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 and divestitures 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, 2009. 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 semiconductor applications such as wafer inspection and fabrication. We also provide radio frequency 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 our wholly-owned subsidiary, MFS, to focus on reaching the federal intelligence agencies and homeland security programs.

In June 2009, we closed on the sale of our former VSG operating segment for gross consideration of $12.0 million in cash.

In January 2009, we signed a definitive agreement and closed on the sale of our former VI operating segment for gross consideration of $3.0 million in cash. Of the proceeds, a total of $1.1 million was held back for general indemnification purposes and employee termination payments to be incurred by the buyer.

In September 2008, we closed on the sale of our former Biotech business for a $0.1 million cash payment, and $0.3 million of preferred shares in the acquiring entity.

In May 2008, we closed on the sale of our former ES/PS business for $0.4 million plus future royalties, net of tax.

The accounting for these sales and the VSG and VI operating segments' operating results are included in discontinued operations for fiscal 2009 and prior period results have been reclassified to reflect the discontinuation and sale (see Note P to the consolidated financial statements).

Following the divestiture of those businesses, we have organized our operations into the following two business units:

Advanced Computing Solutions ("ACS"). This business unit is focused on specialized, high performance computing solutions with key market segments, including aerospace and defense, semiconductor, telecommunications and medical diagnostic imaging. This segment also provides software and customized design services to meet the specified requirements of military and commercial applications.

Mercury Federal Systems (MFS). Formerly referred to as the "Emerging Business Unit" segment, this business unit has historically been focused on the cultivation of new business opportunities that benefit from our capabilities across markets. Following the sale of the Biotech business and the shutdown of the Avionics and Unmanned Systems Group ("AUSG") reporting unit, this business unit now solely consists of the Company's wholly-owned subsidiary, Mercury Federal Systems, Inc. As such, beginning in the first quarter of fiscal 2010, this segment was renamed "Mercury Federal Systems (MFS)". Current areas of focus include services and support work with federal intelligence agencies and homeland security programs including designing and engineering new ISR capabilities to address present and emerging threats to U.S. forces.

Since we are an OEM supplier to our commercial markets and conduct business with our defense customers via commercial items, 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 OF OPERATIONS:

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



                                                               Three Months Ended
                                                                  September 30,
                                                              2009             2008
Net revenues                                                   100.0 %          100.0 %
Cost of revenues                                                42.4             44.4

Gross margin                                                    57.6             55.6
Operating expenses:
Selling, general and administrative                             23.9             27.0
Research and development                                        21.5             22.9
Amortization of acquired intangible assets                       0.9              2.2
Restructuring                                                    0.6              0.5

Total operating expenses                                        46.9             52.6

Income from operations                                          10.7              3.0
Other income, net                                                0.5              0.0

Income from continuing operations before income taxes           11.2              3.0
Provision for income taxes                                       1.9              0.0

Income from continuing operations                                9.3              3.0
Income (loss) from discontinued operations, net of
taxes                                                            0.1             (7.0 )
(Loss) gain on sale of discontinued operations, net
of taxes                                                        (0.2 )            1.1

Net income (loss)                                                9.2 %           (2.9 )%

REVENUES



                                   As a % of                        As a % of
                  September 30,    Total Net       September 30,    Total Net
(in thousands)        2009          Revenue            2008          Revenue        $ Change       % Change
ACS              $        44,359          94 %    $        44,635         100 %    $     (276 )           1 %
MFS                        3,072           6 %                205          -            2,867         1,399 %

Total revenues   $        47,431         100 %    $        44,840         100 %    $    2,591             6 %

Total revenues increased $2.6 million or 6% to $47.4 million during the three months ended September 30, 2009 as compared to the comparable period in fiscal 2009. International revenues represented approximately 6% and 5% of total revenues during the three months ended September 30, 2009 and 2008, respectively.

Net ACS revenues decreased $0.3 million or 1% during the three months ended September 30, 2009 as compared to the same period in fiscal 2009. This decrease was primarily driven by a $4.7 million reduction in sales to commercial customers, primarily relating to the semiconductor equipment and medical markets. This decrease was offset by an increase in sales to defense customers of $4.4 million, mostly driven by an increase in electronic warfare applications.

Net MFS revenues increased $2.9 million during the three months ended September 30, 2009 as compared to the same period in fiscal 2009. MFS began generating external revenues in the first quarter of fiscal 2009, and primarily serves defense intelligence, surveillance, and reconnaissance ("ISR") markets.

Effective July 1, 2009, we adopted ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements ("ASU 2009-13"), which amends FASB ASC Topic 605, Revenue Recognition. ASU 2009-13 amends the FASB ASC to eliminate the residual method of allocation for multiple-deliverable revenue arrangements, and requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. As a result of implementing ASU 2009-13, we recognized $1.9 million in the three months ended September 30, 2009 within the ACS business unit that would have been deferred under the previous guidance for multiple-deliverable arrangements. We anticipate that the effect of the adoption of this guidance on subsequent periods will be primarily based on the arrangements entered into and the timing of shipment of deliverables. See Note C to the consolidated financial statements for further discussion of our multiple-deliverable arrangements.

GROSS PROFIT

Gross profit was 57.6% for the three months ended September 30, 2009, an increase of 200 basis points from the 55.6% gross profit achieved during the same period in fiscal 2009. The increase in gross profit was primarily due to a $1.3 million decrease in provisions for obsolete inventory as compared to the same period in fiscal 2009. Significant reserves for inventory obsolescence were booked in the three months ended September 30, 2008 largely due to the decline in commercial revenue.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses decreased $0.8 million or 7% to $11.3 million during the three months ended September 30, 2009 compared to $12.1 million during the comparable period in fiscal 2009. The decrease was primarily due to a $0.3 million decrease in employee compensation expense, including stock-based compensation expense, driven by our restructuring and cost saving measures. Additionally, there was a $0.3 million decrease in audit expense and a $0.2 million decrease in legal expense.

RESEARCH AND DEVELOPMENT

Research and development expenses decreased $0.1 million or 1% to $10.2 million during the three months ended September 30, 2009 compared to $10.3 million during the comparable period in fiscal 2009. The decrease was primarily the result of a $0.6 million increase in the time spent by our engineers on billable projects, and a $0.1 million decrease in depreciation expense due to assets becoming fully depreciated, partially offset by a $0.6 million increase in outside development expenses related to new product development initiatives. Research and development continues to be a focus of our business with approximately 21.5% of our revenues dedicated to research and development activities during the three months ended September 30, 2009 and approximately 22.9% of our revenues dedicated to such activities during the same period in fiscal 2009. Continuing to improve the leverage of our research and development investments in order to realize a more near-term return is a priority.

AMORTIZATION OF ACQUIRED INTANGIBLE ASSETS

Amortization of acquired intangible assets decreased $0.6 million or 60% to $0.4 million for the three months ended September 30, 2009 as compared to $1.0 million during the comparable period in fiscal 2009. The decrease in amortization expense was primarily due to more assets becoming fully amortized prior to the three months ended September 30, 2009.

RESTRUCTURING EXPENSE

Restructuring expense remained relatively flat at $0.3 million during the three months ended September 30, 2009 compared to $0.2 million during the comparable period in fiscal 2009. Restructuring activities during the three months ended September 30, 2009, were primarily due to the elimination of four positions under the Q1 FY10 Plan as a result of our continued cost savings efforts within the ACS segment. During the three months

ended September 30, 2008, restructuring charges primarily related to the elimination of two positions and additional severance accruals for our ACS Plan, which was enacted in fiscal 2008 to reduce payroll and overhead costs to realign costs with our revenue base.

INTEREST INCOME

Interest income for the three months ended September 30, 2009 decreased by $0.9 million to $0.1 million compared to the same period in fiscal 2009. The decrease was primarily attributable to decreased rates of return on our marketable securities, as well as a decrease in the amount of cash invested in marketable securities as a result of the February 2009 and May 2009 repurchase of an aggregate of $125.0 million of our Convertible Senior Notes (the "Notes").

INTEREST EXPENSE

Interest expense for the three months ended September 30, 2009 decreased by $0.8 million to $0.1 million compared the same period in fiscal 2009. The decrease was primarily due to lower interest incurred as a result of the repayment of our Notes in February 2009 and May 2009.

INCOME TAX PROVISION

We recorded a provision for income taxes of $0.9 million during the three months ended September 30, 2009 as compared to nil during the same period in fiscal 2009. Our effective tax rate for the three months ended September 30, 2009 differed from the U.S. statutory tax rate of 35% primarily due to research and development tax credits and a decrease in the valuation allowance on deferred tax assets.

SEGMENT OPERATING RESULTS

Operating profit for ACS increased $2.5 million during the three months ended September 30, 2009 to $5.6 million as compared to $3.1 million for the same period in fiscal 2009. The increase in operating profit was primarily driven by an improvement in gross profit of $1.9 million. This improvement was largely attributable to a $1.3 million decrease in provisions for obsolete inventory as compared to the same period in fiscal 2009. The increase in operating profit in the three months ended September 30, 2009 was also due to a decrease in operating expenses of $0.8 million, largely due to a decrease in associate headcount as a result of fiscal 2009 restructuring efforts.

Results from operations of the MFS segment increased $0.5 million during the three months ended September 30, 2009 to an operating loss of $0.1 million as compared to an operating loss of $0.6 million for the same period in fiscal 2009. The increase in results from operations was primarily due to an increase in revenues in the ISR markets. The increase in results from operations was partially offset by an increase in operating expense primarily due to an increase in MFS headcount.

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

OFF-BALANCE SHEETARRANGEMENTS

Other than lease commitments incurred in the normal course of business, certain guarantees made related to the sale of our VSG business in the fourth quarter of fiscal 2009 and our ES/PS business during the fourth quarter of fiscal 2008 (see Note P to the consolidated financial statements) and certain indemnification provisions (see Note N 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



(in thousands)                                      September 30,             September 30,
As of and for the period ended                          2009                      2008
Net cash provided by operating activities          $         2,607           $         2,636
Net cash used in investing activities                         (257 )                  (1,002 )
Net cash (used in) provided by financing
activities                                                    (112 )                     243
Net increase in cash and cash equivalents                    2,300                     1,881
Cash and cash equivalents at end of period                  49,250                    60,926

Cash and Cash Equivalents

Our cash and cash equivalents decreased by $11.7 million from September 30, 2008 to September 30, 2009, primarily as the result of the repurchase of $125.0 million aggregate principal amount of our Notes, offset by net sales of marketable securities, a $33.1 million borrowing against our auction rate securities, cash provided by operating activities and cash proceeds from the sale of discontinued operations.

During the three months ended September 30, 2009, cash generated from operations remained relatively flat at $2.6 million as compared to the same period in fiscal 2009. The cash generated from operations was largely driven by a $12.6 million decrease in cash generated from accounts receivable and a $3.1 million reduction in cash generated from prepaid expenses, offset by higher comparative net income, an $8.7 million decrease in cash used for accounts payable and accrued expenses and a $3.7 million improvement in cash generated from deferred revenues. 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, 2009, we used $0.3 million in cash in investing activities compared to $1.0 million used in investing activities during the same period in fiscal 2009. The $0.7 million decrease in cash used in investing activities was primarily driven by a $0.3 million decrease in capital expenditures, a $0.3 million increase in proceeds from net sales of marketable securities and $0.2 million in cash proceeds from the sale of discontinued operations.

During the three months ended September 30, 2009, we used $0.1 million in cash from financing activities compared to $0.2 million generated from financing activities during the same period in fiscal 2009. The decrease in cash generated from financing activities was primarily due to payments of $0.3 million under our ARS line of credit. In October 2008, we received a rights offering from UBS (the "offering") in which we have elected to participate. By electing to participate in the offering, we (1) received the right to sell these ARS back to UBS at par plus interest, at our sole discretion, during a two-year period beginning on June 30, 2010, and (2) received an option to borrow up to 75% of the fair value of the ARS. Upon borrowing against the ARS, we forgo the interest income on the underlying ARS while the borrowings are outstanding and in return are not charged any interest expense. The line of credit included in the offering replaced our previous margin loan facility with UBS. As of September 30, 2009, we had $33.1 million outstanding under this line of credit, collateralized by the $49.7 million par value of auction rate securities.

During fiscal 2009, our primary source of liquidity came from existing cash and marketable securities, the cash generated from operations and the $33.1 million borrowing under our line of credit. Our near-term fixed commitments for cash expenditures consist primarily of payments under operating leases, a supply agreement and inventory purchase commitments with our contract manufacturers. We do not currently have any material commitments for capital expenditures.

Based on our current plans and business conditions, we believe that existing cash, cash equivalents, marketable securities, available line of credit and cash generated from operations 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 $125.0 million aggregate principal amount of Notes, which had an original maturity date of May 1, 2024, bearing interest at 2% per year, payable semiannually in arrears in May and November. The Notes were unsecured, ranked equally in right of payment to our existing and future unsecured senior debt, and did not subject us to any financial covenants.

On February 4, 2009, we repurchased $119.7 million (face value) aggregate principal amount of our Notes from a holder of such Notes. We repurchased the Notes for aggregate consideration equal to the principal amount of the Notes plus accrued interest. We paid the consideration for the Notes from a combination of cash on hand and the proceeds from the sale of certain U.S. Treasury securities held by us.

On May 1, 2009, we repurchased the remaining aggregate principal amount outstanding of $5.3 million (face value) of our Notes from the holders of such Notes. We repurchased the Notes for aggregate consideration equal to the principal amount of the Notes plus accrued interest. We paid the consideration for the Notes from cash on hand. We have no further obligations under the Notes.

Borrowings Under Line of Credit

In October 2008, we elected to participate in a rights offering from UBS with the option to borrow up to 75% of the fair value of our $49.7 million par value ARS. Upon borrowing against the ARS, the interest expense incurred by us will not exceed the interest income earned on the underlying ARS. As of September 30, 2009, we had $33.1 million outstanding against this line of credit.

Shelf Registration Statement

On April 28, 2009, we filed a shelf registration statement on Form S-3 with the SEC. The shelf registration statement, which has been declared effective by the SEC, registered up to $100 million of debt securities, preferred stock, common stock, warrants and units. We may sell any combination of these securities, either individually or in units, in one or more offerings. We intend to use the net proceeds from the sale of any securities under the shelf registration statement for general corporate purposes, which may include the following:

• the acquisition of other companies or businesses;

• the repayment and refinancing of debt;

• capital expenditures;

• working capital; and

• other purposes as described in any prospectus supplement under the shelf registration statement.

We may sell the securities under a variety of methods including directly to investors, using an underwriting syndicate, through brokers, by block trade or by other methods described in the shelf registration statement.

Commitments and Contractual Obligations

The following is a schedule of our commitments and contractual obligations
outstanding at September 30, 2009:



                                                Less Than      2-3       4-5      More Than
  (in thousands)                     Total       1 Year       Years     Years      5 Years
  Borrowings under line of credit   $ 33,105   $    33,105   $    -    $    -    $        -
  Purchase obligations                22,558        22,558        -         -             -
  Operating leases                    19,487         3,166     5,794     4,980         5,547
  Supply agreement                     1,847            -      1,847        -             -
  Capital lease obligations                9             9        -         -             -

                                    $ 77,006   $    58,838   $ 7,641   $ 4,980   $     5,547

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 $22.6 million at September 30, 2009.

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 us to place orders for the inventory four times a year. Upon the earlier of January 31, 2007 or completion of the wafer fabrication process, we were required to and paid approximately $1.9 million of the $6.5 million. Further, upon expiration of the agreement on August 31, 2012, if we do not purchase the full $6.5 million in inventory, we may be required to pay a penalty equal to 35% of the remaining inventory balance. As of September 30, 2009, the remaining . . .