. Statement 145 amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. This amendment is consistent with the FASB’s goal of requiring similar accounting treatment for transactions that have similar economic effects. The Company adopted Statement 145 at the beginning of the first quarter of fiscal year 2003. The adoption of Statement 145 did not have a material impact on the Company’s results of operations or financial position.
8.		Comprehensive Loss
		The components of comprehensive loss are as follows:

9.		Related Party Transactions
		In the normal course of business, the Company sold services to Center 7, Inc. (“Center 7”), a subsidiary of Canopy. Services sold to Center 7 in the second quarter of fiscal years 2003 and 2002 were $13 and $150, respectively. Services sold to Center 7 in the first six months of fiscal years 2003 and 2002 were $29 and $350, respectively. Ralph J. Yarro, III, one of our Directors, is also a Director, President and Chief Executive Officer of Canopy. Darcy G. Mott, one of our Directors, is also a Vice President, Treasurer and Chief Financial Officer of Canopy. Canopy beneficially owns approximately 45% of our outstanding common stock. At October 5, 2002 and April 6, 2002, there was $13 and no outstanding balance due from Center 7, respectively.
10.		Litigation.
		From July through September 2000, several class action complaints were filed against the Company and several of its officers, alleging that the Company was aware of adverse information that it failed to disclose primarily during fiscal year 2000 and, hence, that it violated specified provisions of the Securities Exchange Act of 1934 and the rules promulgated thereunder. The plaintiffs in those cases filed a consolidated amended complaint in the federal court for the Central District of California on or about December 5, 2000, making similar allegations. This consolidated complaint alleges a class period from July 22, 1999 to July 27, 2000 and alleges that the defendants were aware of certain adverse information that they failed to disclose during that period. The Company filed a motion to dismiss the complaint which the district court granted. However, the plaintiffs filed a Second Amended Complaint, and, on October 9, 2001, the district court denied the Company’s motion to dismiss that complaint, although on June 12, 2002, the Court did strike all but six allegations of the Second Amended Complaint. The Second Amended Complaint alleges a class period from July 22, 1999 to July 12, 2000. The trial is set to begin on or about August 19, 2003.
		The plaintiffs have not specified the amount of damages they seek. Although the Company believes the alleged claims in this lawsuit are without merit and is defending the lawsuit vigorously, due to the inherent uncertainties of the litigation process and the judicial system, the Company is unable to predict the outcome of this litigation. This litigation may result in substantial costs and distract management’s attention and resources. As of October 5, 2002, the Company met the deductible of its insurance policy. A judgement against the Company in this case that exceeds the limits of the insurance policy or is not covered by the insurance policy could have a material adverse effect on the Company’s financial position, results of operations or liquidity.
		The Company is also, from time to time, subject to claims and suits arising in the ordinary course of business. In its opinion, the ultimate resolution of these matters is not expected to have a material adverse effect on its financial position, results of operations or liquidity.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Some of the statements included in this report are not historical or based on historical facts and constitute “forward-looking statements” involving known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements or industry results to be materially different from any future results, performance or achievements, expressed or implied by these forward-looking statements. Forward-looking statements include, but are not limited to, statements about our restructuring activities, revenue, margin, the effect of accounting changes, attempts to raise additional funds, proprietary product sales and changes in product mix, customers, reductions in research and development expenditures, foreign currency hedging activity, anticipated decreases in spending, dependence on new products and quarterly fluctuations. Our transition to sales of integrated solutions and focus of sales efforts on Global 2000 accounts may not be successful. We may fail to achieve anticipated revenue levels and efficiencies of operation. Estimates made in connection with our critical accounting policies may differ from actual results. Given these uncertainties, investors in our common stock are cautioned not to place undue reliance on our forward-looking statements. Future events occurring in response to or in connection with the terrorist attacks in the United States, including, but not limited to, future terrorist attacks against United States targets, actual conflicts involving the United States or its allies, or military or trade disruptions could negatively impact our business, financial condition and results of operations and may result in increased volatility in the market price of our common stock. The forward-looking statements in this report speak only as of the date of this report and we do not undertake to revise or update any of them. We urge you to review and carefully consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission. Additional information on potential factors that could affect our business or financial results or condition is included in our Annual Report on Form 10-K for the year ended April 6, 2002 and on subsequent reports on Forms 10-Q and 8-K.

MTI is a registered trademark of the Company. All other company, brand or product names are registered trademarks or trademarks of their registered holders.

On May 30, 2002, we received a notification letter from Nasdaq for non-compliance with Marketplace Rule 4450(a)(5) since the bid price of our common stock had closed at less than $1.00 per share over the previous 30 consecutive trading days. We had 90 calendar days, or until August 28, 2002, to regain compliance. On August 16, 2002, our securities ceased trading on the Nasdaq National Market and began trading on the Nasdaq SmallCap Market. We were granted an additional 90 calendar days, or until November 26, 2002, to demonstrate compliance with the minimum $1.00 per share requirement. If we are not in compliance by November 26, 2002, but we meet the initial listing criteria of Marketplace Rule 4310(c)(2)(A), which we expect to meet, we may receive an additional 180 calendar day grace period from Nasdaq to demonstrate compliance. If we do not demonstrate compliance, our securities will be delisted. There can be no assurance that we will be in compliance with the required listing standards at the expiration of our grace period. If we are delisted, we may not be able to secure listing on other exchanges or quotation systems. This would materially adversely affect the price and liquidity of our common stock.

Overview

The Company is a provider of high-availability, fault-tolerant solutions for the mid-range and enterprise-storage marketplace. We offer a complete line of integrated storage related products, incorporating proprietary and best of breed commercially available hardware and software. When these products are combined with our professional services and field service capabilities, we are able to offer our customers end-to-end, solutions that are tailored to their individual needs. Historically, we have sold our solutions and service to the Global 2000 companies for their data center computing environments. In an effort to restore profitability and improve liquidity, we are developing and implementing solutions that incorporate a broad array of commercial technologies that meet customer requirements in the areas of Storage Area Networks, data protection, tape backups and business continuity while minimizing our past dependencies on our proprietary RAID controller technology.

The solutions that we deliver to the market are compatible with Sun Solaris, HP-UX, Windows NT, Novell Netware, IBM AIX, and Linux operating systems. Having the ability to work on these operating platforms enables us to meet varied customer demands. Our customers represent a cross section of industries and governmental agencies and range from Fortune 500 companies to small businesses.

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Restructuring

During the fourth quarter of fiscal year 2002, we recorded a restructuring charge of $4.9 million which consisted of $4.3 million, $0.3 million and $0.3 million charges related to the abandonment of either underutilized or historically unprofitable facilities, a headcount reduction of 56 employees, and the disposal of certain fixed assets, respectively. The cash impact of the restructuring charge was $0.3 million, related to severance, of which $0.1 million was paid in fiscal year 2002. The remaining $0.2 million was paid in the first quarter of fiscal year 2003.

During the first quarter of fiscal year 2003, we recorded a restructuring charge of $1.0 million which consisted of charges of $0.5 million related to a headcount reduction of 39 employees, or 15% of the Company’s workforce, and $0.5 related to the disposal or abandonment of fixed assets. Of the 39 employees terminated, 14, 3, 6, 1, 14, and 1 were from the Sales, Marketing, General and Administrative, Field Services, Research and Development, and Manufacturing departments, respectively. The expected cash impact of the restructuring charge is $0.5 million related to severance, of which none and $0.3 million was paid in the first and second quarters of fiscal year 2003, respectively. The remaining amount is expected to be paid during the third and fourth quarters of fiscal year 2003.

We also completed consolidating our manufacturing facility to Dublin, Ireland, in July 2002, and anticipate reducing the amount of space leased for our corporate headquarters after our Anaheim, California lease expires in January 2003.

As part of the restructuring, we plan to emphasize our expertise in the design, deployment and servicing of fully integrated solutions for the enterprise-storage marketplace. We anticipate changing our product sales mix away from designing proprietary RAID engines to incorporating RAID engines from LSI (Formally IBM)/Mylex, as we do in our Vivant 400 architecture. We also anticipate selling a higher proportion of non-MTI branded products. Although we expect to continue to develop and manufacture proprietary products, we plan to do so at significantly reduced levels from prior years, including lower research and development expenditures.

The primary goal of the restructuring is to reduce costs. We believe the restructuring may have other benefits as well, including the ability to offer a wider range of products, greater flexibility in designing solutions for our customers, and the ability to react more quickly to changing technologies.

We face significant risks and uncertainties in connection with these restructuring activities and we have incurred substantial charges in connection with the restructuring. Despite the restructuring activities that have taken place to date, we have continued to incur recurring losses from operations. There can be no assurance that the restructuring will be successful or that the anticipated cost savings will be realized.

Critical Accounting Policies

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosure of contingent assets and liabilities as of the date of our financial statements.

We based our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially produce materially different results under different assumptions and conditions. We believe the following critical accounting policies reflect significant judgments and estimates used in the preparation of our consolidated financial statements. For a detailed discussion of the application of these and other accounting policies refer to “Summary of Significant Accounting Policies” included in our Annual Report on Form 10-K for the fiscal year ended April 6, 2002.

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Revenue Recognition. We record sales of our equipment upon pick-up by the domestic common carrier for FOB origin shipments and upon delivery to the customer for FOB destination shipments, net of an allowance for estimated returns, as long as no significant post-delivery obligations exist and collection of the resulting receivable is probable and the sales price is fixed and determinable. Product sales are not contingent upon customer testing, approval and/or acceptance. We record revenue from equipment maintenance contracts as deferred income when billed and we recognize this revenue as earned over the period in which the services are provided, primarily straight-line over the term of the contract. We accrue for warranty expense at the time revenue is recognized and maintain a warranty accrual for the estimated future warranty obligation based upon the relationship between historical and anticipated costs and sales volumes.

We apply Statement of Position (“SOP”) 97-2, “Software Revenue Recognition” as amended by SOP 98-9, “Modification of SOP 97-2 with Respect to Certain Transactions,” whereby revenue is recognized from software licenses, provided the software has been delivered to the customer, persuasive evidence of an arrangement exists, the price charged to the customer is fixed or determinable at fair value and there are no significant obligations on our part related to the sale and the resulting receivable is deemed collectible, net of an allowance for returns, cancellations and maintenance, including vendor and post-contract support obligations. We recognize revenue from maintenance agreements ratably over the term of the related agreement. Revenue from consulting and other software-related services is recognized as the services are rendered.

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make payments for services. We analyze accounts receivable, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers deteriorates, resulting in an inability to make payments, additional allowances may be required.

Income Taxes. We are required to estimate our income taxes which includes estimating our current income taxes as well as measuring the temporary differences resulting from different treatment of items for tax and accounting purposes. These temporary differences result in deferred tax assets or liabilities. We apply Statement 109, “Accounting for Income Taxes”; under the asset and liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse, net of a valuation allowance. We have recorded a full valuation allowance against our deferred tax assets as management has determined that it is more likely than not that these assets will not be utilized. In the event that actual results differ from our estimates, our provision for income taxes could be materially impacted.

Valuation of Goodwill and Other Intangible Assets. We assess the impairment of goodwill and other intangible assets in accordance with Statement 142 on an annual basis or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include significant under-performance relative to expected historical or projected future operating results, significant changes in the manner of our use of acquired assets or the strategy for our overall business, and significant negative industry or economic trends. Upon the adoption of Statement 142 in fiscal year 2002, the carrying value of our goodwill and other intangible assets was determined to not be impaired. Changes in assumptions and estimates included within this analysis could produce significantly different results than those identified above and those recorded in the consolidated financial statements. The Company completed its annual assessment for goodwill impairment in the second quarter of fiscal year 2003 and no impairment was found to exist.

Inventories. Inventories are valued at the lower of cost (first-in, first-out) or market, net of an allowance for obsolete, slow-moving, and unsalable inventory. The allowance is based upon management’s review of inventories on-hand, historical product sales, and forecasts. We use rolling forecasts based upon anticipated product orders to determine our component and product inventory requirements. Lead times for products, materials and components that we order may vary significantly and depend upon factors such as specific supplier requirements, contract terms and current market demand. As a result, our product and component requirement forecasts may not be accurate. If we overestimate our product or component requirements, we may have excess inventory, which could lead to additional excess and obsolete charges.

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Results of Operations

The following table sets forth selected items from the Condensed Consolidated Statements of Operations as a percentage of total revenue for the periods indicated, except for product gross profit and service gross profit, which are expressed as a percentage of the related revenue. This information should be read in conjunction with the Condensed Consolidated Financial Statements included elsewhere herein:

Net Product Revenue: Net product revenue for the second quarter of fiscal year 2003 decreased $8.7 million, or 44.0% from the same quarter of the prior year. This decrease was primarily because of a $7.1 million, or 52.8%, and a $1.6 million, or 25.6% decrease in domestic and international product revenue, respectively. Net product revenue for the first six months of fiscal year 2003 decreased $18.9 million, or 50.8% from the same period of the prior year. This decrease was primarily because of a $15.9 million, or 63.4%, and a $3.0 million, or 24.4% decrease in domestic and international product revenue, respectively. The continued economic downturn has resulted in a general capital and, specifically, information technology spending slowdown thus decreasing the current demand for our information-storage systems and software. Aggressive competition in the form of pricing discounts from EMC, Hewlett-Packard Company, Sun Microsystems, Inc., IBM, and Network Appliance, Inc., each of which has substantially greater name recognition, engineering, manufacturing and marketing capabilities than us, and greater financial and personnel resources than we have, also contributed to the decrease in our sales.

Service Revenue: Service revenue for the second quarter of fiscal year 2003 decreased by $1.5 million, or 11.8% from the same quarter of the prior year. This decrease was attributable to decreased maintenance revenue of $0.8 million, decreased consulting revenue of $0.4 million and other decreased revenue of $0.3 million. Service revenue for the first six months of fiscal year 2003 decreased by $3.1 million, or 12.4% from the same period of the prior year. This decrease was attributable to decreased maintenance revenue of $1.9 million, decreased consulting revenue of $0.5 million and other decreased revenue of $0.7 million. The decrease in maintenance revenue is primarily due to our inability to fully offset expired maintenance contracts with renewed and new maintenance contracts. We attribute the lower number of renewals to the loss of customers to our competitors during the period, customers that have updated their technology which is now covered by warranty, and customers that have ceased operations. The decrease in consulting and other revenue is primarily attributable to decreased product revenue.

Product Gross Profit: We realized product gross profit of $3.1 million, or 28.0%, for the second quarter of fiscal year 2003, as compared to product gross profit of $5.1 million, or 25.9%, for the same quarter of the preceding year. The increase in product gross profit percentage was mainly due to improved manufacturing efficiencies, partially offset by increased pricing competition.

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We realized product gross profit of $0.4 million, or 2.2%, for the first six months of fiscal year 2003, as compared to product gross profit of $5.6 million, or 15.1%, for the same period of the preceding year. This decrease was mainly due to increased pricing competition and changes in product mix, partially offset by improved manufacturing efficiencies. While we continue to restructure our operations in an effort to reduce operating expenses and improve our product gross margin, there can be no assurance that such activities will be successful.

Service Gross Profit: Service gross profit was $3.9 million for the second quarter of fiscal year 2003, a decrease of $1.3 million, or 24.8% from the same period of the previous year. Service gross profit was $7.7 million for the first six months of fiscal year 2003, a decrease of $2.4 million, or 24.1% from the same period of the previous year. We attribute the decreases in service gross profit primarily due to lower field service revenue supported by a relatively fixed cost structure.

Selling, General and Administrative: Selling, general and administrative expenses for the second quarter of fiscal year 2003 decreased $3.2 million, or 31.3% over the same quarter of the preceding year. Selling, general and administrative expenses for the first six months of fiscal year 2003 decreased $7.8 million, or 34.3% over the same period of the preceding year, despite booking a loss in the first quarter of fiscal year 2003 of $0.2 million on disposal of fixed assets no longer in use. These decreases in selling, general and administrative expenses were primarily due to a substantial decrease in salary and benefit expenses resulting from reduced headcount, a decrease in marketing and promotional expenses, reduced bad debt expense, and consulting and professional service fees. During the first quarter of fiscal year 2002, we recovered $0.5 million from one account that was previously determined to be uncollectible.

Research and Development: Research and development expenses for the second quarter of fiscal year 2003 decreased $2.6 million, or 76.3% over the same quarter of the preceding year. Research and development expenses for the first six months of fiscal year 2003 decreased $3.4 million, or 48.4% over the same period of the preceding year, despite booking a loss in the first quarter of fiscal 2003 of $0.7 million on disposal of fixed assets no longer in use. These decreases were primarily attributable to a decrease in salary and benefit expenses resulting from headcount reductions. As part of our restructuring activities, we plan to focus our expertise in the design, deployment and servicing of integrated solutions for the enterprise-storage marketplace. We anticipate changing our product sales mix away from using a proprietary RAID controller design to using integrated products, such as Vivant 400, which use an LSI (FORMALLY IBM)/Mylex-based RAID controller architecture. We also anticipate selling a higher proportion of non-MTI branded products. Although we expect to continue to develop and manufacture proprietary products, we plan to do so at significantly reduced levels from the prior year, resulting in lower research and development expenditures.

Restructuring: We recorded $1.0 million of restructuring charges in the first quarter of fiscal year 2003, which consisted of charges of approximately $0.5 million related to a headcount reduction of 39 employees, or 15% of our workforce, and $0.5 million related to the disposal or abandonment of fixed assets. Of the 39 employees terminated, 14, 3, 6, 1, 14, and 1 were from the Sales, Marketing, General and Administrative, Field Services, Research and Development, and Manufacturing departments, respectively. The expected cash impact of the restructuring charge is $0.5 million related to severance, of which $0.4 was paid in the second quarter and the first six months of fiscal year 2003. We completed consolidating our manufacturing facility to Dublin, Ireland, in July 2002.

Interest and Other Income, Net: Interest and Other Income, net for the second quarter of fiscal year 2003 was $1.0 million, a decrease of $1.5 million from the same quarter of the preceding year. Interest and Other Income, net for the first six months of fiscal year 2003 was $1.1 million, a decrease of $1.3 million for the same period of the preceding year. The amount for the second quarter and the first six months of fiscal year 2003 is primarily due to the gain recognized on the sale of our investment in the stock of Caldera International, Inc. (“Caldera”). The amount for the second quarter and the first six months of fiscal year 2002 is primarily due to patent income from EMC Corporation, which ceased after the third quarter of fiscal year 2002.

Equity in Net Loss of Affiliate: Equity in net loss of affiliate represented our proportionate share of Caldera’s net losses and amortization of the goodwill related to an investment made in Caldera in August 1999. The original investment in Caldera was $7.6 million and included: (a) a cash payment of $3.0 million, (b) a note payable of $3.0 million bearing interest at the prime rate plus one percent per annum and payable in two equal semi-annual payments beginning February 2000 and (c) investment costs of $1.6 million, including the issuance of a warrant to purchase 150,000 shares of our common stock. The excess of our investment in Caldera over the related underlying equity in net assets of $6.9 million was being amortized on a straight-line basis over seven years. However, we adopted Statement 142 as of April 8, 2001, the beginning of our fiscal year 2002, and therefore ceased to amortize the remaining balance of goodwill

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related to our investment in Caldera of $4.2 million, which we wrote off during the third quarter of fiscal year 2002 due to an other than temporary decline in value and recognized our proportional share of Caldera’s net loss. Our proportional share of Caldera’s net loss was included in “Equity in net loss of affiliate”.

Foreign Currency Transactions: In order to minimize the risk of foreign exchange loss, from time to time we have used hedging programs, currency forward contracts, currency options and/or other derivative financial instruments commonly used to reduce financial-market risks, although none of these were outstanding at October 5, 2002. There can be no assurance, however, that the use of these investments will successfully reduce our exposure to financial-market risks.

Income Tax Expense: The income tax expense for the second quarter of fiscal year 2003 was $0.02 million as compared to no income tax expense recorded for the same quarter of the prior year. The income tax expense for the first six months of fiscal year 2003 was $0.05 million, a decrease of $24.3 million as compared to the same period of last year. We recorded a valuation allowance against the remaining $24.3 million net deferred-tax asset in the first quarter of fiscal year 2002 because our management believed that it was more likely than not that we would not realize the benefits of the deferred tax asset because of the decline in the market value of our holding of Caldera stock and continued softness in the U.S. and European markets for our products.

New Accounting Standards

The FASB recently issued Statement 143, “Accounting for Asset Retirement Obligations,” addressing financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Statement 143 requires an enterprise to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of a tangible long-lived asset. Statement 143 also requires the enterprise to record the contra to the initial obligation as an increase to the carrying amount of the related long-lived asset and to depreciate that cost over the remaining useful life of the asset. The liability is changed at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the initial fair value measurement. Statement 143 is effective for fiscal years beginning after June 15, 2002. We are currently examining the impact of this pronouncement on the results of our operations and financial position, but currently believe the impact will not be material.

In July 2002, the FASB issued Statement 146, “Accounting for Costs Associated with Exit or Disposal Activities.” Statement 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by Statement 146 include lease termination costs and certain employee severance costs that are associated with restructuring, discontinued operations, plant closing or other exit or disposal activities. Statement 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with early adoption encouraged. As the provisions of Statement 146 are required to be applied prospectively after the adoption date, management cannot determine the potential effects that adoption of Statement 146 will have on our consolidated financial statements.

Liquidity and Capital Resources

Cash and cash equivalents were $6.2 million at October 5, 2002. The decrease in cash and cash equivalents of $2.2 million from April 6, 2002, was due primarily to cash used in operating activities of $3.3 million for the first six months of fiscal year 2003, which was attributable to the net loss from continuing operations of $10.4 million offset by $7.1 million in non-cash adjustments and changes in assets and liabilities primarily consisting of accounts receivable, loss on disposal of fixed assets, inventories, depreciation and provision for inventory obsolescence.

We have experienced recurring decreases in revenues and margins, which have resulted in significant losses and cash used in operations and significantly reduced available working capital. As of October 5, 2002, we have working capital of $2.0 million, as compared to working capital of $8.3 million at the end of the prior fiscal year. In response, we have taken the following actions:

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•     During the fourth quarter of fiscal year 2002, we recorded a restructuring charge of $4.9 million which consisted of $4.3 million, $0.3 million and $0.3 million charges related to the abandonment of either underutilized or historically unprofitable facilities, a headcount reduction of 56 employees or 13%, and the disposal of certain fixed assets, respectively. Of the 56 employees terminated, 15, 8, 6, 10, 14 and 3 were from the Sales, Marketing, General and Administrative, Field Services, Research and Development and Manufacturing departments, respectively. The cash impact of the restructuring charge was $0.3 million, related to severance, of which $0.1 million was paid in fiscal year 2002. The remaining $0.2 million was paid in the first quarter of fiscal year 2003.

•     In the first quarter of fiscal year 2003, we reduced our domestic headcount by an additional 15%, or 39 employees. We also terminated 20 additional manufacturing employees on July 31, 2002. As a result, we expect to reduce our quarterly cash outlays by approximately $0.4 million.

•     In February 2002, we borrowed $1.9 million from Canopy. On June 27, 2002, in response to limited borrowing ability, we replaced a $15.0 million line of credit with Silicon Valley Bank with a $7.0 million revolving line of credit from Canopy. During the second quarter of fiscal year 2003, the outstanding $1.9 million loan was paid-off and $1.9 million was borrowed against this line of credit. The new line will mature on June 30, 2003, bearing an interest rate of nine percent per annum and is secured by a security interest in substantially all of our assets. The Canopy Loan Agreement contains negative covenants placing certain restrictions on our ability to repurchase capital stock, pay dividends or make distributions, purchase or sell assets, incur liens on our assets, incur additional debt, merge with another entity, make loans or investments, amend our charter Certificate of Incorporation or bylaws or issue stock. Although we are currently in compliance with all of the terms of the Canopy Loan Agreement, and believe that we will remain in compliance, there can be no assurance that we will be able to borrow under the Canopy Loan Agreement. Canopy may terminate the Canopy Loan Agreement and declare all amounts outstanding immediately due and payable upon an event of default, including upon 30 days notice in the event that Canopy in good faith deems its interest in the Company to be insecure, the value of the collateral to have significantly declined, or the prospect of timely payment or performance to be impaired. Canopy owns approximately 14,463,000 shares, or 44.7%, of our issued and outstanding common stock.

•     On July 23, 2002 we sold our remaining shares of Caldera common stock to Caldera and we collected approximately $1.1 million in net proceeds, which we used to pay down our credit line with Canopy.

•     In July 2002, we completed the consolidation of our manufacturing facility to Dublin, Ireland. All excess fixed assets and inventory were brokered or re-deployed.

•     In November 2002, the Company entered into an agreement with Comerica Bank for a line of credit up to $7.0 million secured by a Letter of Credit. The Letter of Credit is guaranteed by Canopy.

Effective February 9, 1996, we entered into an agreement (the “EMC Agreement”) with EMC Corporation (“EMC”), in which we sold to EMC substantially all of our existing patents, patent applications and related rights. We were entitled to receive $30.0 million over the life of the EMC Agreement. The final payment of $5.0 million was received in January 2001. We also were entitled to receive royalty payments in the aggregate of up to a maximum of $30.0 million over the term of the EMC Agreement.

As part of the maximum $30.0 million in royalties, minimum royalties of $10.0 million were to be received in five annual installments, beginning within thirty days of the first anniversary of the effective date of the EMC Agreement, and within thirty days of each subsequent anniversary thereof. As of March 2001, we had received all installments. Also, as a result of a computer and technology agreement between EMC and IBM announced in March 1999, the minimum royalties of $10.0 million were to be increased to $15.0 million. Payments were to be received under the EMC Agreement in five equal annual installments. We received the first three annual installments in March 2000, March 2001 and March 2002, and are expecting to receive the two remaining annual installments of $3.0 million in March 2003 and 2004.

We also received from EMC an irrevocable, non-cancelable, perpetual and royalty-free license to exploit, market and sell the technology protected under the applicable patents. This license will terminate in the event of a change in control of the Company involving certain acquirers. As part of the EMC Agreement, the Company and EMC granted to each other a license to exploit, market and sell the technology associated with each of their respective existing and future patents arising from any patent applications in existence as of the effective date of the EMC Agreement for a period of five years, which expired February 2001.

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We require substantial working capital to fund our business. We use cash generated from our operations, equity capital, financings, and sales of our equity securities to fund capital expenditures, as well as to invest in and operate our existing operations. As of October 5, 2002, we had working capital of $2.0 million.

If we are unable to meet our anticipated revenue and expense levels, we may need additional outside sources of financing in order to meet our liquidity requirements to carry on our operations as presently conducted, and we are actively exploring financing alternatives which may include bank borrowings or public or private offerings of equity or debt securities. We cannot assure you that such additional sources of financing will be available on acceptable terms, if at all. If additional sources of financing are not available, we would have to implement further measures to conserve cash and reduce costs, which may include, among other things, making additional cost reductions. However, there is no assurance that these measures would be successful. Our failure to raise additional funds or to secure an additional credit facility would adversely affect our ability to:

	•		maintain, develop, or enhance our product offerings;
	•		take advantage of future opportunities;
	•		respond to competitive pressures; or
	•		continue operations in the short-term.

Additional funds raised through the issuance of equity securities or securities convertible into our common stock may have the following negative effects on the then-current common stockholders:

	•		dilution in percentage of ownership in the Company; and
	•		the rights, preferences or privileges of the new security holders may be senior to those of the common stockholders; and
	•		increased pressure on the Company’s ability to meet all of the maintenance or initial listing standards for various stock exchanges or markets.

The following represents a comprehensive list of our contractual obligations and commitments as of October 5, 2002: