FORWARD-LOOKING STATEMENTS

From time to time, information provided, statements made by our employees or information included in our filings with the Securities and Exchange Commission may contain statements that are not historical facts but that are "forward-looking statements," which involve risks and uncertainties. The words "may," "will," "should," "plan," "expect," "anticipate," "continue," "estimate," "project," "intend," and similar expressions are intended to identify forward-looking statements regarding events, conditions and financials trends that may affect our future plans of operations, business strategy, results of operations and financial position. These forward-looking statements, which include those related to our strategic plans, business outlook, and future business and financial performance, involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include, but are not limited to, general economic and business conditions, including unforeseen economic weakness in our markets, effects of continued geo-political unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing various engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, continued funding of defense programs and the timing of such funding, changes in the U.S. Government's interpretation of federal procurement rules and regulations, market acceptance of our products, shortages in components, production delays due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, inability to identify opportunities to rationalize our business portfolio in a timely manner or at all, difficulties in retaining key employees and customers, and various other factors beyond our control. These risks and uncertainties also include such additional risk factors as set forth under Part I-Item 1A (Risk Factors) in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2008. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.

OVERVIEW

We design, manufacture and market high-performance embedded, real-time digital signal and image processing systems and software for embedded and other specialized computing markets. Our solutions play a critical role in a wide range of applications, transforming sensor data to information for analysis and interpretation. In military reconnaissance and surveillance platforms our systems process real-time radar, sonar, and signals intelligence data. Our systems are also used in state-of-the-art medical diagnostic imaging devices including MRI, PET, and digital X-ray, and in semiconductor imaging applications including photomask generation and wafer inspection. We provide advanced three-dimensional (3D) image processing and visualization software and optimized systems to diverse end markets including life sciences, geosciences, and simulation. We also provide radio frequency (RF) products for enhanced communications capabilities in military and commercial applications. Additionally, we entered the Defense prime contracting market space in fiscal 2008 through the creation of a federal business group to focus on reaching the intelligence agencies and homeland security programs. Further, in the three month period ending September 30, 2008 and fiscal 2008, the consolidated financial statements, excluding the statement of cash flows, were restated to reflect the discontinuation and sale of the Biotech business ("Biotech") and the Embedded Systems and Professional Services ("ES/PS") businesses, respectively, in accordance with Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Asset (see Note N to the consolidated financial statements).

Since we are an OEM supplier to our commercial markets and conduct business with our defense customers via commercial off-the-shelf (COTS) distribution, requests by customers are a primary driver of revenue fluctuations from quarter to quarter. Customers specify delivery date requirements that coincide with their need

for our product. Because these customers may use our products in connection with a variety of defense programs or other projects with different sizes and durations, a customer's orders for one quarter generally do not indicate a trend for future orders by that customer. Additionally, order patterns of one customer do not necessarily correlate with the order patterns of another customer and, therefore, we generally cannot identify sequential quarterly trends, even within our business units.

RESULTS OFOPERATIONS:

The following tables set forth, for the periods indicated, certain financial
data as a percentage of total revenues:



                                                            Three Months Ended
                                                              September 30,
                                                            2008          2007
  Net revenues                                               100.0 %       100.0 %
  Cost of revenues                                            42.4          35.0

  Gross margin                                                57.6          65.0
  Operating expenses:
  Selling, general and administrative                         32.2          39.8
  Research and development                                    24.2          27.4
  Amortization of acquired intangible assets                   2.8           3.7
  Restructuring                                                1.1           0.1

  Total operating expenses                                    60.3          71.0

  Loss from operations                                        (2.7 )        (6.0 )
  Other income, net                                            0.6           3.2

  Loss from continuing operations before income taxes         (2.1 )        (2.8 )
  Provision for income taxes                                   0.0           3.8

  Net loss from continuing operations                         (2.1 )        (6.6 )
  Loss from discontinued operations, net of taxes             (1.5 )        (0.3 )
  Gain on sale of discontinued operations, net of taxes        0.9           0.0

  Net loss                                                    (2.7 )%       (6.9 )%

REVENUES



                                   As a % of                       As a % of
                  September 30,    Total Net      September 30,    Total Net
(in thousands)        2008          Revenue           2007          Revenue       $ Change      % Change
ACS              $        44,635          91 %   $        42,197          88 %   $    2,438            6 %
Visage                     1,965           4 %             2,764           6 %         (799 )        (29 )%
VSG                        2,294           4 %             2,565           5 %         (271 )        (11 )%
EBU                          205           1 %               482           1 %         (277 )        (57 )%

Total revenues   $        49,099         100 %   $        48,008         100 %   $    1,091            2 %

Total revenues increased $1.1 million or 2% to $49.1 million during the three months ended September 30, 2008 as compared to the comparable period in fiscal 2008. International revenues represented approximately 8% and 13% of total revenues during the three months ended September 30, 2008 and 2007, respectively.

ACS revenues increased $2.4 million or 6% during the three months ended September 30, 2008 as compared to the same period in fiscal 2008. The increase in revenue quarter over quarter was driven primarily by a $6.1 million increase in sales relating to defense applications. This increase was partially offset by decreases of

$3.7 million for commercial customers driven by reductions in revenue for legacy medical and telecommunications customers of $2.0 million and $1.7 million, respectively.

Visage revenues decreased $0.8 million or 29% during the three months ended September 30, 2008 as compared to the same period in fiscal 2008. The decrease in Visage revenues was a result of the continued decline in our legacy product line, Magicweb, which experienced quarter over quarter decreases of $1.0 million or 77%. We expect our legacy business will continue to decrease over the near term as we focus our investment in our new Visage CS Product lines and direct sales.

VSG revenues decreased $0.3 million or 11% during the three months ended September 30, 2008 as compared to the same period in fiscal 2008. The VSG revenues remained relatively flat quarter over quarter with a slight decline due to the timing of customer orders.

EBU revenues decreased $0.3 million or 57% during the three months ended September 30, 2008 as compared to the same period in fiscal 2008. The decrease in EBU revenues was primarily a result of the shutdown of our AUSG business through the exclusive license of AUSG's IP in the fourth quarter of fiscal 2008. This decrease was partially offset by the first time revenues generated from external customers for the Mercury Federal Systems ("MFS") business.

GROSS PROFIT

Gross profit was 57.6% for the three months ended September 30, 2008, a decrease of 740 basis points from the 65.0% gross profit achieved during the same period in fiscal 2008. The decrease in gross profit was primarily due to an unfavorable customer mix, product mix, higher excess and obsolete inventory reserve provisions driven by changing customer demands, and a decrease in sales in our high margin business, VSG.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses decreased $3.3 million or 17% to $15.8 million during the three months ended September 30, 2008 compared to $19.1 million during the comparable period in fiscal 2008. The decrease was primarily due to a $2.1 million decrease in employee compensation expense driven by our cost cutting measures, through restructuring, taken late in fiscal year 2008 and in the first quarter of fiscal year 2009, including the shutdown of our AUSG business unit, and a $0.4 million decrease in depreciation expense driven by these assets becoming fully depreciated in the current period.

RESEARCH AND DEVELOPMENT

Research and development expenses decreased $1.2 million or 9% to $11.9 million during the three months ended September 30, 2008 compared to $13.1 million during the comparable period in fiscal 2008. The decrease was primarily the result of a decrease in salary expenses and outside consulting expenses driven by our cost saving measures. Additionally, the shutdown of our AUSG business late in fiscal year 2008 attributed to $0.5 million of this decrease. Research and development continues to be a focus of our business with approximately 24.2% and 27.4% of our revenues dedicated to research and development activities during the three months ended September 30, 2008 and 2007, respectively. Improving the effectiveness of our research and development investments so as to realize a more near-term return is a priority.

AMORTIZATION OF ACQUIRED INTANGIBLE ASSETS

Amortization of acquired intangible assets decreased $0.4 million or 22% to $1.4 million for the three months ended September 30, 2008 as compared to $1.8 million during the comparable period in fiscal 2008. The decrease in amortization expense was primarily due to assets becoming fully amortized during the three months ended September 30, 2008.

RESTRUCTURING EXPENSE

Restructuring expense increased $0.5 million to $0.6 million during the three months ended September 30, 2008 compared to $0.1 million during the comparable period in fiscal 2008. This increase was primarily due to the size of each of the restructuring activities incurred in the respective periods. During the three months ended September 30, 2008, as part of the Company's cost cutting initiatives, we terminated additional employees in our Fuerth Germany location (see Footnote Q).

INTEREST INCOME

Interest income for the three months ended September 30, 2008 decreased by $1.1 million to $1.0 million compared to the same period in fiscal 2008. The decrease in interest income was primarily related to decreased rates of return on our marketable securities quarter over quarter .

INTEREST EXPENSE

Interest expense for the three months ended September 30, 2008 remained relatively flat at $0.8 million compared to the same period in fiscal 2008.

INCOME TAX PROVISION

We recorded a provision for income taxes of nil during the three months ended September 30, 2008 as compared to $1.8 million during the same period in fiscal 2008. Our effective tax rate for the three months ended September 30, 2008 differed from the U.S. statutory tax rate of 35% primarily due to the valuation allowance recorded and the impact of certain non-tax deductible items such as amortization expense that cause us to be in an income tax neutral, rather than benefit, position despite incurring a pre-tax loss during the quarter.

SEGMENT OPERATING RESULTS



                                                    Three Months Ended
                                                      September 30,
             (in thousands)                         2008          2007
             ACS income from operations          $    3,498     $   2,961
             Visage loss from operations             (2,653 )      (2,504 )
             VSG (loss) income from operations         (152 )         405
             EBU loss from operations                  (612 )      (1,103 )

Results from operations of the ACS segment increased $0.5 million during the three months ended September 30, 2008 to operating income of $3.5 million as compared to an operating income of $3.0 million for the same period in fiscal 2008. The increase in operating results was primarily driven by a reduction in operating expenses of $1.7 million related to the effect of reduced salaries from restructuring. The decrease in operating expenses were partially offset by decreases in gross margin of $1.2 million related to a change in product mix and an increase in obsolescence reserves due to shifts in customer demands.

Results from operations of the Visage segment decreased $0.2 million during the three months ended September 30, 2008 to an operating loss of $2.7 million as compared to an operating loss of $2.5 million for the same period in fiscal 2008. The slight decrease in operating results of the Visage segment was primarily related to decreased revenue which was offset by lower operating expenses due to restructuring activities and the closure of our Fuerth Germany facility (see Note Q to the Consolidated Financial Statements).

Results from operations of the VSG segment decreased $0.6 million during the three months ended September 30, 2008 to an operating loss of $0.2 million as compared to an operating income of $0.4 million for the same period in fiscal 2008. The decrease in operating results of the VSG segment was primarily related to a decline in revenue and an increase in R&D expenses.

Results from operations of the EBU segment increased $0.5 million during the three months ended September 30, 2008 to an operating loss of $0.6 million as compared to an operating loss of $1.1 million for the same period in fiscal 2008. The increase in results from operations was primarily due to the shutdown of our AUSG business in the third quarter of fiscal 2008. $1.1 million of expenses were recorded during the three months ended September 30, 2007 for the AUSG business, compared to $0.1 million for the three months ended September 30, 2008, offset by a decrease in operating results from our MFS business.

See Note H to our consolidated financial statements included in this report for more information regarding our operating segments.

OFF-BALANCE SHEET ARRANGEMENTS

Other than lease commitments incurred in the normal course of business, certain guarantees made related to the sale of our ES/PS business during the fourth quarter of fiscal 2008 (see Note N to the Consolidated Financial Statements) and certain indemnification provisions (see Note J to the Consolidated Financial Statements), we do not have any off-balance sheet financing arrangements or liabilities, guarantee contracts, retained or contingent interests in transferred assets, or any obligation arising out of a material variable interest in an unconsolidated entity. We do not have any majority-owned subsidiaries that are not consolidated in the financial statements. Additionally, we do not have an interest in, or relationships with, any special purpose entities.

LIQUIDITY AND CAPITAL RESOURCES



                                                     September 30,            September 30,
As of and for the period ended                           2008                     2007
Net cash provided by operating activities           $         2,636          $         3,962
Net cash used in investing activities                        (1,002 )                 (4,530 )
Net cash provided by financing activities                       243                      360
Net increase (decrease) in cash and cash
equivalents                                                   1,881                      (48 )
Cash and cash equivalents at end of period                   60,926                   51,245

Cash and Cash Equivalents

Our cash and cash equivalents increased by $9.7 million from September 30, 2007 to September 30, 2008, primarily as the result improved linearity in sales which resulted in improved collections on receivables.

During the three months ended September 30, 2008, we generated $2.6 million in cash from operations compared to $4.0 million generated from operations during the same period in fiscal 2008. The $1.4 million decrease in the amount of cash generated from operations was largely driven by reduced deferred revenues and customer advances, lower accounts payable and accrued expense balances, offset by improved account receivable collections and lower inventory balances. Our ability to generate cash from operations in future periods will depend in large part on profitability, the rate of collection of accounts receivable, our inventory turns and our ability to manage other areas of working capital.

During the three months ended September 30, 2008, we used $1.0 million in cash from investing activities compared to $4.5 million used in investing activities during the same period in fiscal 2008. The decrease in cash used in investing activities was primarily driven by lower net purchases of marketable securities and a decrease in cash used in acquisitions. The collapse of the auction rate securities ("ARS") markets has resulted in $50.3 million of our auction rate securities becoming illiquid. As a result, we will not be able to access these funds until future auctions for these ARS are successful, the securities are sold in a secondary market which currently is not active, or the securities are called by the issuer. As such, the ARS investments currently lack short-term liquidity and were therefore classified as non-current in the September 30, 2008 and June 30, 2008 consolidated balance sheets. In October 2008, we received a rights offering from UBS, in which we have elected to participate. The

offering will allow us to redeem our ARS at par plus accrued interest on June 30, 2010. The offering also contains an option to borrow up to 75% of the fair value of the ARS at no cost. Upon borrowing against the ARS, we would forgo the interest income on the underlying ARS, while the borrowings are outstanding. We expect to redeem our ARS on June 30, 2010. The loan facility included in the offering will replace our previous margin loan facility with UBS.

During the three months ended September 30, 2008, we generated $0.2 million in cash from financing activities compared to $0.4 million generated from financing activities during the same period in fiscal 2008. There were no material changes in financing activities.

During the three months ended September 30, 2008, our prime source of liquidity came from existing cash and marketable securities and the cash generated from operations. Our near-term fixed commitments for cash expenditures consist primarily of payments under operating leases, an alliance purchase agreement, a supply agreement and inventory purchase commitments, as well as interest payments on our long-term debt. We do not currently have any material commitments for capital expenditures. On May 1, 2009 our convertible debt may be put to us which, if such put is made in full, would result in a required cash payment of $125.0 million. If cash generated from operations is insufficient to satisfy working capital requirements and/or to make any required payments of our convertible debt, we may need to access funds through our loan facility with the holder of our ARS. Between now and June 30, 2010, we can borrow on up to 75% of this facility. There can be no assurance that we will be able to raise any such capital on terms acceptable to us, on a timely basis or at all. If we are unable to secure additional financing, we may not be able to develop or enhance our products, take advantage of future opportunities, respond to competition or continue to effectively operate our business. In addition, failure to repurchase our convertible debt when tendered in accordance with its terms would constitute an event of default under the related indenture.

Based on our current plans and business conditions, we believe that existing cash, cash equivalents and marketable securities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.

Debt

On April 29, 2004, we completed a private offering of $125,000 aggregate principal amount of Convertible Senior Notes (the "Notes"), which mature on May 1, 2024 and bear interest at 2% per year, payable semiannually in arrears in May and November. The Notes are unsecured, rank equally in right of payment to the Company's existing and future unsecured senior debt, and do not subject the Company to any financial covenants.

The terms of our convertible senior notes contain certain contingent conversion provisions. Under certain circumstances, the notes will be convertible into our common stock at a conversion rate of 33.0797 shares per $1,000 principal amount of the notes, subject to adjustment in certain circumstances. The conversion rate is equal to an initial conversion price of approximately $30.23 per share. At the option of the holder, the convertible notes may be converted on the final maturity date if, on or prior to May 1, 2019, the closing price of our common stock exceeds $36.28 for at least 20 trading days in a specified 30-day period of each fiscal quarter or on any date after May 1, 2019, the closing price of our common stock exceeds $36.28. The notes may also be converted at the option of the holder if prior to May 1, 2019, the average trading price for the convertible senior notes is less than 98% of the average conversion value for the convertible senior notes during any five consecutive trading-day period. The convertible notes mature on May 1, 2024 and bear interest at 2% per year, payable semiannually in arrears in May and November. The convertible notes are unsecured, rank equally in right of payment to our existing and future senior debt, and do not subject us to any financial covenants. The holders may require us to repurchase the notes, in whole or in part, (a) on May 1, 2009, 2014 or 2019, (b) upon a change in control, or (c) if our common stock is neither listed nor approved for trading on specified markets. At our option, we may redeem any of the convertible notes on or after May 1, 2009 at a price equal to 100% of the principal amount of the convertible notes to be redeemed plus accrued and unpaid interest.

Commitments and Contractual Obligations

The following is a schedule of our commitments and contractual obligations
outstanding at September 30, 2008:



                                                            Less Than       2-3        4-5       More Than
(in thousands)                                   Total        1 Year       Years      Years       5 Years
Notes payable and capital lease obligations    $ 125,385    $  125,370    $    15    $    -     $        -
Interest due on notes payable                      2,503         2,502          1         -              -
Purchase obligations                              20,016        20,016         -          -              -
Supply agreement                                   1,960            -          -       1,960             -
Operating leases                                  23,237         3,786      6,283      5,071          8,097
IP Agreement                                         100           100         -          -              -

                                               $ 173,201    $  151,774    $ 6,299    $ 7,031    $     8,097

Notes payable, capital lease obligations and interest due on notes payable consists of various domestic and foreign debt agreements and the interest due on such agreements. (See Note O to the consolidated financial statements for further financial information regarding these agreements). Our pension obligation and deferred compensation plan liabilities which are not included in the table above, are included in accrued expenses in our consolidated balance sheets.

Purchase obligations represent open non-cancelable purchase commitments for certain inventory components and services used in normal operations. The purchase commitments covered by these agreements are generally for less than one year and aggregated approximately $20.0 million at September 30, 2008.

In September 2006, we entered into a supply agreement with a third party vendor to purchase certain inventory parts that went "end of life." This supply agreement, as subsequently amended, commits the vendor to acquiring and storing approximately $6.5 million of inventory until August 31, 2012 and allows the Company to place orders for the inventory four times a year. Upon the earlier of January 31, 2007 or completion of the wafer fabrication process, the Company was required to and paid approximately $1.9 million of the $6.5 million. Further, upon expiration of the agreement on August 31, 2012, if the Company does not purchase the full $6.5 million in inventory, the Company may be required to pay a penalty equal to 35% of the remaining inventory balance. As of September 30, . . .