MERCURY COMPUTER SYSTEMS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER - 000-23599

---------------

MERCURY COMPUTER SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

MASSACHUSETTS 04-2741391
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)

199 RIVERNECK ROAD, CHELMSFORD MASSACHUSETTS 01824
(Address of principal executive offices) (Zip code)

(978) 256-1300 NASDAQ NATIONAL MARKET
(Registrant's telephone number including area code) (Name exchange on which registered)

SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OF THE
SECURITIES EXCHANGE ACT OF 1934:
None

SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE
SECURITIES EXCHANGE ACT OF 1934:
Common Stock, Par Value $.01 Per Share

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 [ ]

Aggregate market value of Registrant's voting stock held by non-affiliates of
the Registrant as of August 31, 1999: $269,402,562.

Shares of Common Stock outstanding as of August 31, 1999: 10,361,637 shares

DOCUMENTS INCORPORATED BY REFERENCE

Excerpts from the Registrant's Annual Report to Shareholders for the year ended
June 30, 1999 is incorporated by reference into parts I and II of this report.

Portions of the Registrant's definitive Proxy Statement for its special meeting
in lieu of the 1999 Annual Meeting of Stockholders to be held on November 18,
1999 (the "Proxy Statement") are incorporated by reference into Part III of this
report.

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

Exhibits Index on Page 18

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PART I

ITEM 1. BUSINESS

OVERVIEW

Mercury Computer Systems, Inc. (the "Company" or "Mercury") designs,
manufactures and markets high performance, real-time digital signal processing
computer systems that transform sensor generated data into information which
can be displayed as images for human interpretation or subjected to additional
computer analysis. These multicomputer systems are heterogeneous and scalable,
allowing them to accommodate several different microprocessor types and to
scale from a few to hundreds of microprocessors within a single system.
Mercury's system architecture is specifically designed for digital signal
processing ("DSP") applications, which are typically, computation intensive and
require I/O capacity and interprocessor bandwidth not available on a general
purpose PC or workstation.

The two primary markets for Mercury's products are defense electronics and
medical diagnostic imaging. Both of these markets have computing needs which
benefit from the unique system architecture developed by the Company. Mercury's
computer systems are generally used on real-world signal data to enable a
military commander to "see" the battle space through natural barriers such as
clouds, darkness, water or foliage, so that the position and strength of the
enemy can be determined, or to enable a physician to "see" within the body
instead of performing invasive surgery.

During the past several years, the majority of the Company's revenues
have been generated from sales of its products to the defense electronics
market, generally for use in reconnaissance and intelligence gathering systems.
The Company's activities in this area have focused on the proof of concept,
development and deployment of advanced military applications in radar, sonar
and airborne surveillance. The Company has established relationships with many
of the major prime contractors to the worldwide defense industry, including
Lockheed Martin Corporation, Hughes Aircraft Company, Raytheon Systems Company,
Northrop Grumman Corporation, MIT/Lincoln Laboratory, GEC Marconi Limited,
Ericsson Microwave Systems AB, MATRA Systems & Information, Mitsubishi Heavy
Industries, Ltd., British Aerospace and a prime contractor owned by the Israeli
Ministry of Defense.

Medical diagnostic imaging is the other primary market currently served by
the Company. Mercury's computer systems are embedded in Magnetic Resonance
Imaging ("MRI"), Computed Tomography ("CT") and Positron Emission Tomography
("PET") machines. Mercury has supplied computer systems for use in several of GE
Medical Systems' diagnostic imaging systems since 1987, and has established
relationships with Siemens Medical Systems, Inc., and Picker International. The
major medical imaging manufacturers are currently developing the next generation
of MRI, CT and digital x-ray machines, which are expected to provide better
performance at lower cost. Mercury has secured design wins on programs with
certain of the major medical imaging manufacturers for their next generation
MRI, CT and digital x-ray machines.

Mercury's computer systems are designed to process continuous streams of
data from sensors attached to radar, sonar, medical imaging equipment and other
devices. The resulting image is transmitted to the battlefield commander, pilot,
technician or physician in order to assist in the decision making or diagnostic
process. Due to the nature of the applications in which many of Mercury's
computer systems are embedded, they are frequently confined in limited spaces
and therefore are designed to generate a minimum amount of heat. The Company
employs the RACEway Interconnect, an industry standard system area network
developed by Mercury, which allows for high interprocessor bandwidth and I/O
capacity. The Company uses its proprietary ASICs to integrate microprocessors,
memory and related components into the RACEway Interconnect to provide optimum
system performance. The Company uses industry standard processors, such as
Motorola's PowerPC and Analog Devices' SHARC, in the same system. The Company
believes that the RACEway Interconnect and its proprietary ASICs, working
together with a group of mixed microprocessors in the same system, allow the
most efficient use of space and power with an optimal price/performance ratio.

Since July 1996, Mercury has targeted the emerging shared storage market for
introduction of a new product which draws on the Company's core competencies in
systems engineering and the development of real-time software. This business
unit was created to exploit some of Mercury's innovative software developments.
It has evolved into software for use in applications and market segments that,
while exciting and potentially offering a large

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return, are outside of Mercury's core businesses and strengths. The Company has
therefore issued an offering memorandum seeking alternative ways to fund the
continuing development of this business.

INDUSTRY BACKGROUND

Defense Electronics

Digital signal processing computer systems are embedded into air, sea and
land-based platforms for processing radar, sonar and signal intelligence
applications. The Company believes that an important factor underlying the
development of this market is a continuing desire by military commanders for
increased battle space information, which can be obtained through radar, sonar,
signal intelligence and image intelligence systems. Military commanders also
need more powerful computers with similar attributes in order to conduct dynamic
battle simulations and mission planning tasks utilizing today's complex weapons
systems.

Another important trend in the defense electronics marketplace is the
movement away from so-called "stove pipe" systems designed by prime contractors
with special purpose hardware specifically for a single application, largely
without regard to cost. The market is moving toward the use of systems which
incorporate selected commercial-off-the-shelf ("COTS") hardware and software
components in order to save money and development time. Recent Department of
Defense ("DOD") leaders and federal regulations have mandated widespread use of
COTS components in defense electronics applications. All of Mercury's computer
systems are eligible for use in defense electronics applications as COTS
components.

Medical Imaging

The principal modalities of medical diagnostic imaging systems include MRI,
CT, digital x-ray, PET, SPECT (single photon emission computed tomography) and
ultrasound devices. Although demand for medical imaging equipment has been
sluggish in recent years due primarily to cost containment pressures and
consolidation in the health care industry, the Company believes that demand for
medical diagnostic imaging equipment will increase modestly over the next three
years. The Company believes that this increase will be primarily due to the
introduction of next-generation devices, together with the anticipated future
development by the major medical imaging manufacturers of new international
markets for their diagnostic equipment. The Company believes medical imaging
equipment manufacturers will continue to replace in-house designed digital
signal processing systems with commercially available systems designed by the
Company and others.

This industry's demand is driven in part by the need to provide physicians
with rapid, sharp and clear images of areas of a patient's body suspected to be
diseased or injured, while using the least intrusive means. These images provide
a significant diagnostic tool for the physician, who can more readily understand
the patient's malady and prescribe appropriate corrective action. In order to
provide such images, medical imaging machines must be capable of processing a
continuous stream of data on a real-time basis. A parallel concern in the health
care industry is the need to reduce costs. Hospitals, in particular, continue to
be under significant pressure to contain costs and, at the same time, maintain
quality of care. Such pressures are forcing hospitals to be as technologically
efficient as possible. Toward this end, hospitals seek to reduce the required
period of time a patient must spend in their medical imaging machines, which has
the added benefit of increasing the total number of patients who can be
diagnosed with this expensive equipment during a given period of time. One way
to reduce patient time in medical imaging machines and improve image quality is
to utilize more powerful signal processing computers, such as those supplied by
Mercury.

MARKETS AND CUSTOMERS

Defense Electronics

Mercury provides high performance embedded computer systems as standard
products to the defense electronics market by using commercial and selected
rugged components and by working closely with defense contractors to complete a
design which matches the specified requirements of military applications. The
Company engages in frequent, detailed communication with the end users of
Mercury's systems, military executives and program managers in government and
defense contractors regarding the technical capabilities of Mercury's advanced
signal processing computers and the successful incorporation of its computers in
numerous military programs.

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Mercury employs industry specialist managers to monitor the defense programs
of each major branch of the United States armed services and additional managers
based in Europe and Japan to keep abreast of developments in their respective
regions. This approach provides relevant information to Mercury regarding major
military procurements worldwide. Mercury maintains sales and technical support
groups to service defense industry participants in six branch offices in the
United States, and through Mercury's subsidiary offices or distributors in 11
other countries. At Mercury's headquarters in Chelmsford, Massachusetts, a group
of systems engineers specializing in radar, sonar and surveillance problems
provides support on an as-needed basis to the remote offices to assist in
securing inclusion in targeted military programs.

Medical Imaging

Mercury strives to provide a superior combination of high performance and
competitively priced embedded computer systems to the medical imaging market.
The Company focuses on establishing strong relationships with its customers, the
medical equipment manufacturers. By maintaining frequent, in-depth
communications with its customers and working closely with their engineering
groups, the Company is able to understand their needs and provide appropriate
solutions. In addition, the Company intends to continue its efforts to install
its computer systems in place of alternative designs created by the in-house
design teams employed by the medical imaging equipment manufacturers.

The Company currently is working closely with major medical equipment
companies to design the next generation of MRI, CT and digital x-ray systems,
which the Company believes will lead to faster time-to-market and competitive
advantages for the medical equipment companies that use Mercury's computer
systems for inclusion in their imaging machines. Mercury's industrial PC class
hardware system provides the medical imaging industry with increased performance
densities at lower costs and an architecture that accommodates performance
upgrades as new technology becomes available. Integrating the high-bandwidth
RACEway Interconnect system area network within the PCI environment results in
highly scalable systems. This allows medical equipment suppliers to design
systems that can satisfy a broad range of price/performance requirements and
meet the needs of global markets, all with the same Mercury architecture.

Mercury's medical OEM customers consist of the leading manufacturers of
diagnostic imaging equipment. They include GE Medical, headquartered in
Wisconsin, GE Medical Systems Europe in France, GE Yokugawa Medical Systems in
Japan, Siemens Medical in Germany, and Picker International. These companies
have adopted Mercury's PCI or VME computer systems as part of their developments
in either MRI, CT, or digital x-ray systems and, in the case of some companies,
multiple types of systems. The Company has supplied GE Medical with computer
systems for use in three successive generations of MRI machines from 1987
through the present, as well as for use in other GE Medical equipment, such as
PET. In addition, GE Medical and Siemens Medical, the two leading global
suppliers of medical imaging equipment, have awarded contracts to Mercury to
design the signal processing system for the next generation of certain of their
CT medical diagnostic equipment.

The Company is building systems based on Analog Devices' SHARC DSP processor
and Motorola's Power PC processor to fulfill design wins in CT. The Company also
is building a system based on the Power PC chip to fulfill a design win in
digital x-ray. The Company believes that the principal reason for its medical
imaging design wins is Mercury's experienced team of systems and applications
engineers who work closely with the medical equipment designers and with the
Company's product development engineers. This joint design effort frequently
precedes the first production orders by approximately two to three years.
However, once selected, the production contracts typically continue for the life
of the medical imaging system. In addition, the equipment manufacturers
typically offer computer system upgrades to their customers, potentially
resulting in additional sales of Mercury products.

AgileVision

On September 1, 1999, the Company formed a joint venture with the Sarnoff
Corporation referred to as AgileVision. The venture will use Mercury technology
to design, develop, and deliver products and solutions expected to dramatically
reduce the cost of digital TV infrastructure for the broadcast and cable
markets. The many business uncertainties that attend the new venture make
revenue projections at this time inappropriate. The joint venture does
anticipate it would begin to generate revenues during fiscal 2000. Mercury's
share of gains and losses will be reported as a separate line item in its profit
and loss statement.

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Digital Wireless

During the fourth quarter of fiscal 1999, the Company announced that it will
pursue the digital wireless communications opportunity internally, offering its
technology and expertise to manufacturers for incorporation within new
generations of base stations that require substantially more flexible and
powerful signal processing capabilities. Returns on Mercury's investments in
fiscal 2000 and 2001 would not begin before fiscal 2001. The market opportunity,
however, is very large, amounting to several hundred millions of dollars
annually, and it represents an OEM business model, which Mercury understands
well. In this past year, Mercury has carried out extensive activities creating a
business development plan that merges its future technology with the processing
requirements of the evolving wireless infrastructure.

KEY TECHNOLOGY COMPETENCIES

Many of Mercury's customers share a common requirement: the need to process
high-volume, real-time data streams. Whether from an antenna in a defense
application or a medical scanner, the computer must have the ability to process
incoming data as quickly as it is received. Data rates can range from a few to
several hundreds of megabytes per second (or several billion bits per second).
The ability to process this continuous flow of high-bandwidth data is a
fundamental difference between the majority of computing systems in the world
(such as personal computers, workstations and servers) and the computers built
by Mercury.

Mercury has developed a set of core technical strengths specifically
targeted to, and defined by, the application areas of signal, image and media
processing. These technical strengths are pivotal to Mercury's success in the
real-time market segments of the defense electronics and medical imaging
industries and have resulted in the following developments and capabilities:

Heterogeneous Switched-Fabric Interconnects. Mercury connects different
microprocessor types (RISC, DSP and specialized computing devices) and I/O
devices in a bus-less, high-bandwidth manner based on multi-stage switches in
its system area network. Among the engineering developments which distinguish
Mercury's systems are the RACEway Interconnect built using the multi-port
RACEway crossbar chip which supports high bandwidth point-to-point data
transfers and fibre channel chassis-to-chassis extensions for RACEway in large
system configurations.

Heterogeneous Processor Integration. Mercury has developed several ASICs
which integrate standard microprocessors and special purpose mathematics and
graphics processors into a single heterogenous environment. Mercury develops
systems consisting of different microprocessor types with a single-system
software model. Mercury's processor independent software offers a consistent set
of software tools and interfaces, which can drive a heterogeneous mix of
microprocessor types, such as Motorola's PowerPC processor and Analog Devices'
SHARC DSP processor.

Performance Density. The Company has been using high performance packaging
technology such as multi-chip modules and ball grid arrays in its systems since
the early 1990's. The Company's thermal analysis expertise allows it to design
products that optimize the dissipation of heat from the system in order to meet
the environmental constraints imposed by many of its customers' applications.
The Company's modular hardware and software building blocks allow it to design
systems that best meet the application's specific data profiles. All together,
these attributes combine to deliver the maximum performance in processing,
reliability and bandwidth in the smallest possible space.

Scalable Software. Mercury's software has been designed to scale to nearly
one thousand processors in real-time environments while maintaining a
high-bandwidth capability. Regardless of the number of processors, the Company's
software provides the same programming environment for a software developer
working with Mercury's computer systems, allowing faster time-to-market and
lower life cycle maintenance costs for its customers.

Optimized Algorithm Development. Mercury specializes in algorithm
development for single and multi-processor implementations. The Company believes
that using the mathematical algorithms in Mercury's scientific algorithm library
significantly increases the performance of customers' applications, reduces
development time and minimizes life cycle support costs.

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System Engineering Expertise. Mercury has established a core competency in
providing total system solutions to its customers. The Company has the knowledge
and technical staff to act as an extension of the customer's engineering
organization in order to fashion solutions to some of the world's most demanding
real-time, signal processing applications. Mercury has partnered with its
customers to understand and resolve the challenging problems encountered in
applications as diverse as radar, sonar and signal intelligence for the
military, and diagnostic imaging for MRI, CT, PET and digital x-ray in the
medical imaging market. The Company also provides an integration and development
service to meet the demands of its customers with advanced applications that
cannot be satisfied with standard products. This service combines the variety of
standard products with custom hardware and software to meet the specific
configuration demands of an application.

Leverage and Create Standards. Mercury uses existing standards where
applicable and has been successful in developing new standards. For example,
Mercury adheres to VME and PCI standard bus interfaces and form factors. The
RACEway Interconnect system area network that Mercury developed was adopted as
an ANSI/VITA standard in 1995, and since then has been adopted by several
companies offering products and services for embedded real-time applications.

PRODUCTS

HARDWARE PRODUCTS

Mercury offers three classes of systems for the Company's target markets.
Each class of product is scalable to meet the full range of requirements in
signal processing applications.

High Performance Class. For the highest-performance applications, Mercury
offers a family of high performance systems for the most compute intensive and
I/O capacity and interprocessor bandwidth demanding applications in the defense
electronics market. These applications include space time adaptive processing,
ground-penetrating and foliage-penetrating radar and synthetic aperture radar.
These high-performance systems, known as MultiPort(TM), can scale to a thousand
processors and today include compute modules based on the SHARC and PowerPC
processors.

VME Class. The VME bus has been the traditional standard for many embedded
applications. Mercury's VME systems each support RACEway Interconnect. Systems
contain modules based on the SHARC, PowerPC and i860 processors and can scale to
several hundred processors. The VME-based systems and components are primarily
used in the defense market where backward and forward compatibility is required
for the long system life cycles of military equipment. This class of RACE Series
systems meets the computing speed, bandwidth and scaleability requirements of
many of today's medium performance radar, sonar and signal intelligence
applications. Advanced and future radar systems are more likely to use the high
performance class systems.

Industrial PC Class. Based on the PCI bus standard, these systems use the
RACEway Interconnect to provide the extended bandwidth required for real-time
applications. Currently Mercury provides compute modules based on the SHARC and
PowerPC processors. These systems scale to hundreds of processors and are
primarily directed to the medical imaging market, which is moving from VME to
PCI based designs.

SOFTWARE PRODUCTS

Mercury has developed a comprehensive line of signal processing software
products for the defense and medical imaging markets. Certain of Mercury's
software products are included in a heterogeneous development software package
that enables customers to develop application software that will run on Mercury
hardware. The development software package includes the MC/OS operating system,
scientific algorithm libraries, debugging tools and compilers. License fees
range from $10,000 to $50,000 based on the number of seats chosen by the user
for its application, ranging from a single user license to a project license.

Set forth below are certain signal processing software products offered by
the Company.

MC/OS Version 4.X. The MC/OS runtime operating environment allows maximum
use of the RACE heterogeneous multi-computer architecture in a single-system
model incorporating a consistent set of system and application programming
interfaces, and a common development environment. MC/OS is supported on the high
performance, VME and industrial PC classes of Mercury hardware systems. MC/OS is
included in Mercury's

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development software package.

Scientific Algorithm Library (SAL). Mercury's scientific algorithm library
consists of more than 400 assembly language routines developed by Mercury's
programmers and optimized for execution on Mercury's RACE architecture,
permitting extensive code reusability. The library encompasses a comprehensive
selection of functions including vector processing and data conversion commonly
performed by digital signal processing applications. SAL is included in
Mercury's development software package.

Parallel Application System (PAS). PAS is a set of high performance
libraries which form a complete programming environment for developing parallel
applications in a distributed memory multicomputer system. The libraries speed
the development of advanced applications using many processors in parallel. PAS
is included in Mercury's development software package.

SuperVision(TM). SuperVision(TM) is a state-of-the-art debugging tool for
observation and control of embedded, real-time multicomputing systems.
SuperVision(TM) speeds application development by selectively monitoring
individual and large groups of processors, while simultaneously performing
detailed process-level debugging. SuperVision(TM) is sold separately.

ENGINEERING, RESEARCH AND DEVELOPMENT

The Company's engineering, research and development efforts are focused on
developing new products as well as enhancing existing products. Mercury's
research and development goal is to fully exploit and maintain the Company's
technological lead in the high performance, real-time, signal processing
industry.

Mercury is involved with researchers from other companies and government
organizations to develop new signaling technologies using fiber optics. This has
the potential for providing more bandwidth per line than conventional techniques
and is directed at the 21(st) century challenges of the next generation of
advanced signal processing systems. Similar cooperative developments are
underway to develop open software solutions for code portability. This research
is focused on developing generic applications, which can be targeted to
Mercury's products through the use of industry standard tools with
Mercury-specific libraries. Some of these research areas benefit from cost
sharing through DARPA grants in those areas where the DoD will obtain benefit
from the development.

As of June 30, 1999, the Company had 136 people primarily engaged in
engineering, research and development, including hardware and software
architects, design engineers and engineers with expertise in developing medical,
defense and shared storage software systems. During fiscal years 1999, 1998 and
1997, the Company's total research and development costs were approximately
$20.7 million, $14.5 million, and $12.8 million, respectively.

CUSTOMER SUPPORT AND INTEGRATION

Mercury's Customer Services Group is engaged in a full range of support
functions, including training, technical program management, integration and
design services, host porting services and the traditional maintenance and
support services. The Company has invested in the range of tools, analyzers,
simulators, instruments and workstations to provide a rapid response to both
development and customer support requirements. Within the Customer Services
Group, the solutions systems department has developed many custom interfaces,
reviewed customers' designs, developed special hardware and software components
and provided program management on behalf of defense and medical customers. The
capabilities of this group enable the Company to respond to the demanding
individuality of many programs and have resulted in Mercury being selected for
both development, high volume production and deployed programs.

MANUFACTURING AND TESTING

Mercury's strengths include the design, development and testing of products
which meet the exacting technology and quality expectations of the Company's
defense electronics and medical imaging customers. Board assembly is outsourced
to a number of electronic contract manufacturers. The supplier typically inserts
most of the components into a printed circuit board, solders the connections,
conducts preliminary testing and returns the boards to Mercury. The Company
conducts final assembly, burn-in and system level testing.

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Mercury utilizes Optimal Supply Chain Management to provide highly flexible
manufacturing solutions which can be tailored to the specific needs of the
Company's customers, while maintaining the highest level of quality and control
of product assembly. This standard is maintained through demanding Quality
Assurance and Reliability Programs, such as Statistical Process Control, which
are integrated throughout the manufacturing process.

The Company's outsourcing strategy provides maximum flexibility to respond
to customer requirements and schedule adjustments, with minimal asset investment
by Mercury. This outsourcing strategy also provides multiple sources of supply,
both to support the breadth and complexity of Mercury's product lines, as well
as to ensure continuity of supply. By outsourcing assembly to electronic
contract manufacturers, Mercury is able to focus its manufacturing efforts on
designing more reliable products, designing more efficient methods of building
its products, systems integration, testing and supply chain management.

Mercury's manufacturing approach is based on a highly integrated process
that takes a product from concept through production. All products are required
to meet specified standards of performance, quality, reliability and safety. The
Company manufactures both commercial and ruggedized versions of its computer
systems. Extensive testing is a fundamental part of the Company's process.
Computer Integrated Manufacturing, Concurrent Engineering, Material Requirements
Planning and Just-In-Time techniques are also integrated into manufacturing
operations as part of an on-time delivery philosophy. Mercury has been ISO 9001
certified since 1995.

COMPETITION

The markets for the Company's products are highly competitive and are
characterized by rapidly changing technology, frequent product performance
improvements and evolving industry standards. Competition typically occurs at
the design stage, where the customer evaluates alternative design approaches,
including those from internal development organizations. A design win usually
ensures a customer will purchase the product until their next generation system
is developed. Occasionally, the Company's computer systems compete with computer
systems from workstation vendors, all of whom have substantially greater
research and development resources, long term guaranteed supply capacity,
marketing and financial resources, manufacturing capability and customer support
organizations than those of the Company. The Company believes that its future
ability to compete effectively will depend, in part, upon its ability to
continue to improve product and process technologies and develop new
technologies in order to maintain the performance advantages of products and
processes relative to competitors, to adapt products and processes to
technological changes, to identify and adopt emerging industry standards and to
adapt to customer needs.

The principal bases for selection in sales of digital signal processing
systems to the defense electronics industry are performance (measured primarily
in terms of processing speed, I/O capacity and interprocessor bandwidth,
processing density per cubic foot, power consumption and heat dissipation),
systems engineering support, overall quality of products and associated
services, use of industry standards, ease of use and price. Competitors in the
defense electronics industry include a relatively small number of companies that
design, manufacture and market DSP board level products and in-house design
teams employed by prime defense contractors. In-house design efforts
historically have provided a significant amount of competition to the Company.
However, competition from in-house design teams has diminished in significance
in recent years due to the increasing use of COTS products and the trend toward
greater use of outsourcing. Despite this recent change, there can be no
assurance that in-house developments will not re-emerge as a major competitive
force in the future. Prime contractors are much larger than Mercury and have
substantially more resources to invest in research and development. Increased
use of in-house design teams by defense contractors in the future may have a
material adverse effect on the Company's business, financial condition and
results of operations.

In the medical imaging industry the principal bases for selection are
performance (measured primarily in terms of processing speed, I/O capacity and
interprocessor bandwidth and power consumption), price, systems engineering
support, overall quality of products and associated services, use of industry
standards and ease of use. Competitors in the medical imaging market include
in-house design teams, a small number of companies that design, manufacture and
market DSP board level products and workstation manufacturers. Workstations have
become a competitive factor primarily in the market for low-end MRI and CT
machines and, to date, have not been a significant factor in the
high-performance market, Mercury's primary focus. There can be no assurance that
workstation manufacturers will not attempt to penetrate the high-performance
market for medical imaging machines. Workstation manufacturers typically have
greater resources than Mercury and their entry into markets historically
targeted by Mercury may have a material adverse effect on the Company's
business, financial condition and results

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of operations.

Some of the Company's competitors have greater financial and other resources
than the Company, and the Company may be operating at a cost disadvantage
compared to manufacturers who have greater direct buying power from component
suppliers or who have lower cost structures. There can be no assurance that the
Company will be able to compete successfully in the future with any of these
sources of competition. In addition, there can be no assurance that competitive
pressures will not result in price erosion, reduced margins, loss of market
share or other factors, that could have a material adverse effect on the
Company's business, financial condition and results of operations.

INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

The Company relies on a combination of patent, copyright, trademark and
trade secret laws to establish and protect its rights in its products and
proprietary technology. In addition, the Company currently requires its
employees and consultants to enter into nondisclosure and assignment of
invention agreements to limit use of, access to and distribution of, proprietary
information. There can be no assurance that the Company's means of protecting
its proprietary rights in the U.S. or abroad will be adequate. The laws of some
foreign countries may not protect the Company's proprietary rights as fully or
in the same manner as do the laws of the U.S. Also, despite the steps taken by
the Company to protect its proprietary rights, it may be possible for
unauthorized third parties to copy or reverse engineer aspects of the Company's
products, develop similar technology independently or otherwise obtain and use
information that the Company regards as proprietary. There can be no assurance
that others will not develop technologies similar or superior to the Company's
technology or design around the proprietary rights owned by the Company.
Although the Company is not aware that its products infringe on the proprietary
rights of third parties, there can be no assurance that others will not assert
claims of infringement in the future or that, if made, such claims will not be
successful. Litigation to determine the validity of any claims, whether or not
such litigation is determined in favor of the Company, could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel from daily operations. In the event of any
adverse ruling in any litigation regarding intellectual property, the Company
may be required to pay substantial damages, discontinue the sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses to use infringing or substituted technology. The failure to
develop, or license on acceptable terms, a substitute technology could have a
material adverse effect on the Company's business, financial condition and
results of operations.

The Company holds four issued United States patents covering aspects of the
RACE architecture, the SuperVision( debugging tool, and shared storage area
network technology. In addition, the Company has one pending United States
patent application covering additional aspects of the RACE architecture and the
Company's Parallel Application System. The Company may file additional patent
applications seeking protection for other proprietary aspects of its technology
in the future. Patent positions frequently are uncertain and involve complex and
evolving legal and factual questions. The coverage sought in a patent
application either can be denied or significantly reduced before or after the
patent is issued. Consequently, there can be no assurance that any patents from
pending patent applications or from any future patent application will be
issued, that the scope of any patent protection will exclude competitors or
provide competitive advantages to the Company, that any of the Company's patents
will be held valid if subsequently challenged or that others will not claim
rights in or ownership of the patents and other proprietary rights held by the
Company. Since patent applications are secret until patents are issued in the
United States or corresponding applications are published in international
countries, and since publication of discoveries in the scientific or patent
literature often lags behind actual discoveries, the Company cannot be certain
that it was the first to make the inventions covered by each of its pending
patent applications or that it was the first to file patent applications for
such inventions. In addition, there can be no assurance that competitors, many
of which have substantial resources and have made substantial investments in
competing technologies, will not seek to apply for and obtain patents that will
prevent, limit or interfere with the Company's ability to make, use or sell its
products either in the United States or in international markets.

BACKLOG

As of June 30, 1999, the Company had a backlog of orders aggregating
approximately $52.1 million. The Company includes in its backlog, customer
orders for products and services for which it has accepted signed purchase
orders with assigned delivery dates within twelve months. Orders included in
backlog may be canceled or rescheduled by customers without penalty. A variety
of conditions, both specific to the individual customer and

9
10

generally affecting the customer's industry, may cause customers to cancel,
reduce or delay orders that were previously made or anticipated. The Company
cannot assure the timely replacement of canceled, delayed or reduced orders.
Significant or numerous cancellations, reductions or delays in orders by a
customer or group of customers could materially adversely affect the Company's
business, financial condition and results of operations. Backlog should not be
relied upon as indicative of the Company's revenues for any future period.

EMPLOYEES

At June 30, 1999, the Company employed a total of 435 persons, including 136
in research and development, 158 in sales, marketing and customer support, 60 in
manufacturing and 81 in general and administration. Nine of the Company's
employees are located in Europe, seven in Japan and the remainder in the U.S.
None of the Company's employees are represented by a labor organization and the
Company believes that its relations with employees are good. Competition for
qualified personnel in the engineering fields is intense and the Company is
aware that much of its future success will depend on its continued ability to
attract and retain qualified personnel. The Company seeks to attract new
employees by offering competitive compensation packages, including salary,
bonus, stock options and employee benefits. There can be no assurance, however,
that the Company will be successful in retaining its key employees or that it
will be able to attract skilled personnel for the development of its business.

RISK FACTORS

In this report, as well as oral statements made by the Company, that are
prefaced with the words "may," "will," "expect," "anticipate," "continue,"
"estimate," "project," "intend," "designed" and similar expressions, are
intended to identify forward-looking statements regarding events, conditions and
financial trends that may affect the Company's future plans of operations,
business strategy, results of operations and financial position. These
statements are based on the Company's current expectations and estimates as to
prospective events and circumstances about which the Company can give no firm
assurance. Further, any forward-looking statement speaks only as of the date on
which such statement is made, and the Company undertakes no obligation to update
any forward-looking statement to reflect events or circumstances after the date
on which such statement is made. As it is not possible to predict every new
factor that may emerge, forward-looking statements should not be relied upon as
a prediction of actual future financial condition or results. These
forward-looking statements, like any forward-looking statements, involve risks
and uncertainties that could cause actual results to differ materially from
those projected or unanticipated. Such risks and uncertainties include the
factors set forth below.

DEPENDENCE ON DEFENSE ELECTRONICS BUSINESS; UNCERTAINTY ASSOCIATED WITH
GOVERNMENT CONTRACTS. Sales of the Company's computer systems to the defense
electronics market accounted for approximately 77%, 79%, and 81% of the
Company's revenues in fiscal 1999, 1998, and 1997, respectively. Reductions in
government spending on programs that incorporate the Company's products could
have a material adverse effect on the Company's business, financial condition
and results of operations. Moreover, the Company's government contracts and
subcontracts are subject to special risks, such as: delays in funding; ability
of the government agency to unilaterally terminate the prime contract; reduction
or modification in the event of changes in government policies or as the result
of budgetary constraints or political changes; increased or unexpected costs
under fixed price contracts; and other factors that are not under the control of
the Company. In addition, consolidation among defense industry contractors has
resulted in fewer contractors with increased bargaining power relative to the
Company. No assurance can be given that such increased bargaining power will not
adversely affect the Company's business, financial condition or results of
operations in the future.

The Company's contracts with the U.S. and foreign governments and their
prime and subcontractors are subject to termination either upon default by the
Company or at the convenience of the government. Termination for convenience
provisions generally entitle the Company to recover costs incurred, settlement
expenses and profit on work completed prior to termination. In addition to the
right of the government to terminate, government contracts are generally
conditioned upon the continuing availability of legislative appropriations.
Funds are usually appropriated for a given program each fiscal year even though
contract performance may take more than one fiscal year. Consequently, at the
outset of a major program, the contract is usually partially funded, and
additional monies normally are incrementally committed to the contract by the
procuring agency from appropriations made for future fiscal years. No assurance
can be given that the Company will realize the revenue expected from performing
under such contracts. Because the Company contracts to supply goods and services
to U.S. and foreign governments it is also subject to other risks, including
contract suspensions, protests by disappointed bidders of contract awards which
can result in the reopening of the bidding process, changes in governmental
policies or regulations or other political

10
11

factors.

DEPENDENCE ON KEY CUSTOMERS. The Company is dependent on a small number of
customers for a large portion of its revenues. In fiscal 1999, Raytheon Systems
Company, Lockheed Martin, and GE Medical accounted for 22%, 16%, and 12%,
respectively, of the Company's revenues. In fiscal 1998, Raytheon Systems
Company, GE Medical, and Northrup Grumman Corporation accounted for 20%, 10%,
and 10%, respectively, of the Company's revenues. In fiscal 1997, Lockheed
Martin and Hughes Aircraft accounted for 22% and 10%, respectively, of the
Company's revenues. The Company's largest customer in the medical imaging
market, GE Medical, accounted for 85%, 76%, and 72% of the Company's aggregate
sales to the medical imaging market in fiscal 1999, 1998, and 1997,
respectively. Customers in the defense electronics market generally purchase the
Company's products in connection with government programs that have a limited
duration, leading to fluctuating sales to any particular customer in the defense
electronics market from year to year. By contrast, many customers in the medical
imaging market historically have purchased the Company's products over a number
of years for use in successive generations of medical imaging devices, although
there can be no assurance that such past behavior will continue in the future. A
significant diminution in the sales to or loss of any of the Company's major
customers would have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company's
revenues are largely dependent upon the ability of its customers to develop and
sell products that incorporate the Company's products. No assurance can be given
that the Company's customers will not experience financial or other difficulties
that could adversely affect their operations and, in turn, the results of
operations of the Company.

FLUCTUATIONS IN OPERATING RESULTS. The Company has experienced fluctuations
in its results of operations in large part due to the sale by the Company of its
computer systems in relatively large dollar amounts to a relatively small number
of customers. Operating results also have fluctuated due to competitive pricing
programs and volume discounts, the loss of customers, market acceptance of the
Company's products, product obsolescence and general economic conditions. In
addition, the Company, from time to time, has entered into contracts to engineer
a specific solution based on modifications to the Company's standard products (a
"development contract"). The Company's gross margins from development contract
revenues are typically lower than the Company's gross margins from standard
product revenues. The Company intends to continue to enter into development
contracts and anticipates that the gross margins associated with development
contract revenues will continue to be lower than its gross margins on standard
product revenues. The Company expects research and development expenses to
continue to increase as the Company continues to develop products to serve its
markets, all of which are subject to rapidly changing technology, frequent
product performance improvements and evolving industry standards. The ability to
deliver superior technological performance on a timely and cost effective basis
is a critical factor in securing design wins for future generations of defense
electronics and medical imaging systems. Significant research and development
spending by the Company does not ensure that the Company's computer systems will
be designed into a customer's system. Because future production orders are
usually contingent upon securing a design win, the Company's operating results
may fluctuate due to either obtaining or failing to obtain design wins for
significant customer systems.

The Company's quarterly results may be subject to fluctuations resulting
from the foregoing factors, as well as a number of other factors, including the
timing of significant orders, delays in completion of internal product
development projects, delays in shipping the Company's computer systems and
software programs, delays in acceptance testing by customers, a change in the
mix of products sold to the defense electronics and medical imaging markets,
production delays due to quality problems with outsourced components, shortages
of components, the timing of product line transitions and declines in quarterly
revenues from old generations of products following announcement of replacement
products containing more advanced technology. Another factor contributing to
fluctuations in quarterly results is the fixed nature of the Company's
expenditures on personnel, facilities and marketing programs. The Company's
expense levels for personnel, facilities and marketing programs are based, in
significant part, on the Company's expectations of future revenues on a
quarterly basis. If actual quarterly revenues are below management's
expectations, results of operations likely will be adversely affected. As a
result of the foregoing factors, the Company's operating results, from time to
time, may be below the expectations of public market analysts and investors,
which could have a material adverse effect on the price of the Company's Common
Stock.

DEPENDENCE ON SUPPLIERS. Several components used in the Company's products
are currently obtained from sole source suppliers. Mercury is dependent on LSI
Logic Corporation for four custom designed ASICs, on Analog Devices for its
SHARC processors, on International Business Machines Corporation for ball grid
array packaging, on Motorola for some of its PowerPC processors and on Intel for
its i860 processors. IBM may terminate its contract with the Company without
cause upon thirty days notice and may cease offering products to the Company
upon

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12

sixty days notice. Analog Devices may discontinue or modify any product upon 180
days notice and LSI Logic may discontinue any product upon 180 days notice. If
LSI Logic, Analog Devices, IBM, Motorola or Intel were to limit or reduce the
sale of such components to the Company, or if these or other suppliers to the
Company were to experience financial difficulties or other problems which
prevented them from supplying the Company with the necessary components, such
events could have a material adverse effect on the Company's business, financial
condition and results of operations. These sole source suppliers are subject to
quality and performance issues, materials shortages, excess demand, reduction in
capacity and other factors that may disrupt the flow of goods to the Company or
its customers and thereby adversely affect the Company's business and customer
relationships. The Company has no guaranteed supply arrangements with its
suppliers and there can be no assurance that its suppliers will continue to meet
the Company's requirements. If the Company's supply arrangements are
interrupted, there can be no assurance that the Company would be able to find
another supplier on a timely or satisfactory basis. Any shortage or interruption
in the supply of any of the components used in the Company's products, or the
inability of the Company to procure these components from alternate sources on
acceptable terms could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
severe shortages of components will not occur in the future. Such shortages
could increase the cost or delay the shipment of the Company's products, which
could have a material adverse effect on the Company's business, financial
condition and results of operations. Significant increases in the prices of
these components would also materially adversely affect the Company's financial
performance since the Company may not be able to adjust product pricing to
reflect the increase in component costs. The Company could incur set-up costs
and delays in manufacturing should it become necessary to replace any key
vendors due to work stoppages, shipping delays, financial difficulties or other
factors and, under certain circumstances, these costs and delays could have a
material adverse effect on the Company's business, financial condition and
results of operations.

DEPENDENCE UPON KEY PERSONNEL AND SKILLED EMPLOYEES. The Company is largely
dependent upon the skills and efforts of its senior management, particularly
James R. Bertelli, its President and Chief Executive Officer, as well as its
managerial, sales and technical employees. None of the senior management or
other key employees of the Company is subject to any employment contract or
noncompetition agreement. The Company maintains key-man life insurance on Mr.
Bertelli and certain other senior managers. The loss of services of any of its
executives or other key personnel could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company's
future success will depend to a significant extent on its ability to attract,
train, motivate and retain highly skilled technical professionals, particularly
project managers, engineers and other senior technical personnel. The Company
believes that there is a shortage of, and significant competition for, technical
development professionals with the skills and experience necessary to perform
the services offered by the Company. The Company's ability to maintain and renew
existing engagements and obtain new business depends, in large part, on its
ability to hire and retain technical personnel with the skills that keep pace
with continuing changes in industry standards, technologies and client
preferences. The inability to hire additional qualified personnel could impair
the Company's ability to satisfy its growing client base, requiring an increase
in the level of responsibility for both existing and new personnel. There can be
no assurance that the Company will be successful in retaining current or future
employees.

DEPENDENCE ON MEDICAL IMAGING MARKET; POTENTIAL ADVERSE EFFECT OF HEALTH
CARE REFORM. Sales of the Company's computer systems to the medical imaging
market accounted for approximately 14%, 13%, and 11% of the Company's revenues
in fiscal 1999, 1998, and 1997, respectively. These customers are original
equipment manufacturers ("OEMs") of medical imaging devices and, as a result,
any change in the demand for such devices which renders any of the Company's
products unnecessary or obsolete, or any change in the technology in such
devices, could have a material adverse effect on the Company's business,
financial condition and results of operations. Such OEM customers, the end-users
of their products and the health care industry generally are subject to
extensive federal, state and local regulation in the U.S. as well as in other
countries. Changes in applicable health care laws and regulations or new
interpretations of existing laws and regulations could have a material adverse
effect on such customers or end-users. There can be no assurance that future
health care or budgetary legislation or other changes in the administration or
interpretation of governmental health care programs both in the U.S. and abroad
will not have a material adverse effect on the Company's business, financial
condition or results of operations.

RISK OF ENTRY INTO NEW MARKETS. The Company's expansion strategy includes
developing new products and entering new markets. The Company's ability to
compete in new markets will depend upon a number of factors including, without
limitation, the Company's ability to create demand for its products in such
markets, its ability to manage its growth effectively, the quality of its
products, its ability to respond to changes in its customers' businesses by
updating existing products and introducing, in a timely fashion, products which
meet the needs of its

12
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customers and the ability of the Company to respond rapidly to technological
change. The failure of the Company to do any of the foregoing could result in a
material adverse effect on its business, financial condition and results of
operations. In addition, the Company may face competition in these new markets
from various companies which may have substantially greater research and
development resources, marketing and financial resources, manufacturing
capability and customer support organizations than those of the Company.

RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. The Company markets and
sells its products in certain international markets, and the Company has
established offices in the United Kingdom, Japan and France. Foreign revenue is
based on the country in which the legal subsidiary is domiciled. Foreign
revenue and long-lived assets represent less than 10% of the Company's total
revenue and long-lived assets for the fiscal years ended June 30, 1999, 1998,
and 1997, respectively. If revenues generated by foreign activities are not
adequate to offset the expense of establishing and maintaining these foreign
subsidiaries and activities, the Company's business, financial condition and
results of operations could be materially adversely affected. In addition,
there are certain risks inherent in transacting business internationally, such
as changes in applicable laws and regulatory requirements, export and import
restrictions, export controls relating to technology, tariffs and other trade
barriers, less favorable intellectual property laws, difficulties in staffing
and managing foreign operations, longer payment cycles, problems in collecting
accounts receivable, political instability, fluctuations in currency exchange
rates, expatriation controls and potential adverse tax consequences, any of
which could adversely impact the success of the Company's international
activities. In the recent past, the financial markets in Asia have experienced
significant turmoil. There can be no assurance that such turmoil in the Asian
financial markets will not negatively affect the sales by the Company to that
region. A portion of the Company's revenues from sales to foreign entities,
including foreign governments, is in the form of foreign currencies. There can
be no assurance that one or more of such factors will not have a material
adverse effect on the Company's future international activities and,
consequently, on the Company's business, financial condition or results of
operations.

TECHNOLOGICAL CHANGES; RISK OF DESIGN-IN PROCESS. The Company's future
success will depend in part on its ability to enhance its current products and
to develop new products on a timely and cost-effective basis in order to respond
to technological developments and changing customer needs. The defense
electronics market, in particular, demands constant technological improvements
as a means of gaining military advantage. Military planners historically have
funded significantly more design projects than actual deployments of new
equipment, and those systems which are deployed tend to contain the components
of the subcontractors selected to participate in the design process. In order to
participate in the design of new defense electronics systems, the Company must
be able to demonstrate its ability to deliver superior technological performance
on a timely and cost-effective basis. There can be no assurance that the Company
will be able to secure an adequate number of defense electronics design wins in
the future, that the equipment in which the Company's products are intended to
function eventually will be deployed in the field, or that the Company's
products will be included in such equipment if it eventually is deployed.

Customers in the medical imaging market also seek technological improvements
through product enhancements and new generations of products. The Company
believes that medical imaging machines in which the Company's computers are
installed have a long product life cycle. Medical equipment OEMs historically
have selected certain suppliers whose products have been included in the OEMs'
machines for a significant portion of the products' life cycle. There can be no
assurance that the Company will be selected to participate in the future design
of any medical imaging equipment, or that, if selected, the Company will
generate any revenues for such design work. Failure to participate in future
designs of medical imaging equipment could have a material adverse effect on the
Company's business, financial condition and results of operations.

The design-in process is typically lengthy and expensive, and there can be
no assurance that the Company will be able to continue to meet the product
specifications of its customers in a timely and adequate manner. In addition,
any failure by the Company to anticipate or respond adequately to changes in
technology and customer preferences, or any significant delay in product
developments or introductions, could have a material adverse effect on the
Company's business, financial condition and results of operations. Because of
the complexity of its products, the Company has experienced delays from time to
time in completing products on a timely basis. If the Company is unable to
design, develop or introduce competitive new products on a timely basis, its
future operating results would be adversely affected. There can be no assurance
that the Company will be successful in developing new products or enhancing its
existing products on a timely or cost-effective basis, or that such new products
or product enhancements will achieve market acceptance.

COMPETITION. The markets for the Company's products are highly competitive
and are characterized by rapidly

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changing technology, frequent product performance improvements and evolving
industry standards. See "Item 1. Business - Competition."

LIMITED PROTECTION OF PROPRIETARY RIGHTS; POTENTIAL INFRINGEMENT OF THIRD
PARTY RIGHTS. There can be no assurance that the Company's means of protecting
its proprietary rights in the U.S. or abroad will be adequate, or that others
will not develop technologies similar or superior to the Company's technology or
design around the proprietary rights owned by the Company. In addition, there
can be no assurance that others will not assert claims of infringement in the
future or that, if made, such claims will not be successful. See "Item 1.
Business - Intellectual Property and Proprietary Rights."

POTENTIAL ACQUISITIONS. In the normal course of its business, the Company
evaluates potential acquisitions of businesses, products and technologies that
could complement or expand the Company's business. In the event the Company were
to identify an appropriate acquisition candidate, there is no assurance that the
Company would be able to successfully negotiate the terms of any such
acquisition, finance such acquisition and integrate such acquired business,
products or technologies into the Company's existing business and operations.
Furthermore, the integration of an acquired business could cause a diversion of
management time and resources. In addition, there can be no assurance that any
acquisition of new technology will lead to the successful development of new
products, or that any such new products, if developed, will achieve market
acceptance or prove to be profitable. There can be no assurance that a given
acquisition, when consummated, would not materially adversely affect the
Company's business, financial condition or results of operations. If the Company
proceeds with one or more significant acquisitions in which the consideration
consists of cash, a substantial portion of the Company's available cash could be
used to consummate the acquisitions. If the Company consummates one or more
significant acquisitions in which the consideration consists of stock, or is
financed with the net proceeds of the issuance of stock, stockholders of the
Company could suffer a significant dilution of their interests in the Company.

YEAR 2000 COMPLIANCE. The Company uses a significant number of computer
software programs and operating systems in its internal operations, including
applications used in manufacturing, product development, financial business
systems and various administrative functions. To the extent that these software
applications contain source code that is unable to appropriately interpret the
upcoming calendar year "2000," some level of modification or even possibly
replacement of such source code or applications will be necessary. The Company
is still in the preliminary stages of analyzing its software applications and,
to the extent they are not fully "Year 2000" compliant, there can be no
assurance that the costs necessary to update software, or potential systems
interruptions, would not have a material adverse effect on the Company's
business, financial condition or results of operations. See "- Year 2000
Compliance."

ITEM 2. PROPERTIES

The Company's headquarters consist of two buildings approximating 187,000
square feet of space in Chelmsford, Massachusetts. These two buildings were
purchased by the Company during fiscal 1999. The Company also maintains offices
near Los Angeles and San Jose, California, and in Lowell, Massachusetts, Dallas,
Texas, Chanhassen, Minnesota, Madison, Wisconsin, Port St Lucie, Florida,
Bellevue, Washington and Vienna, Virginia and has international offices in the
United Kingdom, France and Japan.

ITEM 3. LEGAL PROCEEDINGS

To the Company's knowledge, there are no pending legal proceedings, which
are, material to the Company or its business to which it is a party or to which
any of its properties is subject.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of stockholders during the fourth
quarter of the fiscal year ended June 30, 1999.

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15

PART II

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

The information contained under the heading "Market Information" on page 27
of the Company's Annual Report to Stockholders for the fiscal year ended June
30, 1999 is incorporated herein by reference and is filed herewith as Exhibit
13.1.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The information contained under the heading "Selected Financial Data" on
page 17 of the Company's Annual Report to Stockholders for the fiscal year ended
June 30, 1999 is incorporated herein by reference and is filed herewith as
Exhibit 13.1.

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

The information contained under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations" on pages 18 through
26 of the Company's Annual Report to Stockholders for the fiscal year ended June
30, 1999 is incorporated herein by reference and is filed herewith as Exhibit
13.1. This information should be read in conjunction with the related
consolidated financial statements incorporated by reference under Item 8.

ITEM 7(A) QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The information contained under the heading "Quantitative and Qualitative
Disclosure About Market Risk" on page 26 of the Company's Annual Report to
Stockholders for the fiscal year ended June 30, 1999 is incorporated herein by
reference and is filed herewith as Exhibit 13.1

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information contained in the consolidated financial statements,
notes to consolidated financial statements, report of independent accountants
and supplementary information (unaudited) on pages 28 through 47 of the
Company's Annual Report to Stockholders for the fiscal year ended June 30, 1999
is incorporated herein by reference and is filed herewith as Exhibit 13.1.

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

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is incorporated herein by reference to
the Company's Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated herein by reference to
the Company's Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporated herein by reference to
the Company's Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Company had loaned James R. Bertelli, President of the Company, an
aggregate of $200,000, of which $150,000 accrued interest at an annual rate of
9.75% and $50,000 accrued interest at an annual rate of 10.5%. In addition, the
Company had loaned Albert Belle Isle, a Director of the Company, an aggregate of
$125,000, of which $100,000 accrued interest at an annual interest rate of 8%
and $25,000 accrued interest at 9.25%. The notes evidencing such obligations of
Mr. Bertelli and Dr. Belle Isle were paid in full in October, 1998.

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16

PART IV

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

(a) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS

The financial statements, schedule, and exhibits listed below are included
in or incorporated by reference as part of this report:

1. Financial statements:

Report of Independent Accountants
Consolidated Balance Sheets as of June 30, 1999 and 1998
Consolidated Statements of Operations for the years ended June 30, 1999,
1998, and 1997
Consolidated Statements of Stockholders' Equity for the years ended June 30,
1999, 1998, and 1997
Consolidated Statements of Cash Flows for the years ended June 30, 1999,
1998, and 1997
Notes to Consolidated Financial Statements

2. Financial Statement Schedule:

II. Valuation and Qualifying Accounts

MERCURY COMPUTER SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED JUNE 30, 1999, 1998, AND 1997
(IN THOUSANDS)

BALANCE AT BALANCE
BEGINNING CHARGES TO AT END
OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
--------- -------- ---------- ---------
Allowance for Doubtful Accounts

1999 $218 $249 91 $376
1998 119 99 $-- 218
1997 80 40 $ 1 119

BALANCE AT BALANCE
BEGINNING CHARGES TO AT END
OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
--------- -------- ---------- ---------
Inventory Reserve

1999 $1,857 $2,786 $1,604 $3,039
1998 1,723 1,583 1,449 1,857
1997 1,246 504 27 1,723

Charges to expenses for inventory are due to program cancellations,
engineering change orders and obsolescence. Deductions are recorded when the
inventory is written off. The Company wrote off $1,604,000 and $1,449,000 during
the years ended June 30, 1999 and 1998, respectively, in inventory relating
primarily to engineering change orders and obsolescence.

REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE

To the Board of Directors
of Mercury Computer Systems, Inc.

Our audits of the consolidated financial statements referred to in our report
dated July 29, 1999, except for the information in the first and second
paragraph of Note L as to which date is August 27, 1999 and September 1, 1999,
respectively, in the Annual Report to Shareholders of Mercury Computer Systems,
Inc. (which report and consolidated financial statements are incorporated by
reference in this Annual Report on Form 10-K) also included an audit of the
financial statement schedule listed in item 14 (a)(2) of this Form 10-K. In our
opinion, the financial statement schedule presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.

PricewaterhouseCoopers LLP

Boston, Massachusetts
July 29, 1999

3. Exhibits:

Exhibits required by Item 601 of Regulation S-K are listed in the Exhibit
Index on page 18, which is incorporated herein by reference.

(b) Reports on Form 8-K

None.

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17

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in Chelmsford,
Massachusetts, on September 14, 1999.

MERCURY COMPUTER SYSTEMS, INC.

By: /s/ G. MEAD WYMAN
--------------------------------------
G. MEAD WYMAN
SENIOR VICE PRESIDENT, CHIEF FINANCIAL
OFFICER AND TREASURER

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

SIGNATURE TITLE(S) DATE

/s/ JAMES R. BERTELLI President, Chief Executive Officer September 14, 1999
- ------------------------ and Director (principal executive
JAMES R. BERTELLI officer)

/s/ G. MEAD WYMAN Senior Vice President, Chief September 14, 1999
- ------------------------ Financial Officer and Treasurer
G. MEAD WYMAN (principal financial and
accounting officer)

/s/ GORDON B. BATY Director September 14, 1999
- ------------------------
GORDON B. BATY

/s/ R. SCHORR BERMAN Director September 14, 1999
- ------------------------
R. SCHORR BERMAN

/s/ ALBERT P. BELLE ISLE Director September 14, 1999
- ------------------------
ALBERT P. BELLE ISLE

/s/ SHERMAN N. MULLIN Director September 14, 1999
- ------------------------
SHERMAN N. MULLIN

/s/ MELVIN SALLEN Director September 14, 1999
- ------------------------
MELVIN SALLEN

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18

EXHIBIT INDEX

ITEM NO. DESCRIPTION OF EXHIBIT

3.1 Restated Articles of Organization. (incorporated herein by reference
to Exhibit 3.1 of the Company's Registration Statement on Form S-1
(File No. 333-41139))
3.2 Bylaws. (incorporated herein by reference to Exhibit 3.2 of the
Company's Registration Statement on Form S-1 (File No. 333-41139))
3.3 Articles of Amendment to Articles of Organization. (incorporated
herein by reference to Exhibit 3.3 of the Company's Registration
Statement on Form S-1 (File No. 333-41139))
4.1 Form of Stock Certificate. (incorporated herein by reference to
Exhibit 4.1 of the Company's Registration Statement on Form S-1
(File No. 333-41139))
10.1 1982 Stock Option Plan, as amended. (incorporated herein by reference
to Exhibit 10.1 of the Company's Registration Statement on Form S-1
(File No. 333-41139))
10.2 1991 Stock Option Plan, as amended. (incorporated herein by reference
to Exhibit 10.2 of the Company's Registration Statement on Form S-1
(File No. 333-41139))
10.3 1993 Stock Option Plan for Non-Employee Directors. (incorporated
herein by reference to Exhibit 10.3 of the Company's Registration
Statement on Form S-1 (File No. 333-41139))
10.4 1997 Stock Option Plan. (incorporated herein by reference to Exhibit
10.4 of the Company's Registration Statement on Form S-1 (File No.
333-41139))
10.5 1997 Stock Purchase Plan. (incorporated herein by reference to
Exhibit 10.5 of the Company's Registration Statement on Form S-1
(File No. 333-41139))
10.6 Purchase and Sale Agreement, dated November 8, 1996 between Corcoran
Chelmsford & Associates and Northland Development Corporation.
(incorporated herein by reference to Exhibit 10.7 of the Company's
Registration Statement on Form S-1 (File No. 333-41139))
10.7# Term Purchase Agreement, dated July 25, 1995 between the Company and
Analog Devices, Inc. (incorporated herein by reference to Exhibit
10.8 of the Company's Registration Statement on Form S-1 (File No.
333-41139))
10.8# Risk Reproduction Agreement, dated March 20, 1996, between the
Company and LSI Logic Corporation. (incorporated herein by reference
to Exhibit 10.9 of the Company's Registration Statement on Form S-1
(File No. 333-41139))
10.9# Purchase Offer Agreement for OEM Manufacturer, dated February 16,
1995, between the Company & IBM Microelectronics Division.
(incorporated herein by reference to Exhibit 10.10 of the Company's
Registration Statement on Form S-1 (File No. 333-41139))
10.10 Quitclaim Deed, dated October 1, 1997, executed by Corcoran
Chelmsford & Associates Limited Partnership. (incorporated herein by
reference to Exhibit 10.15 of the Company's Registration Statement
on Form S-1 (File No. 333-41139))
10.11* 1998 Stock Option Plan
13.1* Pages 17 through 47 of the 1999 Annual Report to Stockholders of
Mercury Computer Systems, Inc., a copy of which is furnished for the
information of the Securities and Exchange Commission. Portions of
the Annual Report not incorporated herein by reference are not deemed
"filed" with the Commission.
21.1* Subsidiaries of the Registrant
23.1* Consent of PricewaterhouseCoopers L.L.P.
27.1* Financial Data Schedule.

* Filed with this Form 10-K. # Confidential treatment granted.

18