UNITED STATES 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 July 30, 2006

                                       OR
          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934
              For the transition period from .........to..........

                           Commission File No. 0-5411

                             Herley Industries, Inc.
                             -----------------------
             (Exact name of registrant as specified in its charter)
Delaware                                                              23-2413500
--------                                                              ----------
State or other jurisdiction                                     (I.R.S. Employer
of incorporation or organization                             Identification No.)

101 North Pointe Blvd., Lancaster, Pennsylvania                            17601
-----------------------------------------------                            -----
(Address of Principal Executive Offices)                              (Zip Code)

Registrant's telephone number, including area code:  (717) 735-8117
                                                     --------------

           Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $ .10 par value                 The NASDAQ Stock Market LLC
-----------------------------                 ---------------------------
     (Title of Class)                  Name of each exchange on which registered

        Securities registered pursuant to Section 12(g) of the Act: None
                                                                    ----

Indicate by check mark if the  registrant is a well-known  seasoned  issuer,  as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]


Indicate  by  check  mark if the  registrant  is not  required  to file  reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]


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 [ ]

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. [X]

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated  filer, or a  non-accelerated  filer. See definition of "accelerated
filer and large  accelerated  filer" in Rule 12b-2 of the Exchange  Act.  (Check
one):

[  ] Large accelerated filer   [X] Accelerated filer  [  ] Non-accelerated filer

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]


The  aggregate  market  value of the  Registrant's  voting  Common Stock held by
non-affiliates of the Registrant,  based on the closing sale price of the Common
Stock of $16.96 as reported on The Nasdaq  Global Market as of January 29, 2006,
the last business day of the Registrant's most recently  completed second fiscal
quarter, was approximately $224,984,000.

The number of shares  outstanding of Registrant's  Common Stock, $ .10 par value
on October 18, 2006 was 13,862,149.

Documents incorporated by reference: None
-----------------------------------
<PAGE>

                             HERLEY INDUSTRIES, INC.

                                TABLE OF CONTENTS
                                -----------------
                                                                            Page
                                                                            ----
PART I

Item 1.        Business.                                                      3

Item 1A.       Risk Factors.                                                 11

Item 2.        Properties.                                                   16

Item 3.        Legal Proceedings.                                            16

Item 4.        Submission of Matters to a Vote of Security Holders.          17

PART II

Item 5.        Market for Registrant's Common Equity, Related Stockholder
                   Matters, and Issuer Purchases of Equity Securities.       17

Item 6.        Selected Financial Data.                                      18

Item 7.        Management's Discussion and Analysis of Financial
                   Condition and Results of Operations.                      19

Item 7A.       Quantitative and Qualitative Disclosures about Market Risk.   28

Item 8.        Financial Statements and Supplementary Data.                  29

Item 9.        Changes in and Disagreements with Accountants on
                   Accounting and Financial Disclosure.                      29

Item 9A.       Controls and Procedures.                                      29

Item 9B.       Other Information.                                            32

PART III

Item 10.       Directors and Executive Officers of the Registrant.           32

Item 11.       Executive Compensation.                                       34

Item 12.       Security Ownership of Certain Beneficial Owners and
                  Management and Related Stockholder Matters.                37

Item 13.       Certain Relationships and Related Transactions.               39

Item 14.       Principal Accounting Fees and Services                        40

PART IV

Item 15.       Exhibits and Financial Statement Schedules.                   41

SIGNATURES                                                                   43

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                                   F-1

                                       2
<PAGE>
PART I

Item 1.  Business

FORWARD-LOOKING STATEMENTS

All statements  other than statements of historical fact included in this Annual
Report, including without limitation statements under,  "Management's Discussion
and Analysis of Financial  Condition and Results of Operations"  and "Business,"
regarding our financial position, business strategy and our plans and objectives
of  management   for  future   operations,   are   forward-looking   statements.
Forward-looking   statements  involve  various  important  assumptions,   risks,
uncertainties  and other factors which could cause our actual  results to differ
materially   from   those   expressed   in  such   forward-looking   statements.
Forward-looking statements in this Annual Report can be identified by words such
as "anticipate,"  "believe,"  "could,"  "estimate,"  "expect," "plan," "intend,"
"may," "should" or the negative of these terms or similar expressions.  Although
we believe that the expectations reflected in the forward-looking statements are
reasonable,  we cannot  guarantee  future  results,  performance or achievement.
Actual  results  could  differ   materially  from  those   contemplated  by  the
forward-looking  statements  as a result of certain  factors  including  but not
limited to,  competitive  factors and  pricing  pressures,  changes in legal and
regulatory   requirements,   cancellation   or  deferral  of  customer   orders,
technological change or difficulties,  difficulties in the timely development of
new  products,  difficulties  in  manufacturing,   commercialization  and  trade
difficulties,  the effects of the recently  announced  indictment of the Company
and general  economic  conditions as well as the factors set forth in our public
filings with the Securities and Exchange Commission.

You are cautioned not to place undue reliance on the forward-looking statements,
which  speak  only as of the  date  of this  Annual  Report  or the  date of any
document  incorporated  by  reference,  in this Annual  Report.  We are under no
obligation,  and  expressly  disclaim  any  obligation,  to  update or alter any
forward-looking  statements,  whether  as a result  of new  information,  future
events or otherwise.

For  these  statements,   we  claim  the  protection  of  the  safe  harbor  for
forward-looking  statements  contained in Section 21E of the Securities Exchange
Act of 1934.

GENERAL

The  Company's  corporate  offices  are located at 101 North  Pointe  Boulevard,
Lancaster,  Pennsylvania  17601.  The  telephone  number of the  Company at that
location is (717) 735-8117. The Company's web site is located at www.herley.com.
The Company makes its periodic and current reports available, free of charge, on
its  web  site  as  soon  as  reasonably  practicable  after  such  material  is
electronically  filed  with,  or  furnished  to,  the  Securities  and  Exchange
Commission.  The  Company's  Common Stock is listed on The Nasdaq  Global Market
under the symbol "HRLY."

BACKGROUND

We are a leading  supplier  of  microwave  products  and  systems to defense and
aerospace entities worldwide.  Our primary customers include large defense prime
contractors (including Northrop Grumman,  Lockheed Martin, Raytheon and Boeing),
the U.S.  Government  (including the Department of Defense,  NASA and other U.S.
Government  agencies)  and  international  customers  (including  the  Egyptian,
German,  Japanese and South Korean  militaries  and  suppliers to  international
militaries).  We are a leading  provider of  microwave  technologies  for use in
command  and  control  systems,  flight  instrumentation,  weapons  sensors  and
electronic  warfare  systems.  We have served the defense industry since 1965 by
designing and manufacturing microwave devices for use in high technology defense
electronics  applications.  Our products and systems are currently deployed on a
wide range of high profile military  platforms,  including the F-16 Falcon,  the
F/A-18E/F  Super Hornet,  the RC-135 Rivet Joint,  the E-2C  Hawkeye,  the AEGIS
class surface combatants,  the EA-6B Prowler, the AMRAAM air to air missile, and
unmanned aerial vehicles,  or UAVs, as well as high priority  national  security
programs such as National Missile Defense and the Trident II D-5.

ACQUISITIONS

We have grown  internally and through  strategic  acquisitions  and have evolved
from a  component  manufacturer  to a  systems  and  service  provider.  We have
successfully  integrated these  acquisitions by targeting  microwave  technology
companies and focusing their strengths into our existing operations.  Since July
1995 our acquisitions have included the following:

- In July 1995,  we  acquired  Stewart  Warner  Electronics  Corp.  of  Chicago,
Illinois, a manufacturer of high frequency radio and IFF interrogator systems.

- In August 1997, we acquired Metraplex  Corporation of Frederick,  Maryland,  a
manufacturer of airborne PCM and FM telemetry and data acquisition systems.

                                       3
<PAGE>
- In January 1999, we acquired General Microwave Corporation of Farmingdale, New
York, a manufacturer of microwave components and electronic systems.

- In January  2000,  we acquired  Robinson  Laboratories,  Inc.  of Nashua,  New
Hampshire,  a designer,  developer and manufacturer of microwave  components and
assemblies primarily for defense applications.

- In September 2000, we acquired American Microwave Technology, Inc. of Anaheim,
California,  a  manufacturer  of high  power,  solid  state  amplifiers  for the
scientific and medical markets, which enabled us to enter these markets.

- In September 2002, we acquired EW Simulation  Technology,  Limited ("EWST"), a
company located in Farnborough,  in the United Kingdom.  EWST designs,  develops
and produces  electronic warfare simulator systems for prime defense contractors
and countries worldwide.

- In  March  2004,  we  acquired  Communication  Techniques,  Inc.  ("CTI"),  of
Whippany, New Jersey. CTI designs, develops and produces state-of-the-art signal
generation  components  and  integrated  assemblies  for digital  radio,  SONET,
SatCom, test and instrumentation,  datacom, and wired and wireless  applications
to 45 Gigahertz ("GHz") and 45 Gigabits Per Second ("Gb/s").

- In September 2004, we acquired Reliable System Services  Corporation  ("RSS"),
of Melbourne,  Florida,  a manufacturer  of satellite  based command and control
systems for defense customers.  The RSS Iridium based command and control system
provides  secure  (encryption,  anti-spoof)  global service  coverage,  allowing
multiple  target  operations,  and is  complementary  with the Company's  MAGIC2
command and control systems.

- In February 2005, we acquired Micro Systems,  Inc. ("MSI"), Fort Walton Beach,
Florida,  a market leader in the design and manufacturing of command and control
systems  for  operation  of unmanned  aerial,  seaborne  and ground  targets and
missiles.

- In  April  2005,  we  acquired  Innovative  Concepts,  Inc.  ("ICI"),  McLean,
Virginia,  which has a successful  history of developing and providing  wireless
communications technology and real-time embedded systems, software, hardware and
high-speed processing in support of the defense industry.

BUSINESS STRATEGY

Our goal is to  continue  to  leverage  our  proprietary  technology,  microwave
expertise and  manufacturing  capabilities  to further expand our penetration in
our market. Our strategies to achieve our objectives include:

- INCREASE  LEVELS OF  COMPONENT  INTEGRATION  AND VALUE ADDED  CONTENT.  Due to
growth of engineering expertise, new product development,  and acquisitions,  we
have increased our capability to provide more component integration.  Management
believes component integration adds value and will enable us to increase content
in  defense   platforms  and  systems,   thereby   increasing  our  revenue  and
profitability.

- MAINTAIN  LEADERSHIP  IN  MICROWAVE  TECHNOLOGY.  We intend to pursue  further
technological  advances through continued  investment in  internally-funded  and
customer-funded research and product development.

- STRENGTHEN  AND EXPAND  CUSTOMER  RELATIONSHIPS.  We have  developed  mutually
beneficial  relationships  with  various  agencies  of the U.S.  Government  and
defense and commercial companies.  We expect to continue to build and strengthen
these  relationships with industry leaders by anticipating and recognizing their
needs and providing them with on-time and cost-effective solutions.

- CAPITALIZE ON  OUTSOURCING  DYNAMICS IN THE  AEROSPACE  AND DEFENSE  INDUSTRY.
Microwave  technology has  traditionally  been an in-house resource of the prime
contractors.  However,  the prime  contractors  are  beginning to outsource  the
design  and  manufacture  of  this   specialized   engineering  work  to  system
sub-contractors.  We are well  positioned  to  generate  more  business as prime
contractors continue to focus primarily on integration of defense electronics.

- PURSUE STRATEGIC  ACQUISITIONS.  We intend to continue to augment our existing
technological base by acquiring  specialized companies that complement or expand
our product  offerings and market  strategies.  We believe that expansion of our
core  competencies  through  the  acquisition  of  such  specialized  technology
companies,  when  combined  with our  current  technological  and  manufacturing
skills,  will  provide  us with  improved  levels  of  horizontal  and  vertical
integration, leading to the creation of subsystems and complete system products.

- ENHANCE MANUFACTURING CAPABILITIES. We intend to continue to implement process
manufacturing  automation,  and believe that our ability to develop a high level
of automated  production and test  capability  will help to further  improve our
cost effectiveness and time to market.

                                       4
<PAGE>
- PURSUE  SELECTIVE  COMMERCIAL  OPPORTUNITIES.  We seek to identify  and pursue
selected commercial  applications for our products and technologies where we can
add value based on our microwave expertise.

COMPETITIVE STRENGTHS

Our competitive strengths include:

- TECHNICAL  EXPERTISE.  We have  developed  a leading  position in the field of
microwave  technology  through  more  than 40 years of  focus  on  research  and
development and through our state-of-the-art design and production capabilities.
In fiscal 2002 we  completed  the  expansion  of our  facilities  in  Lancaster,
Pennsylvania,  including  state-of-the-art  manufacturing capacity, where we now
have a full  range of  capabilities  including  long and short  run  production,
hardware  assembly and  full-service  engineering.  In addition,  we have highly
capable manufacturing facilities located in Woburn, Massachusetts;  Farmingdale,
New York;  Whippany,  New  Jersey;  Fort  Walton  Beach,  Florida;  Farnborough,
England; and Jerusalem,  Israel. We continue to develop and reward our engineers
in order to maintain our expertise in-house.

- HIGH PROPORTION OF LONG-TERM SOLE-PROVIDER  PRODUCTION PROGRAMS. We generate a
significant proportion of our revenue from continuing,  long-term programs, both
in the production and upgrade phases,  and continue to target high growth,  high
priority defense programs.  Typically, on such long-term defense programs we are
the sole provider of microwave equipment.

- DIVERSE  PRODUCT AND  CUSTOMER  BASE.  We have a diverse  product and customer
base. The U.S.  Government  accounted for  approximately  22% of our fiscal 2006
revenues.  No other customer accounted for 10% or more of our revenues in fiscal
2006. We are a first-tier supplier to all of the prime defense  contractors,  as
well as a direct supplier to all of the service  branches of the U.S.  military,
including  products found on over 120 individual  platforms.  Foreign  customers
accounted for approximately 24% of our revenues in fiscal 2006.

-  LONG-STANDING  INDUSTRY  RELATIONSHIPS.  We  have  established  long-standing
relationships  with the U.S.  Government  and  other  key  organizations  in the
aerospace  and  defense  industry  after  more  than  40  years  in the  defense
electronic industry. Over this period, we have become recognized for our ability
to develop new technologies and meet stringent program requirements.

-  SUCCESSFUL  ACQUISITION  TRACK  RECORD.  We  have  demonstrated  that  we can
successfully  integrate  acquired  companies.  We are  experienced at evaluating
prospective  operations  in order to increase  efficiencies  and  capitalize  on
market and technological synergies.

-  EMPHASIS  ON  RESEARCH  AND  DEVELOPMENT.  In  fiscal  year  2006,  we  spent
approximately $30.3 million on new product  development,  of which our customers
funded  approximately  $21.2  million.  Our emphasis on new product  development
enables us to maintain our  technological  leadership in current products and to
develop new  capabilities.  This  spending  helps  solidify and  strengthen  our
position  on  different  programs  and may  serve  as a  barrier  to  entry  for
competitors.

- EXPERIENCED MANAGEMENT TEAM. Our senior management team averages over 25 years
of experience in the defense electronics industry.

PRODUCTS AND SERVICES

We are a leading  supplier  of  microwave  products  and  systems to defense and
aerospace entities worldwide. We design and manufacture microwave components and
subassemblies which are embedded in a variety of radars, flight instrumentation,
weapons sensors,  electronic warfare systems and guidance systems. Our microwave
devices are used on our subassemblies and integrated  systems (e.g.  command and
control systems, telemetry systems,  transponders,  flight termination receivers
and identification friend or foe, or IFF,  interrogators),  in addition to being
sold on a component basis.

The following are descriptions of our major systems and products:

Telemetry Systems.  Telemetry systems provide wireless data transmission between
two or more sites for recording and analysis. Missile, UAV, or target testing on
domestic and  international  test ranges  requires flight safety and performance
data   transmission  to  maximize  flight  safety  during  the  test  operation.
Surveillance  and intelligence  gathering UAVs also require a data  transmission
downlink and a command and control  systems uplink to accomplish  their mission.
We have developed a telemetry  system  capability that can be configured to meet
individual  customers'  needs.  Various  components  of the system  include data
encoders,  transmitters and flight termination receivers. Each has a distinctive
role and each is the key to the success of the mission.

                                       5
<PAGE>
We are a leading  manufacturer of Pulse Code  Modulation,  or PCM, and Frequency
Modulation, or FM, telemetry and data acquisition systems for severe environment
applications,  and our  products  are used  worldwide  for testing  space launch
vehicle instrumentation,  aircraft flight testing, and amphibian, industrial and
automotive vehicle testing.  The product portfolio ranges in size and complexity
from miniature encoders to completely programmable data acquisition systems.

We offer a complete  airborne data link system.  With our digital  capability in
data  encoding  and  acquisition  elements  combined  with our  radio  frequency
capability in providing telemetry transmitters and flight termination receivers,
we offer a full line of narrow and wide-band  airborne telemetry systems to meet
a wide variety of industrial needs, both domestically and internationally.

Command and Control Systems.  Our command and control ("C2") systems principally
are used to fly remotely a large variety of unmanned aerial  vehicles,  or UAVs,
typically aircraft used as target drones or Remotely Piloted Vehicles,  or RPVs.
Our C2 systems also control surface  targets.  Operations have been conducted by
users on the open ocean,  remote land masses, and instrumented test and training
ranges. Our C2 systems are currently in service throughout the world. C2 systems
permit a ground operator to fly a target or a UAV through a pre-planned mission.
The mission may be for  reconnaissance,  where the vehicle is equipped with high
definition TV sensors and the necessary data links to send  information  back to
its C2 systems ground  station.  The UAV may also be used as a decoy,  since the
operator can direct the flight  operations that will make the small drone appear
to be a larger combat aircraft.

Our MONTAGE system affords over-the-horizon C2 using GPS guidance and control of
multiple  targets from a single ground station.  The ability to control multiple
targets at increased distances represents a significant product improvement. The
MONTAGE is a highly  flexible,  multiple  processor  design with high resolution
graphics,  which can be  field-configured  within  minutes to fly or control any
selected  vehicle  for which it is  equipped.  The MONTAGE is used in support of
missile,  aircraft and other weapons systems development and testing. The system
meets a growing  requirement to test against multiple threats with the automated
defense capabilities of ships like the AEGIS cruiser and the E-2C aircraft.

In  September  2004,  we closed on the  purchase  of  Reliable  System  Services
Corporation ("RSS"). In addition to complementing and adding to our capabilities
in  Telemetry,  Electronic  Warfare  ("EW")  Simulation  Equipment,  EW  Jamming
Equipment and Range Safety Commanding  applications,  RSS significantly enhanced
our C2 capabilities for UAV platforms, in that RSS provides a C2 system for UAVs
that operates  through the Iridium  satellite  system.  The RSS Iridium based C2
system  provides  secure  (encryption,   anti-spoof)  global  service  coverage,
allowing  multiple  target  operations.  The addition of this RSS Iridium  based
alternate  for UAV C2 systems  enables us to provide a broader  array of systems
configuration solutions to our defense industry customers.

Transponders.  We  manufacture a variety of expendable  transponders,  including
range safety, IFF, command and control, and range scoring systems.  Transponders
are small, expendable, electronic systems consisting of a transmitter, sensitive
receiver  and  internal  signal  processing  equipment  comprised  of active and
passive  components,  including  microwave  subassemblies  such  as  amplifiers,
oscillators  and  circulators.  The  transponder  receives  signals from radars,
changes and amplifies the frequency of the signals,  and transmits  back a reply
on a different  frequency and signal level.  This reply is a strong,  noise-free
signal upon which the  tracking  radar can "lock," and one which is far superior
to skin reflection tracking, particularly under adverse weather conditions after
the launch.

In range safety  applications,  transponders  enable accurate  tracking of space
launch  and  unmanned  aerial  vehicles,  missiles,  and  target  drones so that
position and direction are known  throughout its flight.  In the case of several
defense and commercial  space launch vehicles  (i.e.,  Delta,  Atlas,  Titan and
Pegasus),  our  transponder  is tracked by the ground launch team all the way to
space orbit,  and in certain  instances  through several orbits,  as a reference
location  point in space to assure  that the launch  payload  has been  properly
placed in orbit.

IFF  transponders,  which  are used in  conjunction  with the  Federal  Aviation
Authority Air Traffic Control System,  enable ground controllers to identify the
unmanned  targets,  drones and cruise  missiles  on which these units fly and to
vector  other manned  aircraft  safely away from the flight path of the unmanned
aerial vehicle.

Command and control  transponders  provide the link through the telemetry system
for relaying ground signals to direct the vehicle's flight.  The uplink from the
ground control station, a series of coded pulse groups, carries the signals that
command the flight control  guidance system of the vehicle.  The downlink to the
ground   provides   both  tracking   signals  for  range  safety,   as  well  as
acknowledgment and status of the uplink commands and their implementation in the
vehicle.  The  transponder  is therefore  the means to fly the vehicle.  Scoring
systems are mounted on both  airborne and sea targets.  Scoring  systems  enable
test and  evaluation  engineers  to  determine  the  "miss-distance"  between  a
projectile and the target at which it has been launched.

Flight Termination Receiver. A flight termination receiver, or FTR, is installed
in a test missile,  UAV, target or space launch vehicle as a safety device.  The
FTR has a built-in  decoder that enables it to receive a complex series of audio
tones  which,  when  appropriate,  will set off an  explosive  charge  that will
                                       6
<PAGE>
destroy the vehicle.  A Range  Safety  Officer,  or RSO,  using the range safety
transponder will track the vehicle in flight to determine if it is performing as
required.  If the RSO detects a malfunction  in the test or launch  vehicle that
causes  it to veer  from a  planned  trajectory  in a manner  that may  endanger
personnel or facilities, the RSO will transmit a coded signal to the onboard FTR
to explode the vehicle.

HF  Communications  and  IFF  Interrogators.  We  design  and  manufacture  high
frequency  radio  and IFF  interrogators.  This  high  frequency  communications
equipment  is used by the U.S.  Navy  and  foreign  navies  that  conduct  joint
military exercises with the U.S. Navy. The IFF interrogators are used as part of
shipboard  equipment and are also placed on coastlines,  where they are employed
as silent sentries. We have been a significant supplier to the Republic of Korea
for over twenty years and have a large, established installed base of equipment.
We have been,  and  continue to be, a supplier to the Republic of Korea DDX, LPX
and KDX destroyer programs.

High Power  Amplifier.  We design and manufacture  high power amplifier  systems
with frequencies  ranging from 1.5 Megahertz ("MHz") to 12 GHz with power levels
from  multi-kilowatts  up to 15W,  depending  on the  frequency.  Our high power
amplifier  applications  include but are not  limited to defense  communication,
electronic warfare, radar and avionics.

Microwave  Integrated  Circuits.  We design and  manufacture  complex  microwave
integrated  circuits,  or MICs, which consist of  sophisticated  assemblies that
perform many functions,  primarily involving switching of microwave signals. Our
MICs are employed in many defense electronics systems and missile programs.

High/Low Power Integrated Assembly. Our high power microwave devices are used in
radar  system  transmitters  and in  long-range  missiles.  High  power  devices
frequently  use small amounts of nuclear  material to enhance  breakdown of high
energy  pulses,  and we are one of very few  companies  with an  active  nuclear
license that permits the handling of these trace  amounts of nuclear  materials.
There are  relatively  few companies with the expertise or facilities to design,
manufacture and test high power devices. We also produce lower power, broad band
microwave  integrated  assemblies for the defense  electronics  industry.  These
complex   assemblies   combine   microwave   functions  such  as  amplification,
attenuation,  switching of multiple  signals,  and phase and amplitude  control.
Their  applications  include  Rear  Warning  Receivers,   or  RWRs,  Electronics
Countermeasure, or ECM, systems and highly sensitive receiver systems.

Solid  State  Receiver  Protector.  We have  become  a  preeminent  supplier  of
solid-state  receiver  protector  devices that are able to withstand high energy
pulses without the use of nuclear materials.  These high power devices protect a
radar  receiver from  transient  bursts of microwave  energy and are employed in
almost every military and commercial radar system.  For our engineering  efforts
in designing  solid-state  receiver  protectors  for the F-16,  we received cash
awards  from the  United  States  Air  Force as part of the  government's  value
engineering program.

Digitally  Tuned  Oscillators  (DTO's).  We  produce  microwave  sources,  which
generate signals that are used in microwave  oscillators.  Our microwave sources
are sold to the U.S.  defense  industry and to various foreign  governments.  We
specialize in digitally tuned oscillators, or DTOs, a critical component in many
ECM systems.

Simulation Equipment.  EW Simulation Technology Limited ("EWST"), a U.K. company
and  wholly  owned  subsidiary,   designs  and  manufactures  radar  threat  and
electronic  countermeasures simulation equipment for electronic warfare training
and test and evaluation applications. Radar threat and countermeasures simulator
products include but are not limited to the following:

CHAMELEON is a real time electronic  countermeasures  ("ECM") jamming simulator.
It uses a variety of ECM techniques  and radar target  modeling for training and
testing of both radar and EW operators  and systems.  The system  offers a fully
programmable ECM capability using Digital RF Memories ("DRFM")  technology;  and
offers  fully  coherent  jamming in both range and  velocity  through the use of
8-bit DRFM  technology  together with GUI software.  The CHAMELEON is suited for
ground-based and airborne ECM test and training systems.

The RSS8000 Series Radar Threat Simulator  generates real-time user programmable
radar  threats  and  provides  output   configurations   in  digital   (On-board
trainer-OBT) and RF (RSS series)  formats.  The system can be used for EW system
test and  evaluation as well as for EW operator  training in laboratory and more
rugged environments. The RSS8000 equipment covers the 100MHz to 40 GHz range and
can be configured to suit any application  from a portable single RF source unit
to a  multiple  RF source  and  multiple  port DF  system.  The DF  systems  are
available in  amplitude,  DTOA and/or phase formats with the ports being capable
of angular rotation.

Mobile EW and Radar Test Systems  ("MERTS") is a mobile EW and radar test system
providing  complete  jamming and radar  threat test  facility  for field use. It
provides a turnkey test and  evaluation  equipment  for field  applications  and
includes both the CHAMELEON and RSS8000 systems  integrated into one operational
unit.  The MERTS  equipment is housed  within an  air-conditioned  ISO container
mounted on a four-wheel  drive truck that allows  on-site test and evaluation of
radar and EW systems as well as operator training.
                                       7
<PAGE>
Scientific  Products.  Our scientific  products are used  extensively in Nuclear
Magnetic  Resonance  (NMR)  systems.  These  amplifiers,  which  have  dual mode
capability and can be operated in either a pulsed or continuous  wave, cover the
frequency  ranges of 6 MHz to 950 MHz,  with power  levels as high as 2.0KW peak
power  at 10%  duty  cycle.  Scientific  customers  include  Original  Equipment
Manufacturers ("OEM"), system manufacturers and research centers.

Medical  Products.  Our medical products vary in complexity from single modules,
to rack mounted amplifiers, to complete systems. The rack-mounted amplifiers and
complete systems  typically  include  detection/protection  circuitry,  built-in
power  supplies,  front panel  metering  and  digital  and/or  analog  interface
controls.  Both  forced air and/or  water  cooling  are used,  depending  on the
customer's  requirements.  Our medical  products are used in Magnetic  Resonance
Imaging,  or MRI,  systems.  All amplifiers have dual mode capability and can be
operated in either a pulsed or  continuous  wave mode,  and cover the  frequency
ranges of 10 MHz to 200 MHz with  power  levels as high as 12.0KW  peak power at
10% duty cycle.  Medical  customers  include  OEM, as well as  universities  and
research centers.

All products feature highly reliable  technical  solutions designed for improved
production and reliability. Producibility is enhanced through the use of surface
mount  components  and circuit  designs  which  eliminate the need for excessive
alignment during the production  cycle. High reliability is achieved through the
implementation  of conservative  thermal and RF circuit design and sophisticated
self-protection schemes. Reliability is further enhanced during the design phase
by employing detailed environmental testing.

CUSTOMERS

During the fiscal years ended July 30, 2006 and July 31, 2005, approximately 22%
and 25% of our net sales  respectively,  were  attributable  to  contracts  with
offices and agencies of the U.S.  Government.  During the fiscal year ended July
31, 2005,  Northrop  Grumman  accounted for  approximately  11% of net sales. No
other  customers  accounted  for shipments of 10% or more of net sales in fiscal
2006 or 2005.

We provide defense electronics  equipment to major defense prime contractors for
integration into larger platforms and systems. Some of our customers for defense
electronics equipment include:

   The Boeing Company           BAE Systems                   Harris Corporation
   Lockheed Martin Corporation  Northrop Grumman Corporation  Raytheon Company

During fiscal 2006, sales to foreign  customers  accounted for approximately 24%
of our net  sales.  Sales  to  foreign  customers  from our  domestic  locations
accounted for 12% of net sales. Sales from England were 4%, and Israel 8% of net
sales to foreign customers. The governments of Egypt, Japan, South Korea, Taiwan
and the  United  Kingdom  are all  significant  customers  of  ours.  All of our
domestic contracts with foreign customers are payable in U.S. dollars. Contracts
with customers  originating in Israel and England are either in U.S.  dollars or
the local  functional  currency.  International  sales are  subject to  numerous
risks, including political and economic instability in foreign markets, currency
and economic  difficulties  in the Pacific Rim,  restrictive  trade  policies of
foreign  governments,  inconsistent  product  regulation by foreign  agencies or
governments,  imposition  of product  tariffs and burdens and costs of complying
with a wide  variety  of  international  and U.S.  export  laws  and  regulatory
requirements.  Our  international  sales also are subject to us obtaining export
licenses for certain products and systems.

SALES AND MARKETING

We  market  our  products  worldwide  to the  United  States  Government,  prime
contractors  and various  countries  in defense  markets,  and to OEM,  research
institutions and universities in commercial markets. Sales are primarily through
a sales force  generally  organized by  geographic  territory  and  markets.  In
addition,  we have contracts with  manufacturers'  representatives in the United
States and international  representatives who are located in Western Europe, the
Middle East and Asia.  As part of our marketing  efforts,  we advertise in major
trade publications and attend major industrial shows in the commercial, medical,
satellite communications and defense markets.

After we have identified key potential  customers,  we make sales calls with our
own sales,  management and engineering personnel. In order to promote widespread
acceptance of our products and provide  customers  with  support,  our sales and
engineering teams work closely with our customers to develop tailored  solutions
to their requirements. We believe that our customer engineering support provides
us with a key competitive advantage.

We also produce  microwave  components that are sold through our catalog,  which
for more than forty  years has been an  industry  leader,  and sell  attenuating
devices and IQ modulation  and phase shifters  through the microwave  engineer's
handbook.
                                       8
<PAGE>
MANUFACTURING

We manufacture our products from standard components, as well as from items that
are  manufactured  by vendors to our  specifications.  A majority of our defense
electronics  and  commercial   assemblies  and  subsystems  contain  proprietary
technology  which is designed and tested by our engineers and technicians and is
manufactured at our own facilities.

We continue to invest in improving our proprietary  manufacturing  processes and
the automation of the manufacturing processes. Automation is critical in meeting
our  customers'  demands  for price  competitiveness,  world  class  quality and
on-time  delivery.  We are also investing to enhance our  responsiveness  to the
production demands of our customers.

We purchase  electronic  components and other raw materials used in our products
from a large number of suppliers and all such  materials  are readily  available
from alternate sources.

We maintain minimal levels of finished products  inventory,  principally to meet
the needs of our medical products customers. We generally purchase raw materials
for specific contracts, and we purchase common components for stock based on our
firm fixed backlog.

There are no significant  environmental  control procedures  required concerning
the discharge of materials into the environment that require us to invest in any
significant  capital  equipment  or that  would  have a  material  effect on our
earnings or our competitive position.

Quality  assurance  checks are performed on manufacturing  processes,  purchased
items,  work-in-process  and finished  products.  Due to the  complexity  of our
products, final tests are performed on some products by highly skilled engineers
and technicians.

Our primary manufacturing facilities have earned the ISO 9001 Registration.  The
ISO 9000 series  standards are  internationally  recognized  quality  management
system requirements.  ISO 9001, the most comprehensive  Standard in the ISO 9000
Series,  covers  design,  manufacturing,  installation,  and servicing  systems.
Assembly,  test,  package and shipment of products are done at our manufacturing
facilities located in the following cities:

Lancaster, Pennsylvania
Farmingdale, New York
Woburn, Massachusetts
Whippany, New Jersey
Fort Walton Beach, Florida
McLean, Virginia
Jerusalem, Israel
Farnborough, England

BACKLOG

Our total funded  backlog of orders was  approximately  $125 million on July 30,
2006 which are orders covered by funded signed contracts or purchase orders. The
funded  backlog on July 31, 2005 was  approximately  $145 million.  There was no
"unfunded"  backlog at July 30, 2006 or July 31, 2005.  Of our total  backlog at
July 30, 2006,  $89 million  (71%) is  attributable  to domestic  orders and $36
million (29%) is attributable to foreign orders.

Backlog is not  directly  indicative  of future  sales.  Accordingly,  we do not
believe that our backlog as of any particular date is  representative  of actual
sales for any succeeding period.  Management  anticipates that approximately 84%
of the  backlog at July 30,  2006 will be shipped  during the fiscal year ending
July 29, 2007.

Approximately 94% of our contracts are firm fixed price contracts, some of which
require  delivery  over time  periods  in excess of one year.  With this type of
contract we agree to deliver  products at a fixed price,  subject to adjustment,
for  costs  incurred  because  of change  orders  issued  by the  customer.  The
remaining contracts are cost plus type contracts.

In accordance with  Department of Defense  procedures,  all contracts  involving
government programs may be terminated by the government, in whole or in part, at
the  government's  discretion  for  cause  or  convenience.  In the  event  of a
termination for convenience, prime contractors on such contracts are required to
terminate  their  subcontracts  on the program,  and the government or the prime
contractor  is obligated  to pay the costs  incurred by us under the contract to
the date of termination plus a fee based on the work completed.

                                       9
<PAGE>
PRODUCT DEVELOPMENT

We believe that our growth depends,  in part, on our ability to renew and expand
our  technology,  products,  and  design  and  manufacturing  processes  with an
emphasis  on cost  effectiveness.  We focus our primary  efforts on  engineering
design and product development  activities rather than pure research. Our policy
is to assign the required engineering and support people, on an ad hoc basis, to
new product  development as needs require and budgets permit.  The cost of these
development activities, including employees' time and prototype development, was
approximately   $30.3  million  in  fiscal  2006  (of  which  $14.2  million  is
attributable to the  acquisitions of MSI and ICI),  $10.3 million in fiscal 2005
and $11.1 million in fiscal 2004.  The portion of these costs not  reimbursed by
customers was approximately  $9.1 million in fiscal 2006, $5.0 million in fiscal
2005 and $5.4 million in 2004.  These  increases in  development  spending  were
undertaken to continue to provide future business opportunities for the Company.
Future product  development costs will depend on the availability of appropriate
development opportunities within the markets served by the Company.

COMPETITION

The microwave  component and subsystems  industry is highly  competitive  and we
compete  against  many  companies,  both  foreign  and  domestic.  Many of these
companies are larger,  have greater financial resources and are better known. As
a  supplier,  we also  experience  significant  competition  from  the  in-house
capabilities of our customers.

Competition is generally based upon  technology,  design,  past  performance and
price. Our ability to compete  depends,  in part, on our ability to offer better
design and  performance  than our  competitors  and our readiness in facilities,
equipment and personnel to complete the programs.  Many of the programs in which
we participate  are long standing  programs in which we are the sole provider of
our product.

GOVERNMENT REGULATION

Because of our participation in the defense  industry,  we are subject to audits
by various government  agencies for our compliance with government  regulations.
We are also  subject  to a  variety  of  local,  state  and  federal  government
regulations relating to, among other things, the storage,  discharge,  handling,
omission,  generation,  manufacture  and  disposal  of toxic or other  hazardous
substances  used to  manufacture  our  products.  We believe that we operate our
business in material  compliance with applicable laws and regulations.  However,
any failure to comply with existing or future laws or  regulations  could have a
material  adverse  impact on our  business,  financial  condition and results of
operations.

INTELLECTUAL PROPERTY

We rely primarily on a combination of trade secrets and employee and third-party
non-disclosure  agreements  to protect  our  intellectual  property,  as well as
limiting  access  to the  distribution  of  proprietary  information.  We cannot
provide  assurance  that the steps  taken to protect our  intellectual  property
rights will be  adequate to prevent  misappropriation  of our  technology  or to
preclude competitors from independently developing such technology. Furthermore,
we cannot provide  assurance that, in the future,  third parties will not assert
infringement  claims  against us with  respect to our  products.  Asserting  our
rights or defending  against third party claims could involve  substantial costs
and  diversion  of  resources,  thus  materially  and  adversely  affecting  our
business,  financial  condition and results of operations.  In the event a third
party  were  successful  in a  claim  that  one of our  products  infringed  its
proprietary rights, we may have to pay substantial royalties or damages,  remove
that  product from the  marketplace  or expend  substantial  amounts in order to
modify the product so that it no longer  infringes on such  proprietary  rights,
any of which could have a material  adverse  effect on our  business,  financial
condition and results of operations.

EMPLOYEES

As of July 30,  2006 we had  1,014  employees.  We  believe  that  our  employee
relations are  satisfactory.  None of our approximately 871 U.S. based employees
are  represented by a labor union.  Employment by functional area as of July 30,
2006 is as follows:
<TABLE>
                     <S>                        <C>
                     Executive                     16
                     Administration                59
                     Manufacturing                647
                     Engineering                  225
                     Sales and Marketing           67
                                                -----
                     Total                      1,014
                                                =====
</TABLE>
We believe  that our future  success  will  depend,  in part,  on our  continued
ability to recruit and retain highly skilled technical, managerial and marketing
personnel,  including microwave engineers. To assist in recruiting and retaining
such personnel, we have established  competitive benefits programs,  including a
401(k)  employee  savings plan for our U.S.  employees,  and stock option plans.

                                       10
<PAGE>
OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
Name                                   Age         Served as Officer Since          Position(s) and Offices
----                                   ---         -----------------------          -----------------------
<S>                                    <C>                  <C>                     <C>
Myron Levy                             66                   1988                    Chairman of the Board,
                                                                                    Chief Executive Officer,
                                                                                     and Director
John M. Kelley                         53                   1998                    President
Kevin J. Purcell                       48                   2006                    Vice President and
                                                                                     Chief Financial Officer
Charles L. Pourciau, Jr.               58                   2006                    Vice President - Administration
                                                                                     and Governance
Andy Feldstein                         55                   2006                    Vice President and Chief
                                                                                     Technology Officer
Rozalie Schachter                      60                   2000                    Vice President - Business
                                                                                      Development
Anello C. Garefino                     59                   1993                    Vice President - Finance
John A. Carroll                        55                   2003                    Vice President - Human
                                                                                     Resources
Richard Poirier                        41                   2003                    Vice President
</TABLE>
Item 1A.  Risk Factors

You should carefully  consider the factors described below and other information
contained in this report.  The risks and  uncertainties  described below are not
the only ones we face. Additional risks and uncertainties not presently known to
us, which we currently  deem  immaterial  or which are similar to those faced by
other  companies  in our  industry or  business in general,  may also impair our
business  operations.  If  any of  the  following  risks  actually  occurs,  our
business,  financial  condition or results of operations could be materially and
adversely  affected.  In such case,  the trading price of our common stock could
decline,  and you may  lose all or part of your  investment.  This  report  also
contains forward-looking statements that involve risks and uncertainties. Please
refer to "Forward-Looking Statements" included elsewhere in this report.

                    Risks Related to Recent Legal Proceedings

A finding  of  criminal  liability  against  us in  connection  with the  recent
indictment by the U.S. Attorney's office could have a material adverse effect on
our business and operating results.

On June 6, 2006 an indictment was returned against Herley  Industries,  Inc. and
Lee Blatt,  our former  Chairman by the U.S.  Attorney's  Office for the Eastern
District of Pennsylvania in connection with three government contracts completed
in October 2002  aggregating  revenue of  approximately  $3.9 million.  No other
officer,  director  or  employee  of  ours  was  named  in the  indictment.  The
indictment  is on  multiple  charges in  connection  with  purported  activities
resulting in alleged  excessive  profits by us on three  contracts with the U.S.
Government. We and Mr. Blatt could be fined up to approximately $13 million each
and we could be required to forfeit monies paid under the  contracts.  Under the
terms of an indemnification  agreement with Mr. Blatt, the Company has agreed to
provide  indemnification  with regard to certain legal proceedings so long as he
has acted in good faith and in a manner  believed  to be in, or not  opposed to,
the Company's  best interest with respect to any criminal  proceeding and had no
reasonable  cause to  believe  his  conduct  was unlawful.  We  believe  we have
substantial  defenses to the  charges  alleged in the  indictment  and intend to
vigorously defend against these allegations;  however, there can be no assurance
that we will be successful.

A further  suspension of certain of our  facilities  from receiving new contract
awards could have a material adverse effect on our business.

On June 13, 2006,  we were notified  that as a  consequence  of the  indictment,
certain of our operations had been suspended from receiving new contract  awards
from  the U. S.  Government.  The  affected  operations  include  facilities  in
Lancaster,  Pennsylvania,  Woburn,  Massachusetts,  Chicago,  Illinois  and  our
subsidiary  in  Farmingdale,  New York.  The  Chicago,  Illinois  location  is a
two-person  marketing  office.  The  result of this  suspension  was that  these
facilities  could not be  solicited  for or awarded  new  contracts  or contract
extensions  without  special  exceptions,  pending the  outcome of the  criminal
proceeding.   The  suspended   facilities   could  receive  contract  awards  or
subcontracts  from the Federal  Government  if the head of the agency  states in
writing the compelling reason to do so.

                                       11
<PAGE>
Effective October 12, 2006, we entered into an Administrative Agreement with the
Department of the Navy, on behalf of the Department of the Defense that required
us, among other  things,  to  implement a  comprehensive  program of  compliance
reviews,  audits and reports for a period of three years or until  settlement or
adjudication of the legal matter  referenced above,  whichever is later,  unless
shortened or extended by written agreement of the parties. In addition,  we were
required to sever our relationship with Mr. Lee N. Blatt, former Chairman of the
Board of  Directors,  as our employee or  consultant.  In return,  the Navy,  on
behalf of the  Department of Defense has terminated the suspension and debarment
of our operations from receiving new contract  awards from the U.S.  Government.
Our failure to comply with this  Administrative  Order or an unfavorable outcome
of the recent indictment could lead to a further suspension.

The recent class-action  complaints against us could result in costly litigation
and payment of damages.

Since June 6, 2006,  we have been served with  several  class-action  complaints
against us and  certain  of our  officers  and  directors  in the United  States
District Court for the Eastern District of Pennsylvania. The claims arise out of
the  criminal  indictment  and are made  under  Section  10(b)  and 20(a) of the
Securities  Exchange act of 1934 and Rule 10b-5  thereunder.  While we intend to
vigorously defend against these actions, their ultimate outcome is presently not
determinable as they are in the preliminary  phase. Thus, we cannot at this time
determine the likelihood of an adverse  judgment or a likely range of damages in
the event of an adverse  judgment.  If a class were  ultimately  certified,  any
settlement of or judgment  arising from such lawsuit  could be material,  and we
cannot give any  assurance  that we would have  resources  available to pay such
settlement or judgment. Additionally, any litigation to which we are subject may
be costly and could require significant involvement of our senior management and
may divert management's attention from our business and operations.

                          Risks Related to Our Business

A significant  percentage of our sales are under government  contracts which are
only partially  funded initially and may lose funding or be terminated in future
years.

Approximately  67% of our net sales for fiscal 2006 and 65% of our net sales for
fiscal 2005 were made to United States government agencies and their contractors
and subcontractors for defense programs. Over its lifetime, a government program
may be  implemented  by the award of many  different  individual  contracts  and
subcontracts.  The funding of  government  programs is subject to  congressional
appropriations.  Although  multi-year  contracts may be authorized in connection
with major procurements,  Congress generally appropriates funds on a fiscal year
basis even  though a program  may  continue  for  several  years.  Consequently,
programs are often only  partially  funded  initially and  additional  funds are
committed  only as Congress  makes further  appropriations.  The  termination of
funding for a government  program would result in a loss of  anticipated  future
revenues  attributable to that program which could have a negative impact on our
operations.

Generally,  government  contracts contain  provisions  permitting the government
agency  to  terminate  the  contract  at its  convenience,  in whole or in part,
without prior notice,  and to provide for payment of compensation  only for work
done and commitments  made at the time of termination.  We cannot guarantee that
one or more of our  government  contracts  will not be  terminated  under  these
circumstances.  Also, we cannot  guarantee  that we would be able to procure new
government  contracts to offset the revenues lost as a result of  termination of
any contracts.  Because a substantial  part of our revenues are dependent on our
procurement, performance and payment under our contracts, our failure to replace
sales  attributable  to  a  significant  defense  program  or  contract  at  its
termination,  whether due to cancellation,  spending cuts, budgetary constraints
or otherwise, could have a material adverse effect upon our business,  financial
condition and results of operations.

Fixed-price contracts are common in all of our markets and may increase risks of
cost overruns and product non-performance.

Our customers set demanding specifications for product performance,  reliability
and cost.  Most of our  customer  contracts  are firm,  fixed  price  contracts,
providing  for a  predetermined  fixed  price  for the  products  that we  make,
regardless of the costs we incur. Thus, we must make pricing  commitments to our
customers  based on our  expectation  that we will achieve  more cost  effective
product  designs  and  automate  more  of  our  manufacturing  operations.   The
manufacture  of  our  products  requires  a  complex  integration  of  demanding
processes  involving unique technical skill sets. We face risks of cost overruns
or order  cancellations  if we fail to  achieve  forecasted  product  design and
manufacturing  efficiencies  or if products cost more to produce than  expected.
The expense of producing  products can rise due to increased  cost of materials,
components, labor, capital equipment or other factors. We may have cost overruns
or problems with the performance or reliability of our products in the future.

                                       12
<PAGE>
If we  fail  to  win  competitively  awarded  contracts  in the  future,  we may
experience  a  reduction  in  our  sales,  which  could  negatively  affect  our
profitability.

We obtain many of our U.S.  Government  contracts through a competitive  bidding
process.  We cannot provide assurance that we will continue to win competitively
awarded  contracts or that awarded  contracts will generate sales  sufficient to
result in our  profitability.  We are also subject to risks  associated with the
following:

     o    the frequent  need to bid on programs in advance of the  completion of
          their   design   (which   may  result  in   unforeseen   technological
          difficulties and cost overruns);

     o    the substantial time and effort, including the relatively unproductive
          design and development  required to prepare bids and proposals,  spent
          for competitively awarded contracts that may not be awarded to us;

     o    design complexity and rapid technological obsolescence; and

     o    the constant need for design improvement

Our government  contracts may be subject to protest or challenge by unsuccessful
bidders or to termination,  reduction or modification in the event of changes in
government  requirements,  reductions in federal  spending or other factors.  In
addition, failure to obtain a renewal or follow-on contract with U.S. Government
or foreign governments would result in a loss of revenues.  If revenues from the
award of new  contracts  fail to offset  this  loss,  it could  have a  material
adverse effect on our results of operations and financial position.

Our  international  sales are  subject  to risks  related to doing  business  in
foreign countries.

In fiscal 2006 and 2005,  international  sales comprised  approximately  24% and
27%, respectively, of our net sales, and we expect our international business to
continue  to  account  for a  significant  part of our  revenues.  We  currently
maintain significant  manufacturing facilities in the United Kingdom and Israel.
International  sales are  subject to numerous  risks,  including  political  and
economic instability in foreign markets,  currency and economic  difficulties in
the Pacific Rim, restrictive trade policies of foreign governments, inconsistent
product  regulation by foreign  agencies or  governments,  imposition of product
tariffs and burdens and costs of complying with a wide variety of  international
and U.S.  export laws and  regulatory  requirements.  The  governments of Japan,
South Korea,  Taiwan and the United Kingdom are all significant  customers.  Our
international sales also are subject to us obtaining export licenses for certain
products  and  systems.  We  cannot  provide  assurance  that we will be able to
continue  to  compete   successfully  in  international   markets  or  that  our
international  sales will be  profitable.  Substantially  all of our revenues in
fiscal  2006  at our  domestic  locations  and  our  operation  in  Israel  were
denominated in U.S.  dollars,  and we intend to continue to enter only into U.S.
dollar-denominated  contracts. Revenues reported at our EWST (U.K.) facility are
primarily  denominated in Pound Sterling and accounts for approximately 4% to 8%
of our  consolidated net sales in U.S. dollars over the last three fiscal years.
In addition,  fluctuations  in currency  could  adversely  affect our customers,
which may lead to delays in the timing and execution of orders.

We rely on a small number of significant customers.

A significant  part of our sales have  historically  come mainly from  contracts
with  agencies  of, and prime  contractors  to, the U.S.  government.  Net sales
directly to the U.S. government accounted for 22% of fiscal year 2006 net sales.
Additionally,  approximately  38% of our net sales were attributable to our next
five largest  customers  for fiscal year 2006.  Variations in the demand for our
products by any of these  direct and  indirect  customers  could have a serious,
adverse impact on our performance.  If we were to lose any of these or any other
major customers, or if orders by any major customer were otherwise to be delayed
or reduced,  including  reductions  due to market or  competitive  conditions in
commercial markets or further decreases in government defense spending, then our
business, financial condition and results of operations would be harmed.

We have limited intellectual property rights.

Our success is dependent upon our  proprietary  technology.  We do not currently
have any material  patents.  We rely  principally  on trade secret and copyright
laws,  certain employee and third-party  non-disclosure  agreements,  as well as
limited  access to and  distribution  of  proprietary  information,  in order to
protect our technology.  Trade secret laws afford us limited  protection because
they  cannot be used to prevent  third  parties  from  reverse  engineering  and
reproducing our products. Similarly, copyright laws afford us limited protection
because copyright  protection  extends only to how an idea is expressed and does
not protect the idea itself. Moreover, third parties could independently develop
technologies  that compete with our  technologies.  We cannot provide  assurance
that the  obligations  on the part of our  employees  and  business  partners to
maintain  the  confidentiality  of  our  proprietary   technology  will  prevent

                                       13
<PAGE>
disclosure of such information by our employees or third parties. Litigation may
be necessary  for us to defend  against  claims of  infringement  or protect our
proprietary  technology,  which  could  result  in  substantial  cost  to us and
diversion of our efforts.  We cannot provide  assurance that we would prevail in
any such litigation.  Our inability to protect our proprietary  technology could
have a material adverse effect on our business,  financial condition and results
of operations.  Although we believe that our products and proprietary  rights do
not infringe on the patents and proprietary  rights of third parties,  we cannot
provide  assurance that  infringement  claims,  regardless of merit, will not be
asserted  against  us.  In  addition,   effective  copyright  and  trade  secret
protection  of our  proprietary  technology  may be  unavailable  or  limited in
certain foreign countries.

We are subject to environmental  laws and regulations and our ongoing operations
may expose us to environmental liabilities.

Our operations are subject to federal,  state,  foreign and local  environmental
laws and  regulations.  As a  result,  we may be  involved  from time to time in
administrative or legal proceedings relating to environmental matters. We cannot
provide  assurance that the aggregate  amount of future clean-up costs and other
environmental   liabilities  will  not  be  material.  We  cannot  predict  what
environmental  legislation  or  regulations  will be enacted in the future,  how
existing or future laws or regulations  will be  administered  or interpreted or
what environmental conditions may be found to exist. Enactment of more stringent
laws  or  regulations  or more  strict  interpretations  of  existing  laws  and
regulations may require us to make additional expenditures,  some of which could
be material.

A failure to attract and retain  technical  personnel  could reduce our revenues
and our operational effectiveness.

There is a continuing demand for qualified technical personnel.  We believe that
our future growth and success will depend upon our ability to attract, train and
retain such  personnel.  Competition  for  personnel in the defense  industry is
intense and there are a limited number of persons,  especially  engineers,  with
knowledge of and experience in microwave technology.  Our design and development
efforts depend on hiring and retaining qualified technical  personnel.  Although
we  currently  experience  relatively  low rates of turnover  for our  technical
personnel,  the rate of turnover  may  increase in the future.  An  inability to
attract or maintain a  sufficient  number of  technical  personnel  could have a
material  adverse  effect  on our  contract  performance  or on our  ability  to
capitalize on market opportunities.

The markets in which we operate are competitive.

Our  historical  defense  markets  and our more  recent  commercial  markets are
characterized  by rapid  technological  change  as new  products  are  generally
developed  quickly and industry  standards are  constantly  evolving.  Thus, our
products  can become  obsolete  over a short period of time unless we succeed in
remaining technologically innovative and in anticipating new market demands.

The defense  industry in particular has  experienced  substantial  consolidation
due, among other things, to increasing  pressures for cost reductions.  This has
substantially  increased competitive pressures and introduced delays in contract
funding and awards into our historical markets in the defense industry.  Many of
our competitors are larger than us and have substantially  greater financial and
other  resources  than we have. As a supplier,  we also  experience  significant
competition  from the in-house  capabilities  of our  customers.  Our ability to
compete for defense contracts largely depends on the following factors:

     o    our ability to offer better performance than our competitors;
     o    the readiness of our facilities,  equipment and personnel to undertake
          the programs for which we compete; and
     o    the  effectiveness  and  innovations  of our research and  development
          programs.

We may encounter difficulties in effectively integrating acquired businesses.

As part of our business  strategy,  we have  augmented  our  technology  base by
acquiring companies with compatible or related products.  Historically,  we have
acquired a number of such  companies  and  products  and have  integrated  those
companies into our business.  These and any future  acquisitions we make will be
accompanied by the risks  commonly  encountered  in  acquisitions  of companies,
which include, among other things:

     o    potential exposure to unknown liabilities of acquired companies;
     o    higher than anticipated acquisition costs and expenses;
     o    difficulty and expense of assimilating the operations and personnel of
          the   companies,   especially   if   the   acquired   operations   are
          geographically distant;
     o    potential   disruption  of  our  ongoing  business  and  diversion  of
          management time and attention;
     o    failure to  maximize  our  financial  and  strategic  position  by the
          successful incorporation of acquired technology;
     o    difficulties in adopting and maintaining uniform standards,  controls,
          procedures and policies;

                                       14
<PAGE>
     o    loss  of key  employees  and  customers  as a  result  of  changes  in
          management; and
     o    possible dilution to our shareholders.

We may not be  successful  in  overcoming  these  risks  or any  other  problems
encountered in connection with any of our acquisitions.  We may make a strategic
acquisition  knowing that the  transaction  may adversely  affect our short-term
profitability,  perhaps  because the  acquisition  candidate may be experiencing
operating  losses.  We may believe that acquiring  such a company  outweighs the
operating  losses the candidate is experiencing and the losses that we expect to
experience before being able to make the acquisition candidate  profitable.  The
completion  of such an  acquisition  in the future would  negatively  affect our
profitability and may cause a decline in our stock price.

Our backlog is subject to reduction and cancellation.

Backlog  represents  products or services that our customers  have  committed by
contract to purchase from us. Our backlog as of July 30, 2006, was approximately
$125 million. Typically, the majority of our backlog is filled within 12 months.
Our backlog is subject to  fluctuations  and is not  necessarily  indicative  of
future  backlog  or  sales.  Moreover,   cancellations  of  purchase  orders  or
reductions of product quantities in existing  contracts could  substantially and
materially reduce our backlog and, consequently, future revenues. Our failure to
replace canceled or reduced backlog could result in lower revenues.

                         Risks Related to Our Securities

Our stock price has fluctuated significantly and may continue to do so.

A number  of  factors  could  cause  the  market  price of our  common  stock to
fluctuate significantly, including:

     o    our quarterly operating results or those of other defense companies;
     o    the public's  reaction to our press  releases,  announcements  and our
          filings  with  the  Securities  and  Exchange  Commission,   including
          developments with respect to the recent indictment and suspension;
     o    changes in earnings estimates or recommendations by research analysts;
     o    changes in general  conditions in the U.S. economy,  financial markets
          or defense industry;
     o    natural disasters, terrorist attacks or acts of war; and
     o    other developments affecting us or our competitors.

In recent  years,  the stock  market has  experienced  extreme  price and volume
fluctuations.  This volatility has had a significant  effect on the market price
of securities  issued by many  companies for reasons  unrelated to the operating
performance of these companies.

Delaware  law and our charter  documents  may impede or  discourage  a takeover,
which could cause the market price of our shares to decline.

We are a Delaware corporation and the anti-takeover provisions of Delaware law
impose various impediments to the ability of a third party to acquire control of
us, even if a change in control would be beneficial to our existing
shareholders. Our certificate of incorporation and by-laws provide, among other
things, for a classified board of directors serving staggered three-year terms.
Our incorporation under Delaware law, the acceleration of the vesting of
outstanding stock options including options that we have granted upon a change
in control, and certain provisions of our certificate of incorporation and
by-laws could impede a merger, takeover or other business combination involving
us or discourage a potential acquirer from making a tender offer for our common
stock, which, under certain circumstances, could reduce the market value of our
common stock.

                                       15
<PAGE>
Item 2.  Properties

Our facilities are as follows:
<TABLE>
<CAPTION>
                                                                                                   Owned
                                                                                                     Or
Location                                Purpose of Property                         Area           Leased
--------                                -------------------                        -------         ------
<S>                         <C>                                                 <C>                <C>
Lancaster, PA               Corporate headquarters                               3,300 sq. ft.     Leased
Lancaster, PA               Production, engineering and administration          86,200 sq. ft.     Owned
Woburn, MA                  Production, engineering and administration          60,000 sq. ft.     Owned
Farmingdale, NY (1)         Production, engineering and administration          46,000 sq. ft.     Leased
                                                                                14,000 sq. ft.     Leased
Whippany, NJ (2)            Production, engineering and administration          23,000 sq. ft.     Leased
Fort Walton Beach, FL       Production, engineering and administration          20,000 sq. ft.     Owned
Fort Walton Beach, FL (4)   Production, engineering and administration          31,500 sq. ft.     Leased
McLean, VA (5)              Production, engineering and administration          43,260 sq. ft.     Leased
Jerusalem, Israel           Production, engineering and administration          29,580 sq. ft.     Leased
Farnborough, England (3)    Production, engineering and administration           7,570 sq. ft.     Leased
Chicago, IL                 Engineering and administration                       3,000 sq. ft.     Leased
Lancaster, PA               Land held for expansion                                37 Acres        Owned
--------------
<FN>
     (1) On September 23, 1999 we closed on the sale of its prior owned facility
in  Amityville,   NY  and  relocated  the  plant  to  this  leased  facility  in
Farmingdale,  NY. The Company  entered into two 10 year lease  agreements with a
partnership  owned by the children of Messrs Blatt and Levy.  The leases provide
for  initial  minimum  annual  rent  of  approximately   $312,000  and  $92,000,
respectively,  in each case subject to escalation of  approximately  4% annually
throughout the 10 year term.
     (2) We entered into an  agreement  as of March 29, 2004 to acquire  certain
assets and the business of Communication Techniques, Inc. as discussed in Note B
of the financial statements.
     (3) As of September 1, 2002, we entered into an agreement to acquire all of
the issued and outstanding common stock of EW Simulation Technology, Limited.
     (4) As of February 1, 2005,  we entered into an agreement to acquire all of
the issued and outstanding  common stock of Micro Systems,  Inc. as discussed in
Note B of the financial  statements.  Prior to the  acquisition  of MSI, MSI had
leased  one of its  two  buildings  in  Fort  Walton  Beach,  Florida  from  MSI
Investments,  a Florida  General  Partnership.  MSI Investments is owned by four
individuals,  three of whom are  currently  employees of MSI.  This lease has an
original term of 15 years,  ending  December 31, 2012. The lease costs currently
are approximately $287,000 on an annual basis, including the tenant's obligation
to pay for insurance and property  taxes.  The base lease rate is adjusted every
January for changes in the consumer price index, using 1997 as the base year.
     (5) As of April 1, 2005, we entered into an agreement to acquire all of the
issued and outstanding common stock of Innovative Concepts,  Inc., including its
wholly owned  subsidiary  Stapor in Chantilly,  VA as discussed in Note B of the
financial statements.
</FN>
</TABLE>
We believe that these  facilities  are  adequate  for our current and  presently
anticipated future needs.

Item 3.  Legal Proceedings

As previously  reported,  there has been a continuing  investigation by the U.S.
Attorneys'  Office in Pennsylvania  which,  inter alia,  involves  pricing under
contracts  with the U.S.  Department  of Defense  relating  to  voltage  control
oscillators and powerheads.  The contracts aggregate  approximately $3.9 million
in total revenue.

On June 6, 2006 an  indictment  was returned  against the Company and Lee Blatt,
its former  Chairman.  No other  officer or director of the Company was named in
the indictment. The indictment alleges 29 counts of violations of the wire fraud
statute (18 U.S.C. Section 1343); 2 counts of violations of the obstruction of a
federal audit statute (18 U.S.C.  Section  1516); 1 count of violating the major
fraud against the United States  statute (18 U.S.C.  Section  1031); 3 counts of
violating the false  statements  to the  government  statute (18 U.S.C.  Section
1001) and a notice of forfeiture.  The Company believes that no criminal conduct
has occurred and will vigorously  contest the charges.  If convicted,  Mr. Blatt
and the Company  could be fined up to  approximately  $13  million  each and the
Company could be required to forfeit  approximately  $2.9 million paid under the
contracts.  Under the terms of an indemnification  agreement with Mr. Blatt, the
Company  has  agreed to provide  indemnification  with  regard to certain  legal
proceedings so long as he has acted in good faith and in a manner believed to be
in, or not opposed to, the Company's  best interest with respect to any criminal
proceeding and had no reasonable cause to believe his conduct was unlawful.

                                       16
<PAGE>
In June  and July  2006,  the  Company  was  served  with  several  class-action
complaints  against the Company and certain of its officers in the United States
District  Court for the Eastern  District of  Pennsylvania.  The claims are made
under  Section 10(b) and 20(a) of the  Securities  Exchange act of 1934 and Rule
10b-5  thereunder.  In July 2006, the Company and its directors were also served
with a derivative  complaint  for breach of fiduciary  duty brought  pursuant to
Rule 23.1 of the Federal Rules of Civil Procedure.  The complaints relate to the
Company's  indictment in the matter discussed  above. In addition,  in June 2006
the Company was  notified by  representatives  of the United  States  Attorney's
Office for the  Eastern  District of  Pennsylvania,  Civil  Division,  that they
intended to file a civil lawsuit against the Company pursuant to inter alia, the
False Claims Act, 31 U.S.C. ss. 3729 et. seq. The Company entered into a Tolling
Agreement on June 21, 2006, and does not anticipate any further activity related
to this potential claim until after the trial of the criminal  matter  mentioned
above.

The Company  believes it has substantial  defenses to the charges alleged in the
indictment and intends to vigorously defend against these allegations.

In connection with the Robinson Laboratories, Inc. ("RLI") litigation settled in
2005, by Order Dated February 17, 2005, the Company was awarded $2.1 million for
attorneys'  fees.  The judgment has not been paid by RLI and the  receivable for
this  award  has not  been  recorded  in the  Company's  consolidated  financial
statements because RLI has no assets.

The Company is involved in various  other  legal  proceedings  and claims  which
arise in the ordinary course of its business.  While any litigation  contains an
element of uncertainty,  management believes that the outcome of such litigation
will not have a material adverse effect on the Company's  financial  position or
results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

     Not Applicable.

PART II

Item 5. Market for Registrant's Common Equity,  Related Stockholder Matters, and
     Issuer Purchases of Equity Securities.

(a)  Our Common  Stock is traded in The Nasdaq  Global  Market  under the symbol
     HRLY.  The following  table sets forth the high and low closing sales price
     as  reported  by The Nasdaq  Global  Market  for our  Common  Stock for the
     periods indicated.
<TABLE>
<CAPTION>

                                                                         Common Stock
                                                                      High           Low
                                                                      ----           ---
    <S>                                                               <C>            <C>
     Fiscal Year 2004
         First Quarter.............................................   20.55          17.50
         Second Quarter............................................   22.85          18.24
         Third Quarter.............................................   21.90          18.88
         Fourth Quarter............................................   21.92          18.50

     Fiscal Year 2005
         First Quarter ............................................   19.77          17.32
         Second Quarter............................................   20.60          18.04
         Third Quarter.............................................   20.27          16.40
         Fourth Quarter............................................   19.82          17.38

     Fiscal Year 2006
         First Quarter.............................................   21.54          16.45
         Second Quarter ...........................................   17.80          15.74
         Third Quarter ............................................   21.38          16.98
         Fourth Quarter ...........................................   20.77           9.21
</TABLE>
     The closing price on October 18, 2006 was $15.52.

As of October  18,  2006,  there were  approximately  190  holders of record and
approximately 2,400 beneficial holders of our Common Stock.

     There  have been no cash  dividends  declared  or paid by us on our  Common
Stock during the past two fiscal years.

(b)  Not applicable.

                                       17
<PAGE>
Item 6. Selected Financial Data (in thousands except per share data):
<TABLE>
<CAPTION>
                                                                                  53 weeks  52 weeks
                                                               52 weeks ended       ended     ended
                                                    ----------------------------- --------  --------
                                                     July 30,  July 31, August 1, August 3, July 28,
                                                       2006      2005     2004      2003      2002
                                                       ----      ----     ----      ----      ----
<S>                                               <C>           <C>       <C>       <C>        <C>
Net sales (3)                                     $    176,268  151,415   122,154   110,223    92,881

Income from continuing operations                 $     10,354   10,781    13,673    13,937    10,730

Loss from discontinued operations                 $          -        -         -         -      (921)

Cumulative effect of adopting SFAS 142            $          -        -         -         -    (4,637)

Net income                                        $     10,354   10,781    13,673    13,937     5,172

Per share data from continuing operations (1) (2)
     Basic                                        $       0.72     0.75      0.97      0.97      0.89
     Assuming Dilution                            $       0.69     0.72      0.92      0.93      0.83

Total Assets                                      $    251,450  242,023   220,971   197,564   190,202
Total Current Liabilities                         $     33,351   32,090    23,846    18,125    14,557
Long-Term Debt net of current portion             $      5,948    5,000     5,845     6,403     5,684
Other Long-Term Liabilities                       $      1,265    1,042       932       849       706

<FN>
(1)  Earnings per share from continuing  operations are presented and calculated
     before  discontinued  operations and cumulative effect of accounting change
     in 2002.
(2)  No cash dividends have been distributed in any of the years presented.
(3)  See "Acquisitions" under Item 1. "Business".
</FN>
</TABLE>

                                       18
<PAGE>
Item 7.  Management's Discussion and Analysis of Financial Condition and
         Results of Operations

The following  discussion  should be read in conjunction  with the  Consolidated
Financial  Statements  and notes  thereto  included in Item 8 of Part II of this
Annual Report on Form 10-K.

Business Summary

We are a leading  supplier  of  microwave  products  and  systems to defense and
aerospace entities worldwide.  Our primary customers include large defense prime
contractors (including Northrop Grumman,  Lockheed Martin, Raytheon and Boeing),
the U.S.  Government  (including the Department of Defense,  NASA and other U.S.
Government  agencies)  and  international  customers  (including  the  Egyptian,
German,  Japanese and South Korean  militaries  and  suppliers to  international
militaries).  We are a leading  provider of  microwave  technologies  for use in
command  and  control  systems,  flight  instrumentation,  weapons  sensors  and
electronic  warfare  systems.  We have served the defense industry since 1965 by
designing and manufacturing microwave devices for use in high technology defense
electronics  applications.  Our products and systems are currently deployed on a
wide range of high profile military  platforms,  including the F-16 Falcon,  the
F/A-18E/F  Super Hornet,  the RC-135 Rivet Joint,  the E-2C  Hawkeye,  the AEGIS
class surface combatants,  the EA-6B Prowler, the AMRAAM air to air missile, and
unmanned aerial vehicles  ("UAVs"),  as well as high priority  national security
programs such as National Missile Defense and the Trident II D-5.

Significant Events

In  connection  with  the  legal  matter  discussed  in Part I,  Item 3.  "Legal
Proceedings,"  we were  notified on June 9, 2006 that certain of our  operations
were suspended from receiving new contract awards from the U.S. Government.  The
affected  operations  include  facilities  in Lancaster,  Pennsylvania;  Woburn,
Massachusetts;  Chicago,  Illinois and our subsidiary in Farmingdale,  New York.
The Chicago,  Illinois location is a two-person  marketing office. The result of
this suspension was that these  facilities could not be solicited for or awarded
new contracts or contract  extensions  without special  exceptions,  pending the
outcome  of the  legal  proceedings.  The  suspended  facilities  could  receive
contract awards or subcontracts  from the Federal  Government if the head of the
agency stated in writing the compelling  reason to do so. A significant  portion
of our business is received where we are the only qualified supplier on critical
defense programs.

Effective October 12, 2006, we entered into an Administrative Agreement with the
Department of the Navy, on behalf of the Department of the Defense that required
us, among other  things,  to  implement a  comprehensive  program of  compliance
reviews,  audits and reports for a period of three years or until  settlement or
adjudication of the legal matter  referenced above,  whichever is later,  unless
shortened or extended by written agreement of the parties. In addition,  we were
required to sever our relationship with Mr. Lee N. Blatt, former Chairman of the
Board of  Directors,  as our employee or  consultant.  In return,  the Navy,  on
behalf of the  Department of Defense has terminated our suspension and debarment
from receiving new contract awards from the U.S. Government.

Our  facilities  which were not included in the action and who were at all times
free to contract with the U.S.  Government are our  facilities in Whippany,  New
Jersey (Herley-CTI);  Jerusalem  (Herley-Israel);  McLean,  Virginia (Innovative
Concepts, Inc.); Fort Walton Beach, Florida (Micro Systems, Inc. and Herley-RSS)
and Farnborough, U.K. (EW Simulation Technology, Limited).

Effective   October  12,  2006  and  as  a  condition   to  entering   into  the
Administrative Agreement with the Department of the Navy noted above, we entered
into  an  agreement  (the  "Agreement")  with  Lee N.  Blatt  to  terminate  his
Employment  Agreement with us dated as of July 29, 2002 and modified on December
9,  2003.  Under the terms of the  Agreement  Mr.  Blatt will  receive  payments
totaling  $9,461,528 payable $3,000,000 upon the effective date of the Agreement
and  sixty-four  (64)  consecutive  monthly  payments of $100,000  commencing on
January 1, 2007 and a final  payment of $61,528 on May 1, 2012 as evidenced by a
non-interest   bearing   Promissory  Note  dated  effective   October  12,  2006
("Promissory  Note").  In addition  Mr. Blatt will receive his bonus of $636,503
for  fiscal  year  2006,   and  shall  be  entitled  to  receive   medical  care
reimbursement  and insurance,  including life insurance,  in accordance with the
original terms of his Employment Agreement. The Agreement also provides that all
outstanding  stock options  previously  issued to Mr. Blatt which are all vested
and fully  exercisable shall continue to be exercisable by him or, following his
death, by his designated beneficiaries,  on or before the expiration date of the
specific  option.  On  September  26, 2006,  as required  under the terms of the
Administrative  Agreement with the Department of the Navy, Mr Blatt entered into
a voting trust  agreement  wherein  sole voting power to 1,301,000  shares under
stock options held by Mr. Blatt and 28,799 shares held in his IRA was granted to
our  Chairman,  Myron Levy.  In the event of a "change of control" as defined in
the Employment  Agreement all remaining  payments due under the Promissory  Note
become immediately due and payable.  Costs in connection with the Agreement will
be recorded in our consolidated  financial statements in the first quarter ended
October 29, 2006.

In June 2006, in connection  with the legal matter noted above,  we were advised
by BDO SEIDMAN, LLP ("BDO"), our then independent registered public accountants,
that,  due  to  their  need  to  conduct  an  independent  investigation  of the
allegations in the indictment by outside counsel, BDO was unable to complete its
review of the interim  consolidated  financial  statements for the quarter ended
April 30, 2006 by the due date of our Form 10-Q in accordance  with  established
professional   standards  and  procedures  for  conducting  such  reviews.   BDO
subsequently  on July  27,  2006  informed  us that  they  had  resigned  as our
auditors.  In addition,  by letter dated August 14, 2006 BDO informed us that it

                                       19
<PAGE>
was  withdrawing  its opinion on our  financial  statements  for the fiscal year
ended July 31, 2005.

At a meeting held on July 27, 2006, our Audit Committee accepted the resignation
of BDO and approved the  engagement of Marcum & Kliegman LLP as our  independent
registered  public  accountants.  In  addition,  on  August  16,  2006 the Audit
Committee  approved the  engagement  of Marcum & Kliegman LLP to also act as its
independent  auditors  for the fiscal  years  ended July 31,  2005 and August 1,
2004.

By letter dated June 16, 2006, we received written notification from Nasdaq that
since the Form 10-Q filed by us on June 14,  2006 had not been  reviewed  by our
accountants  and did not include  the  required  certifications,  we were not in
compliance with  Marketplace  Rule 4310(c) (14).  Accordingly,  we were informed
that our securities would be delisted from The Nasdaq Stock Market.  On June 22,
2006,  we requested a hearing  which was held on August 3, 2006. By letter dated
August 16, 2006, we received written  notification  from Nasdaq that our request
for continued  listing on The Nasdaq Stock Market had been  granted,  subject to
our filing of a complete  amended Form 10-Q by September  15, 2006. We filed the
required  amended Form 10-Q on  September  14,  2006.  On September  18, 2006 we
received  written  notification  from  Nasdaq  that  since  we had  demonstrated
compliance with all Nasdaq Marketplace Rules our securities would continue to be
listed on The Nasdaq Global Market.

On June 15,  2006 we  announced a  resumption  of the stock  repurchase  program
initially  announced in October  2002  covering  1,000,000  shares of our common
stock and  subsequently  expanded on May 30, 2003 to cover  2,000,000  shares of
common  stock.  As of October 13, 2006 we had acquired  approximately  1,898,000
shares of common stock under this program of which 798,567  shares were acquired
during the fourth quarter of fiscal 2006 at an aggregate  cost of  approximately
$9,044,000.

Results of Operations

The  following  table sets forth for the  periods  indicated  certain  financial
information  derived from our  consolidated  statements of income expressed as a
percentage of net sales.  There can be no assurance  that trends in sales growth
or operating  results  will  continue in the future.
<TABLE>
<CAPTION>
                                                      52 weeks ended
                                          --------------------------------------
                                          July 30,       July 31,      August 1,
                                            2006           2005          2004
                                          -------        -------       --------
<S>                                        <C>            <C>            <C>
Net sales                                  100.0%         100.0%         100.0%
Cost of products sold                       72.6%          70.3%          65.1%
                                          -------        -------       --------
Gross profit                                27.4%          29.7%          34.9%

Selling and administrative expenses         19.8%          20.0%          18.9%
                                          -------        -------       --------
Income from operations                       7.6%           9.7%          16.0%
                                          -------        -------       --------
Other income (expense), net:
     Investment income                       0.5%           0.6%           0.6%
     Interest expense                       (0.2%)         (0.2%)         (0.3%)
     Foreign exchange gain (loss)            0.2%          (0.2%)         (0.1%)
                                          -------        -------       --------
                                             0.5%           0.2%           0.2%
                                          -------        -------       --------
Income before income taxes                   8.1%           9.9%          16.2%
Provision for income taxes                   2.3%           2.8%           5.0%
                                          -------        -------       --------
Net income                                   5.8%           7.1%          11.2%
                                          =======        =======       ========
</TABLE>
     Fiscal 2006 Compared to Fiscal 2005

Net sales for the fifty-two weeks ended July 30, 2006 were approximately  $176.3
million compared to $151.4 million for fiscal 2005, an increase of approximately
$24.9 million (16%).  Net sales  attributable to the acquisitions of MSI and ICI
completed  in the third  quarter of fiscal  2005  accounted  for an  increase of
approximately  $21.3  million  (14%)  in  net  sales.  We  also  experienced  an
approximate  $3.6 million  (2%) net  increase in sales at our other  operations,
most significantly as follows:

o    An increase in sales at our  Lancaster  operation  of $1.9  million,  which
     includes $2.2 million in revenue in connection with a claim due to customer
                                       20
<PAGE>
     delays and changes in specifications and designs under a major program,  as
     well  as an  increase  of  $3.0  million  in the  sales  of  Herley-Medical
     products.  These  increases  were  offset  by  reduced  sales  caused  by a
     reduction  in  scheduled  requirements  of  F18,  IFF,  AMRAAM  and  Meteor
     programs.

o    A net increase in sales at our  Herley-Israel  operation  of  approximately
     $1.7 million, primarily driven by an increase in development and production
     of  sophisticated  microwave  integrated  assemblies  for  military  use to
     various international customers.

Our  level  of  intercompany  sales,  which  are  eliminated  in  consolidation,
increased  to $10.0  million in fiscal 2006 from  approximately  $7.3 million in
fiscal 2005.

The gross profit margin for the fifty-two weeks ended July 30, 2006 was 27.4% as
compared to the margin of 29.7% in fiscal 2005, a decline of 2.3%.  The decrease
in gross profit margins is primarily attributable to the following:

o    Development costs on certain contracts in excess of billings to customers.
o    Engineering costs related to penetration into new military markets.
o    The transition of several new programs from engineering  development to the
     early stage of production,  with startup costs not yet offset by production
     revenues.
o    The  cumulative  effects of changes in contract  cost  estimates on certain
     programs   accounted  for  under  the  percentage   completion   method  of
     accounting.

Offset by

o    Higher gross margins  contributed by our foreign operations and at recently
     acquired businesses (MSI and ICI) from improved pricing, cost efficiencies,
     and product mix.

Selling and administrative  expenses for the fifty-two weeks ended July 30, 2006
were 19.8% of net sales as compared to 20.0% in fiscal  2005,  or an increase of
$4.7 million. Significant increases during the period included:

o    An increase  of  approximately  $4.1  million  attributable  to selling and
     administrative  expenses related to the two  acquisitions  completed in the
     third quarter of fiscal 2005 (MSI and ICI).
o    Stock compensation costs of $0.5 million in connection with the adoption of
     SFAS 123R as of August 1, 2005.

Legal expenses in fiscal 2006 were $2.3 million and were primarily  attributable
to legal costs associated with the  investigation  and subsequent  indictment by
the U.S.  Attorneys'  office in  Pennsylvania.  During fiscal 2005,  legal costs
incurred  were $2.7 million of which $1.8 million  relates to the  investigation
and the  balance  relates  primarily  to the  litigation  and  settlement  costs
involving  Robinson  Laboratories,  Inc. and Ben  Robinson  which was settled in
fiscal 2005.

We spent approximately  $17,000 in out-of-pocket  consulting fees in fiscal 2006
versus  $658,000 in  out-of-pocket  consulting fees in fiscal 2005 in connection
with our Sarbanes-Oxley Section 404 compliance program. The reduction in fees is
attributable to our establishment of an internal audit department and the use of
internal resources for compliance testing activities.

As a result of the above trends,  our operating  income for fiscal year 2006 was
$13,381,100  or 7.6% of net sales,  as  compared to  $14,669,000  or 9.7% of net
sales in fiscal 2005. Our foreign operations contributed $2,748,000 in operating
income for the year as compared to $872,000 in fiscal  2005.  Revenues  from our
foreign  operations  increased by  $1,550,000  as compared to fiscal  2005.  The
increase in revenue and  operating  income  within our  foreign  operations  was
primarily driven by improved performance at Herley-Israel.

Investment  income decreased by $95,000 in fiscal 2006 as a result of a decrease
on average  of  approximately  $27  million in excess  cash  reserves  invested,
attributable to cash used to fund the  acquisitions in fiscal 2005 (see Note B);
offset by an increase of 65% in the rate of interest earned on the investment of
excess cash  reserves and  increased  operating  cash  balances  during the 2006
fiscal year as compared to fiscal 2005.

The  effective  income  tax  rate  for both  fiscal  2006 and 2005 was 28%.  The
effective tax rate is lower than the statutory  income tax rate of 35% primarily
due to net  favorable  tax  benefits.  The largest  benefit in 2006 was due to a
lower  effective  tax  rate on  foreign  source  income,  and in 2005 due to the
recognition of multi-year  research and development tax credits realized.  Other
benefits included research and development credits (prior to December 31, 2005),
tax benefits  attributable to extra territorial  income (i.e. export sales), the
Section 199 manufacturing deduction and tax exempt interest income.

                                       21
<PAGE>
     Fiscal 2005 Compared to Fiscal 2004

Net  sales for the  fifty-two  weeks  ended  July 31,  2005  were  approximately
$151,415,000   compared  to  $122,154,000   for  fiscal  2004,  an  increase  of
approximately $29.3 million (24%). Net sales at our three acquisitions completed
in fiscal 2005 (RSS,  MSI and ICI),  accounted for an increase of  approximately
$22.3 million, or approximately three quarters of the increase for the fifty-two
weeks ended July 31, 2005.  Approximately $11.2 million of net sales increase is
attributable to CTI, which was  consolidated  into our results for only 4 months
in fiscal  2004,  versus a full 12 months in fiscal  2005.  In  addition to this
impact of a full year  results for CTI,  CTI has  experienced  growth of greater
than 20% in sales in the fourth quarter of fiscal 2005 as compared to the fourth
quarter of fiscal  2004,  principally  due to growth at CTI in sales of military
products in CTI's direct synthesizer products.

Other than these acquisition driven impacts,  our other divisions  experienced a
net decline in sales for the year. The largest decline occurred in our Lancaster
operation  with the  decline  in 2005  versus  2004 net  sales  being  primarily
attributable  to a reduction  in revenues  from the  Automatic  Carrier  Landing
System  ("ACLS")  program of $1.7  million  and a reduction  of $1.3  million in
foreign sales.

The ACLS  program was awarded in August 2001 and  included  three  options  over
three years. The third and final option was awarded in June 2005. The decline in
fiscal  year  2005  revenue  versus  fiscal  year  2004 is  attributable  to the
completion  of the second  year  option in fiscal 2005 prior to the award of the
third year option which is currently in production.

Our UK  subsidiary,  EWST,  experienced a reduction in revenue of  approximately
$1.8 million in fiscal 2005 versus fiscal 2004,  principally due to revisions to
(and increases in) estimated costs to complete certain contracts, which resulted
in a  reduction  in  revenue  recognized  on  these  contracts.  EWST  began  to
experience  technical  difficulties  under two contracts in 2004 which continued
into fiscal 2005 causing  delays in  completion  of the  contracts  and costs to
increase.  In both cases,  the primary reasons for costs increasing were changes
in  the  system  design  to  meet  customer  specifications  which  resulted  in
unanticipated  labor and material costs and subsequent  adjustments in the costs
to complete the projects.  There are no specific market trends or other customer
related issues accounting for the fluctuation in foreign revenues other than the
timing of  orders.  There are no  significant  changes in the  customer  base or
products  sold in fiscal 2005 versus  fiscal 2004.  Fifty percent of the foreign
revenue in fiscal 2004 came from three customers. Those same customers accounted
for twenty-eight percent of foreign revenue in fiscal 2005.

Our  level  of  intercompany  sales,  which  are  eliminated  in  consolidation,
increased  from  approximately  $6.1  million in fiscal 2004 to $7.3  million in
fiscal 2005.

The gross profit margin for the  fifty-two  weeks ended July 31, 2005 was 30% as
compared  to the  margin of 35% in fiscal  2004 a decline of 5%.  Excluding  the
impact of our three  acquisitions  completed in fiscal 2005 (RSS,  MSI and ICI),
the decline in gross  profit  margins  would have been  larger.  The decrease in
gross profit margins is primarily attributable to:

o    The transition of several new programs from engineering  development to the
     early stage of production,  with higher engineering costs not yet offset by
     production revenues.

o    Decreases of gross margins at EWST,  principally due to changes in contract
     cost  estimates at that  operation  versus  contract cost  estimates in the
     prior  fiscal year for the same  projects.  The  changes in  contract  cost
     estimates were principally due to unanticipated delays in meeting technical
     requirements and delivery dates on certain EWST contracts.

Offset by:

o    Higher  margins  contributed  by signal  generation  components  and direct
     sources, principally due to the fact that the prior year included only four
     months of results for CTI,  which was  acquired  effective  as of March 29,
     2004.

Selling and administrative  expenses for the fifty-two weeks ended July 31, 2005
were 20% of net sales as compared to 17% in fiscal 2004,  or an increase of $7.3
million. Large increases during the period included:

o    Increases  of  approximately   $4.0  million   attributable  to  our  three
     acquisitions completed in fiscal 2005 (RSS, MSI and ICI).

o    An increase of  approximately  $2.0  million due to the fact that the prior
     year only  included  four  months of results  for CTI,  which was  acquired
     effective as of March 29, 2004.

o    An  increase of  approximately  $935,000  in legal  costs  associated  with
     Robinson  Laboratories  and the  continuing  investigation  and  subsequent
     indictment by the U.S. Attorneys' office in Pennsylvania.

                                       22
<PAGE>
We spent approximately $658,000 in out of pocket consulting fees in fiscal 2005
in connection with our Sarbanes-Oxley Section 404 compliance program.

As a result of the above trends,  our Operating  Income for fiscal year 2005 was
$14,669,000 or 10% of net sales,  as compared to $19,602,000 or 16% of net sales
in fiscal 2004. Our foreign operations  contributed $872,000 in operating income
for the year as compared to $3,017,000 in fiscal 2004. Revenues from our foreign
operations  decreased  by  $1,319,000  as compared to fiscal  2004.  The drop in
revenue and operating income within our foreign  operations was due to revisions
in total cost estimates at our EWST subsidiary in the UK.

Investment  income  increased  by  $260,000 in fiscal 2005 as a result of an 89%
increase  in the rate of  interest  earned  on the  investment  of  excess  cash
reserves  during the 2005 fiscal  year as  compared to interest  rates in fiscal
2004,  and a  decrease  on  average  of  approximately  $27.5  million  in funds
invested.

The  effective  income tax rate for fiscal  2005 was 28% as  compared  to 31% in
fiscal 2004. The effective tax rate is lower than the statutory  income tax rate
of 35% in fiscal 2005 due to various favorable tax benefits. The largest benefit
was from the  recognition of multi year research and development tax credits now
being  realized.   Other  benefits  included  a  lower  effective  tax  rate  on
foreign-source  income,  the US tax benefits  attributable to extra  territorial
income (i.e. - export sales) and tax exempt interest income.

Liquidity and Capital Resources

As of July 30,  2006 and July 31,  2005,  working  capital was  $92,088,000  and
$88,343,000 respectively, and the ratio of current assets to current liabilities
was 3.8 to 1 for each period.

As is customary  in the defense  industry,  inventory  is partially  financed by
progress  payments.  In  addition,  it is customary  for us to receive  advanced
payments  from  customers  on major  contracts at the time a contract is entered
into.  The  un-liquidated  balance of the progress  payments  was  approximately
$2,573,000 at July 30, 2006,  and  $4,060,000  at July 31, 2005.  The balance of
advanced payments was approximately  $3,323,000 at July 30, 2006, and $1,888,000
at July 31, 2005.

Net cash  provided by operating  activities  was  approximately  $15,319,000  in
fiscal 2006 as compared to  $12,968,000  in 2005,  an increase of  approximately
$2.4  million.   Income  from   operations   (adjusted  for   depreciation   and
amortization)  was  $17,450,000  in fiscal 2006 as compared  to  $16,464,000  in
fiscal  2005,  an increase of  approximately  $1.0  million.  Significant  items
contributing  to the net  increase  in cash  provided  by  operating  activities
include the following:

o    A reduction of approximately $3.8 million in the amount of cash invested in
     "Costs incurred and income  recognized in excess of billings on uncompleted
     contracts."  The largest impact comes from  milestone  billings at our EWST
     facility in 2006.

o    A reduction of approximately $0.4 million in the amount of cash invested in
     inventories during fiscal 2006 versus fiscal 2005.

o    An increase of approximately $6.3 million in cash generated through advance
     payments from customers on contracts during the course of fiscal 2006.

o    An increase of  approximately  $1.6 million in cash generated from billings
     to  customers  in  excess  of  costs  incurred  and  income  recognized  on
     uncompleted contracts during the course of fiscal 2006.

Offset primarily by

o    A decrease of approximately  $5.9 million in cash generated from collection
     of accounts  receivable during fiscal 2006 versus fiscal 2005. The increase
     in cash  collections in fiscal 2005 resulted from collections for shipments
     under a major  contract at our  Lancaster  facility in  connection  with an
     upgrade for US Navy  aircraft.  This job was largely  shipped during fiscal
     2004 and early in fiscal 2005,  which resulted in increased  collections of
     accounts  receivable in the first quarter of fiscal 2005. Trade receivables
     increased in fiscal 2006 generally in relationship to the increase in sales
     volume.

o    A decrease of approximately $2.9 million resulting from payments to vendors
     and reductions in accrued expenses.

o    A reduction in income taxes payable of approximately $1 million.

                                       23
<PAGE>
Net cash used in investing activities includes:

o    Additional  payments of $1.3 million in connection with the Xytrans license
     of certain  technology to be used in missile and millimeter  wave products.
     (See Note A-8.)

o    Capital  expenditures of $6.2 million including  approximately $3.8 million
     invested in new equipment to further  automate and upgrade our product test
     facilities.

Net cash used in financing activities of $6.0 million results from the
following:

o    Proceeds from the exercise of stock options for $3.2 million.

o    The income tax benefit of $0.7 million in  connection  with the exercise of
     stock options.

Offset by

o    The purchase of 798,567  shares of treasury  stock in the fourth quarter of
     fiscal 2006 for approximately $9.0 million under a stock repurchase program
     initially  announced in October 2002  covering  1,000,000  shares of common
     stock and  subsequently  expanded on May 30, 2003 to cover 2,000,000 shares
     of common stock.

In June 2002, we entered into a new $50,000,000  Revolving Credit Loan Agreement
with two banks on an  unsecured  basis which may be used for  general  corporate
purposes,  including  business  acquisitions.   The  revolving  credit  facility
requires  the  payment of  interest  only on a monthly  basis and payment of the
outstanding  principal  balance on March 31, 2008 (as amended).  We may elect to
borrow up to a maximum of $5,000,000  with  interest  based on the Federal Funds
Target Rate plus a margin of 1.50% to 1.80%,  or up to a maximum of  $45,000,000
with  interest  based on LIBOR plus a margin of 1.35% to 1.65%.  The  applicable
incremental  margin is based on the ratio of total  liabilities  to tangible net
worth,  as those terms are defined in the  agreement.  The Federal  Funds Target
Rate and the LIBOR rate was 5.25% and  5.40%,  respectively,  at July 30,  2006.
There  is a fee of 15  basis  points  per  annum on the  unused  portion  of the
$45,000,000 LIBOR based portion of the credit facility payable quarterly. During
fiscal  2006,  we utilized the credit  facility  for short term working  capital
needs to the extent of $16.5 million. There were no borrowings outstanding under
the line at July 30,  2006 and July 31,  2005.  Stand-by  letters of credit were
outstanding in the amount of $10,285,000  under the credit  facility at July 30,
2006.

We believe that presently  anticipated future cash requirements will be provided
by  internally  generated  funds,  our existing  unsecured  credit  facility and
existing cash  reserves.  A  significant  portion of our revenue for fiscal 2006
will be generated from our existing backlog of sales orders.  The funded backlog
of orders at July 30, 2006 was approximately  $125 million.  All orders included
in backlog are covered by signed  contracts  or purchase  orders.  Nevertheless,
contracts  involving  government programs may be terminated at the discretion of
the  government.  In the event of the  cancellation  of a significant  amount of
government  contracts included in our backlog,  we will be required to rely more
heavily  on  cash  reserves  and  our  existing  credit  facility  to  fund  our
operations. We are not aware of any events which are reasonably likely to result
in  any  cancellation  of  our  government  contracts.   We  have  approximately
$39,715,000  available  under  our  bank  credit  facility,  net of  outstanding
stand-by  letters of credit of approximately  $10,285,000,  and cash reserves at
July 30, 2006 of approximately $22,303,000.

Contractual Obligations and Commitments

Our obligations and commitments to make future payments under contracts, such as
purchase  orders,   and  debt  and  lease   agreements,   and  under  contingent
commitments, such as stand-by letters of credit are as follows:

We have outstanding an aggregate of  approximately  $23,048,000 in open purchase
orders as of July 30,  2006.  These open  purchase  orders  represent  executory
contracts  for the  purchase of goods and services  which will be  substantially
fulfilled in the next six months.

                                       24
<PAGE>
The following table summarizes the Company's contractual obligations and other
contingent commitments, including interest, at July 30, 2006 (in thousands):

<TABLE>
<CAPTION>
                                                       Within         2-3          4-5        After 5
             Obligations                  Total        1 Year        Years        Years        Years
             -----------                  -----        ------        -----        -----        -----
     <S>                                 <C>          <C>          <C>          <C>          <C>
     Mortgage Note                       $  2,470     $    131     $  2,339     $    -       $    -
     Industrial Revenue Bonds               3,590          220          442          441        2,487
     Operating Lease Obligations           15,742        3,244        5,972        4,293        2,233
     Purchase Obligations                  23,048       22,284          740           24          -
                                           ------       ------       ------       ------       ------
                                           44,850       25,879        9,493        4,758        4,720
     Standby Letters of Credit             10,284        8,067          592          -          1,625
                                           ------       ------       ------       ------       ------
     Total Contractual Obligations       $ 55,134     $ 33,946     $ 10,085     $  4,758     $  6,345
                                           ======       ======       ======       ======       ======
</TABLE>

Effective   October  12,  2006  and  as  a  condition   to  entering   into  the
Administrative  Agreement with the Department of the Navy discussed earlier,  we
entered into an agreement (the  "Agreement")  with Lee N. Blatt to terminate the
Employment  Agreement  between us and Mr.  Blatt  dated as of July 29,  2002 and
modified on December 9, 2003.  Under the terms of the  Agreement  Mr. Blatt will
receive a total payment of $9,461,528 payable $3,000,000 upon the effective date
of the Agreement and sixty-four (64)  consecutive  monthly  payments of $100,000
commencing  on January 1, 2007 and a final  payment of $61,528 on May 1, 2012 as
evidenced by a non-interest  bearing Promissory Note dated effective October 12,
2006.  In addition  Mr. Blatt will receive his bonus of $636,503 for fiscal year
2006, and shall be entitled to receive medical care reimbursement and insurance,
including  life  insurance,  in  accordance  with  the  original  terms  of  his
Employment  Agreement.  The Agreement also provides that all  outstanding  stock
options  previously  issued  to  Mr.  Blatt  which  are  all  vested  and  fully
exercisable  shall continue to be exercisable by him or, following his death, by
his designated  beneficiaries,  on or before the expiration date of the specific
option.  In the event of a "change of  control"  as  defined  in the  Employment
Agreement  all  remaining   payments  due  under  the  Promissory   Note  become
immediately due and payable.

We have an employment  agreement with our Chairman/Chief  Executive Officer (the
"Executive")   which  expires  December  31,  2011,  subject  to  extension  for
additional one-year periods annually each January 1 with a final expiration date
of December 31, 2015. The agreement provides for an annual salary as of July 30,
2006 of $685,758 and provides for a semi-annual cost of living  adjustment based
on  the  consumer  price  index.  The  agreement  also  provides  for  incentive
compensation at 3% in the aggregate of our pretax income.

The agreement also provides that, in the event there is a change in control, the
Executive  has the option to  terminate  the  agreement  and  receive a lump-sum
payment  equal  to the  sum of the  salary  payable  for  the  remainder  of the
employment  term,  plus the annual  bonuses  (based on the  average of the three
highest annual bonuses awarded during the ten preceding years) for the remainder
of the employment  term. As of July 30, 2006, the amount payable in the event of
such termination would be approximately $7,592,000.

In addition,  the agreement provides for a consulting period of ten years at the
end of the employment period at an annual compensation equivalent to one-half of
the executive's  annual salary at the end of the employment  period,  subject to
annual cost of living adjustments.

In addition,  certain of our executive officers have employment agreements which
expire June 6, 2009 providing for aggregate  annual salaries as of July 30, 2006
of $590,000.

An employment  contract of a retired executive  provides for a consulting period
which became effective October 1, 1998, and terminates  December 31, 2010 at the
annual rate of compensation of $100,000.

Several of our officers and key employees  have severance  agreements  providing
for an aggregate lump-sum payment of approximately  $3,320,000 through September
30,  2008 in the event of a change of  control  as  defined  in the  agreements.
Several other employees have severance  agreements,  in the event of termination
of  employment  except for cause,  expiring at various  dates from December 2006
through February 2008, providing for an aggregate payment as of July 30, 2006 of
$1,910,000.

Recent Accounting Pronouncements

In September  2006, the Financial  Accounting  Standards  Board ("FASB")  issued
Statement  of  Financial  Accounting  Standards  ("SFAS")  No. 157,  "Fair Value
Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework
for  measuring  fair value in  generally  accepted  accounting  principles,  and
expands disclosures about fair value  measurements.  It codifies the definitions

                                       25
<PAGE>
of fair value included in other authoritative literature; clarifies and, in some
cases,  expands on the guidance for implementing  fair value  measurements;  and
increases the level of disclosure required for fair value measurements. Although
SFAS 157  applies to (and  amends)  the  provisions  of  existing  authoritative
literature, it does not, of itself, require any new fair value measurements, nor
does it  establish  valuation  standards.  SFAS 157 is effective  for  financial
statements  issued for fiscal years  beginning  after  November  15,  2007,  and
interim periods within those fiscal years.  This statement will be effective for
our fiscal year  beginning  August 2008. We will evaluate the impact of adopting
SFAS  157  but do  not  expect  that  it  will  have a  material  impact  on our
consolidated financial position, results of operations or cash flows.

In September  2006, the staff of the Securities and Exchange  Commission  issued
Staff  Accounting  Bulletin  No. 108 ("SAB  108")  which  provides  interpretive
guidance  on how  the  effects  of the  carryover  or  reversal  of  prior  year
misstatements  should be considered in quantifying a current year  misstatement.
SAB 108 becomes effective in fiscal 2007. Adoption of SAB 108 is not expected to
have a  material  impact on our  consolidated  financial  position,  results  of
operations or cash flows.

In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income  Taxes (as amended) - an  interpretation  of FASB  Statement  No. 109"
("FIN 48").  FIN 48 clarifies the  accounting  for  uncertainty  in income taxes
recognized in an enterprise's  financial  statements in accordance with SFAS No.
109,  "Accounting for Income Taxes," and prescribes a recognition  threshold and
measurement attribute for the financial statement recognition and measurement of
a tax  position  taken or  expected  to be taken  in a tax  return.  FIN 48 also
provides  guidance on  derecognition,  classification,  interest and  penalties,
accounting in interim  periods,  disclosure and transition.  FIN 48 is effective
for fiscal years  beginning  after  December 15, 2006.  We are in the process of
analyzing  the impact of FIN 48,  which is  required  to be adopted by the first
quarter of fiscal 2008.

In March  2006,  the FASB  issued SFAS No. 156,  "Accounting  for  Servicing  of
Financial  Assets,  an amendment of FASB Statements No. 140" ("SFAS 156").  SFAS
156 requires that  servicing  assets and servicing  liabilities be recognized at
fair value, if practicable,  when the Company enters into a servicing agreement.
This new  standard  will be  effective  as of the start of our first fiscal year
that begins after  September 15, 2006. We do not expect the adoption of SFAS 156
to have a material impact on our  consolidated  financial  position,  results of
operations or cash flows.

In February 2006, the FASB issued SFAS No. 155,  "Accounting  for Certain Hybrid
Financial Instruments" ("SFAS 155"), an amendment of SFAS Nos. 133 and 140. SFAS
155 permits a fair value remeasurement for any hybrid financial  instrument that
contains  an embedded  derivative  that  otherwise  would  require  bifurcation;
clarifies which interest-only  strips and principal-only  strips are not subject
to the  requirements  of Statement  133;  establishes a requirement  to evaluate
interests  in  securitized  financial  assets  to  identify  interests  that are
freestanding  derivatives or that are hybrid financial  instruments that contain
an embedded derivative requiring  bifurcation;  clarifies that concentrations of
credit  risk in the form of  subordination  are not  embedded  derivatives;  and
amends   Statement   140  to   eliminate   the   prohibition   on  a  qualifying
special-purpose  entity from  holding a  derivative  financial  instrument  that
pertains  to a  beneficial  interest  other than  another  derivative  financial
instrument.  This new standard will be effective  for all financial  instruments
acquired  or issued  after the  beginning  of our first  fiscal year that begins
after  September  15, 2006.  We do not expect the adoption of SFAS 155 to have a
material impact on our consolidated financial position, results of operations or
cash flows.

In May  2005,  the FASB  issued  SFAS No.  154,  "Accounting  Changes  and Error
Corrections"  ("SFAS  154").  SFAS 154 replaces  APB Opinion No. 20  "Accounting
Changes"  and SFAS No. 3  "Reporting  Accounting  Changes in  Interim  Financial
Statements."  SFAS 154 requires that a voluntary change in accounting  principle
be applied  retrospectively with all prior period financial statements presented
on the new accounting  principle,  unless it is impracticable to do so. SFAS 154
also  provides  that a  correction  of errors  in  previously  issued  financial
statements should be termed a "restatement." This new standard will be effective
for accounting changes and correction of errors for fiscal years beginning after
December  15,  2005.  We do not expect that the adoption of SFAS 154 will have a
material impact on our consolidated financial position, results of operations or
cash flows.

In March 2005,  the FASB  issued FASB  Interpretation  No. 47,  "Accounting  for
Conditional  Asset Retirement  Obligations - An Interpretation of SFAS No. 143."
This  Interpretation  provides  additional  guidance as to when companies should
record  the  fair  value  of a  liability  for a  conditional  asset  retirement
obligation  when  there  is  uncertainty  about  the  timing  and/or  method  of
settlement of the obligation. This Interpretation is effective no later than the
end of fiscal  years ending after  December  15, 2005.  Management  adopted this
Interpretation  effective July 30, 2006.  Adoption of FASB Interpretation No. 47
did not have a material impact on our consolidated  financial position,  results
of operations or cash flows.

In March of 2005, the SEC issued Staff Accounting Bulletin No. 107, "Share-Based
Payment"  ("SAB  107"),  which  provides  interpretive  guidance  related to the
interaction  between SFAS 123(R) and certain SEC rules and regulations,  as well
as provides the SEC staff's views regarding the valuation of share-based payment
arrangements. We have incorporated SAB 107 in the implementation and adoption of
SFAS 123(R).
                                       26
<PAGE>
In December 2004, the FASB issued SFAS No. 123(R),  "Share Based Payment," which
is a revision of SFAS No. 123,  "Accounting for Stock Based Compensation" ("SFAS
123(R)").  SFAS 123(R) is effective  for publicly  traded  companies  for annual
periods beginning after June 15, 2005,  supersedes  Accounting  Principles Board
Opinion No. 25,  "Accounting for Stock Issued to Employees," and amends SFAS No.
95,  "Statement  of Cash Flows."  Management  adopted this standard on August 1,
2005. See Note A-14 for a discussion of the impact on our consolidated financial
position, result of operations and cash flows upon adoption of SFAS 123(R).

Critical Accounting Policies and Estimates

Our  established  policies  are outlined in the  footnotes  to the  Consolidated
Financial  Statements  entitled  "Summary of  Significant  Accounting  Policies"
(contained  in Part II,  Item 8 of this  Form  10-K).  As part of our  oversight
responsibilities,  we  continually  evaluate  the  propriety  of our  accounting
methods as new events  occur.  We believe  that our  policies  are  applied in a
manner  which is  intended  to provide the user of our  financial  statements  a
current,  accurate and complete  presentation  of information in accordance with
accounting  principles  generally  accepted  in the  United  States of  America.
Important accounting practices that require the use of assumptions and judgments
are outlined below.

We generally  recognize revenue when products are shipped and the customer takes
ownership  and assumes risk of loss,  collection  of the relevant  receivable is
probable,  persuasive  evidence of an arrangement  exists and the sales price is
fixed or determinable.  Payments  received from customers in advance of products
delivered are recorded as customer advance payments until earned.  Approximately
94% of our customer  contracts are firm, fixed price contracts,  providing for a
predetermined  fixed  price  for the  products  sold,  regardless  of the  costs
incurred.  Approximately 11% to 14% of revenues over the last three fiscal years
were  derived  from  long-term,  fixed price  contracts  for which  revenues and
estimated  profits are recognized  using the percentage of completion  method of
accounting  based on estimated  completion  to date (the total  contract  amount
multiplied by the  percentage of  performance,  based on total costs incurred in
relation to total  estimated  cost at  completion).  Contract  costs include all
direct  material and labor costs and those  indirect  costs  related to contract
performance. Selling, general and administrative costs are charged to expense as
incurred.  Risks and  uncertainties  inherent in the  estimation  process  could
affect the amounts  reported in our financial  statements.  The key  assumptions
used in the  estimate  of costs to complete  relate to labor costs and  indirect
costs required to complete the contract. The estimate of rates and hours as well
as the  application  of overhead  costs is reviewed on a regular  basis.  If our
business conditions were different,  or if we used different  assumptions in the
application of this and other accounting policies,  it is likely that materially
different amounts would be reported on our financial statements.

Prospective losses on long-term  contracts are based upon the anticipated excess
of costs over the selling price of the  remaining  units to be delivered and are
recorded in the period when first determinable.  Actual losses could differ from
those estimated due to changes in the ultimate costs and contract terms.

Inventories  are stated at lower of cost  (principally  first-in,  first-out) or
market.  A  valuation  allowance  for  obsolete  and  slow-moving  inventory  is
established based upon an aging of raw material components. Current requirements
for raw materials are evaluated  based on current backlog of orders for products
in which the components are used and anticipated future orders.

Goodwill is tested for  impairment in accordance  with SFAS No. 142 using a fair
value  approach  applied  to our one  reporting  unit.  Impairment  charges  are
recognized  for amounts where the  reporting  unit's  goodwill  exceeds its fair
value.  An annual  impairment  test is performed  in the fourth  quarter of each
fiscal year. Any future impairment of goodwill will be charged to operations. We
amortize  the cost of other  intangibles  over  their  estimated  useful  lives.
Amortizable  intangible  assets may also be tested for impairment if indications
of impairment exist.

We  obtained a fair market  value  appraisal  of the  Company by an  independent
investment  banking firm.  Based on this  appraisal,  we have determined that no
impairment in the carrying value of goodwill and intangible  assets has occurred
at July 30, 2006.

Provisions for federal,  foreign, state and local income taxes are calculated on
reported  financial  statement  pretax  income based on current tax law and also
include  the  cumulative  effect of any  changes  in tax rates  from  those used
previously in determining  deferred tax assets and liabilities.  Such provisions
differ from the amounts  currently  payable  because certain items of income and
                                       27
<PAGE>
expense  are  recognized  in  different  time  periods for  financial  reporting
purposes than for income tax purposes.


Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk  associated  with  foreign  currency  exchange and
changes in interest  rates.  We have not entered into any market risk  sensitive
instruments for trading purposes.

Since the acquisitions of General Microwave Corporation and EWST, we are subject
to  movements in foreign  currency  rate changes  related to our  operations  in
Israel and in the U.K.  The  movements  in the  Israeli  Shekel  versus the U.S.
Dollar have not been  significant.  Movements in Pounds Sterling (the functional
currency at EWST) have been more significant.

For the fiscal years 2006, 2005 and 2004, EWST accounts for  approximately 4% to
8% of our  consolidated  net  sales,  based in part on the rate at which  EWST's
Sterling denominated financial statements have been converted into U.S. dollars.
Having a portion  of our  future  revenue  and income  denominated  in  Sterling
exposes us to market risk with respect to  fluctuations in the U.S. dollar value
of future  Sterling  denominated  revenue  and  earnings.  A 10%  decline in the
average value of Sterling in fiscal 2006, for example,  would have reduced sales
by approximately  $680,000,  and would have increased our consolidated operating
income by  approximately  $146,000 due to the reduction in the U.S. dollar value
of EWST's sales and operating loss. The average,  high and low foreign  currency
exchange rates during fiscal year 2006 were 1.79, 1.87 and 1.73 respectively.  A
10% decline in the average value of Sterling in fiscal 2005, for example,  would
have reduced  sales by  approximately  $735,000,  and would have  increased  our
consolidated  operating income by approximately $193,000 due to the reduction in
the U.S. dollar value of EWST's sales and operating loss. The average,  high and
low foreign currency  exchange rates during fiscal year 2005 were 1.85, 1.93 and
1.76 respectively.

We  have  made  inter-company  advances  to  EWST  in the  aggregate  amount  of
approximately  $7.6  million at July 30,  2006 that were  previously  considered
long-term advances.  Since the advances are denominated in U.S. Dollars and EWST
anticipates  reducing the amount of advances during fiscal year 2007, the amount
outstanding is subject to foreign exchange rate fluctuations.

In October  2001,  we entered into an interest rate swap with a bank pursuant to
which it exchanged floating rate interest in connection with the Bonds discussed
in Note H of the financial  statements on a notional  amount of $3,000,000 for a
fixed rate of 4.07% for a ten-year  period ending  October 1, 2011. The notional
amount  reduces  each year in tandem  with the  annual  installments  due on the
Bonds.  The fixing of the interest rate for this period  offsets our exposure to
the  uncertainty of floating  interest rates on the Bonds,  and as such has been
designated as a cash flow hedge.  The hedge is deemed to be highly effective and
any  ineffectiveness  will be  recognized  in interest  expense in the reporting
period.   The  fair  value  of  the  interest  rate  swap  was  a  liability  of
approximately  $30,000  as of  July  30,  2006.  There  was  no  material  hedge
ineffectiveness related to cash flow hedges during the fiscal years presented to
be recognized in earnings.

We also have a $50 million  Revolving Credit Loan Agreement with two banks on an
unsecured  basis which may be used for  general  corporate  purposes,  including
business  acquisitions.  The revolving  credit facility  requires the payment of
interest  only on a  monthly  basis and  payment  of the  outstanding  principal
balance on March 31, 2008.  We may elect to borrow up to a maximum of $5 million
with  interest  based on the Federal Funds Target Rate plus a margin of 1.50% to
1.80%,  or up to a maximum of $45 million  with  interest  based on LIBOR plus a
margin  of 1.35% to 1.65%.  The  applicable  incremental  margin is based on the
ratio of total  liabilities to tangible net worth, as those terms are defined in
the  Agreement.  The Federal  Funds Target Rate and the LIBOR rate was 5.25% and
5.40%, respectively,  at July 30, 2006. The credit line is reviewed on an annual
basis.

There were no borrowings  outstanding  under our revolving credit facility as of
July 30, 2006.

The table below provides information about our debt that is sensitive to changes
in interest  rates.  Future  principal  payment  cash flows by maturity  date as
required under the industrial  revenue bonds, and corresponding fair value is as
follows (in thousands):
<TABLE>
<CAPTION>
            Fiscal year ending                       Bonds
            ------------------                       -----
                  <S>                               <C>
                  2006                              $  115
                  2007                                 120
                  2008                                 125
                  2009                                 130
                  2010                                 135
                  2011 and later                     1,965
                                                   -------
                                                   $ 2,590
                                                   =======
                  Fair value                       $ 2,622
                                                   =======
</TABLE>
                                       28
<PAGE>
We do not  anticipate  any other  material  changes in our  primary  market risk
exposures in fiscal 2006.

Item 8.  Financial Statements and Supplementary Data

The financial  statements and supplementary data listed in the Index on Page F-1
are filed as a part of this report.

Item 9.  Changes in and Disagreements on Accounting and Financial Disclosure

Not applicable.

Item 9A.  Controls and Procedures

I.   Evaluation of Disclosure Controls and Procedures.

     Under  the  supervision  and  with  the  participation  of our  management,
     including  our principal  executive  officer  (Chairman of the  Board/Chief
     Executive  Officer) and principal  financial  officer  (Vice  President and
     Chief  Financial  Officer),  we have  evaluated  the  effectiveness  of our
     disclosure  controls  and  procedures  (as such  term is  defined  in Rules
     13a-15(e)  and  15d-15(e)  under the  Securities  Exchange Act of 1934,  as
     amended (the "Exchange Act")) as of July 30, 2006 (the "Evaluation  Date").
     Based on such evaluation, the principal executive officer and the principal
     financial  officer have  concluded  that, as of the  Evaluation  Date,  our
     disclosure  controls  and  procedures  are  effective,  and are  reasonably
     designed  to  ensure  that  all   material   information   (including   our
     consolidated  subsidiaries) required to be included in our reports filed or
     submitted  under the Exchange Act is recorded,  processed,  summarized  and
     reported  within the time  periods  specified in the rules and forms of the
     Securities and Exchange Commission.

     Our review of our  internal  controls  was made  within the  context of the
     relevant  professional  auditing standards  defining  "internal  controls,"
     "significant  deficiencies" and "material  weaknesses." "Internal controls"
     are  processes   designed  to  provide   reasonable   assurance   that  our
     transactions are properly  authorized,  our assets are safeguarded  against
     unauthorized or improper use, and our  transactions  are properly  recorded
     and reported,  all to permit the preparation of our consolidated  financial
     statements in conformity with accounting  principles  generally accepted in
     the United States. "Significant deficiencies" are control issues that could
     have a  significant  adverse  effect on our ability to  properly  authorize
     transactions; safeguard our assets; or record, process, summarize or report
     financial  data  in the  consolidated  financial  statements.  A  "material
     weakness" is a particularly serious reportable condition where the internal
     control  does  not  reduce  to  a  relatively   low  level  the  risk  that
     misstatements  caused by error or fraud may occur in amounts  that would be
     material in relation to the  consolidated  financial  statements and not be
     detected  within a timely  period  by  employees  in the  normal  course of
     performing  their  assigned  functions.  As part of our  internal  controls
     procedures, we also address other, less significant control matters that we
     identify, and we determine what revision or improvement to make, if any, in
     accordance with our on-going procedures.

II.  Changes in Internal Control over Financial Reporting.

     During the quarter ended July 30, 2006,  there were certain  changes in our
     internal  control over  financial  reporting  which  resulted  from control
     improvement  and  remediation  efforts.  These changes have not  materially
     affected,  and are not likely to materially  affect,  such internal control
     over financial reporting.

III. Management's Annual Report on Internal Control over Financial Reporting.

     We are responsible for  establishing  and maintaining an adequate  internal
     control structure and procedures over financial reporting. We have assessed
     the  effectiveness of internal control over financial  reporting as of July
     30, 2006.  Our  assessment was based on criteria set forth by the Committee
     of Sponsoring  Organizations  of the Treadway  Commission  (COSO)  Internal
     Control-Integrated Framework.

     Our internal  control  over  financial  reporting is a process  designed to
     provide  reasonable   assurance  regarding  the  reliability  of  financial
     reporting and the preparation of financial statements for external purposes
     in accordance with generally accepted accounting  principles.  Our internal
     control over  financial  reporting  includes  those policies and procedures
     that:
                                       29
<PAGE>
     (1)  pertain to the  maintenance  of records that,  in  reasonable  detail,
          accurately and fairly reflect our transactions and dispositions of our
          assets;

     (2)  provide  reasonable   assurance  that  transactions  are  recorded  as
          necessary to permit preparation of financial  statements in accordance
          with generally  accepted  accounting  principles in the United States,
          and  that  our  receipts  and  expenditures  are  being  made  only in
          accordance  with   authorizations  of  our  management  and  board  of
          directors; and

     (3)  provide reasonable  assurance regarding prevention or timely detection
          of  unauthorized  acquisition,  use or  disposition of our assets that
          could have a material effect on our financial statements.

     Because  of its  inherent  limitations,  internal  control  over  financial
     reporting may not prevent or detect all misstatements. Also, projections of
     any evaluation of  effectiveness  to future periods are subject to the risk
     that controls may become  inadequate  because of changes in conditions,  or
     that  the  degree  of  compliance  with  the  policies  or  procedures  may
     deteriorate.

     Based on the COSO criteria,  we believe our internal control over financial
     reporting as of July 30, 2006 was effective.

     Our  management's  assessment of the  effectiveness of our internal control
     over  financial  reporting as of July 30, 2006 has been audited by Marcum &
     Kliegman LLP,  independent  registered public accounting firm, as stated in
     their report which is included below.

     Important Considerations

     The  effectiveness  of our  disclosure  controls  and  procedures  and  our
     internal  control over financial  reporting is subject to various  inherent
     limitations, including cost limitations, judgments used in decision making,
     assumptions  about the  likelihood of future  events,  the soundness of our
     systems,  the  possibility of human error and the risk of fraud.  Moreover,
     projections  of any  evaluation  of  effectiveness  to future  periods  are
     subject to the risk that controls may become inadequate  because of changes
     in conditions  and the risk that the degree of compliance  with policies or
     procedures may deteriorate over time. Because of these  limitations,  there
     can be no assurance  that any system of disclosure  controls and procedures
     or  internal  control  over  financial  reporting  will  be  successful  in
     preventing all errors or fraud or in making all material  information known
     in a timely manner to the appropriate levels of management.

                                       30
<PAGE>
Report of Independent Registered Public Accounting Firm on Internal Control Over
Financial Reporting

To the Audit Committee of the
Board of Directors and Shareholders of
Herley Industries, Inc.

We  have  audited   management's   assessment,   included  in  the  accompanying
Management's  Annual Report on Internal Control over Financial  Reporting,  that
Herley Industries,  Inc. and Subsidiaries (the "Company")  maintained  effective
internal  controls  over  financial  reporting  as of July  30,  2006,  based on
criteria  established  in Internal  Control-Integrated  Framework  issued by the
Committee of Sponsoring Organizations of the Treadway Commission.  The Company's
management  is  responsible  for  maintaining  effective  internal  control over
financial  reporting  and for its  assessment of the  effectiveness  of internal
control over financial reporting. Our responsibility is to express an opinion on
management's  assessment  and an opinion on the  effectiveness  of the Company's
internal control over financial reporting based on our audit.

We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain  reasonable  assurance  about whether  effective
internal  control  over  financial  reporting  was  maintained  in all  material
respects. Our audit included obtaining an understanding of internal control over
financial reporting,  evaluating management's assessment, testing and evaluating
the  design  and  effectiveness  of  internal  control,   and  performing  other
procedures as we considered necessary in the circumstances.  We believe that our
audit provides a reasonable basis for our opinion.

A company's  internal control over financial  reporting is a process designed to
provide reasonable  assurance  regarding the reliability of financial  reporting
and the preparation of financial  statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial  reporting  includes those policies and procedures that (1) pertain to
the  maintenance  of records that, in reasonable  detail,  accurately and fairly
reflect the  transactions  and  dispositions  of the assets of the company;  (2)
provide  reasonable  assurance  that  transactions  are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that the receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company;  and (3) provide  reasonable  assurance  regarding  prevention  and
timely  detection  of  unauthorized  acquisition,  use,  or  disposition  of the
company's assets that could have a material effect on the financial statements.

Because of its inherent  limitations,  internal control over financial reporting
may not prevent or detect misstatements.  Also, projections of any evaluation to
future  periods  are  subject to the risk that  controls  may become  inadequate
because of  changes in  conditions,  or that the degree of  compliance  with the
policies or procedures may deteriorate.

In our opinion,  management's  assessment that the Company maintained  effective
internal control over financial  reporting as of July 30, 2006 is fairly stated,
in  all  material  respects,  based  on the  criteria  established  in  Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission.  Also in our opinion, the Company maintained, in all
material respects,  effective  internal controls over financial  reporting as of
July 30, 2006, based on the criteria established in Internal  Control-Integrated
Framework  issued by the Committee of Sponsoring  Organizations  of the Treadway
Commission.

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight Board (United States),  the consolidated balance sheets as
of July 30, 2006 and July 31, 2005 and the related  consolidated  statements  of
income, shareholders' equity, and cash flows and the related financial statement
schedule for the  fifty-two  (52) weeks ended July 30,  2006,  July 31, 2005 and
August 1, 2004 of the Company and our report dated October 27, 2006 expressed an
unqualified  opinion  on those  financial  statements  and  financial  statement
schedule.

/s/ Marcum & Kliegman LLP
-------------------------

Marcum & Kliegman LLP
Melville, New York
October 27, 2006

                                       31
<PAGE>
Item 9B.  Other Information

     Not applicable

PART III

Item 10.  Directors and Executive Officers of the Registrant

Directors of the Registrant
<TABLE>
<CAPTION>
                                                                                                        Director
                                                                                                        --------
         Name of Director                        Age      Principal Occupation                            Since
         ----------------                        ---      --------------------                          --------
<S>                                              <C>
  Myron Levy                                     66       Chairman of the Board
                                                          and Chief Executive Officer                     1992
  Rear Admiral Edward K. Walker, Jr. (Ret.)      73       Vice Chairman of the Board                      1997
  (1)(2)(3)
  Dr. Edward A. Bogucz (1) (3)                   50       Executive Director of the New York Center       2003
                                                          of Excellence in Environmental Systems
  Rear Admiral Robert M. Moore (Ret.) (1) (2)    67       Business and Financial Management Consultant    2003
  John A Thonet                                  56       President of Thonet Associates                  1991
  Carlos C. Campbell (2) (3)                     69       Business and Financial Management Consultant    2005
--------------------
(1)  Member of Compensation and Audit Committees
(2)  Member of Corporate Governance Committee
(3)  Member of Nominating Committee
</TABLE>

Mr. Myron Levy was appointed Chairman of the Board in June 2006 after serving as
Vice Chairman of the Board since August 2003,  and has been our Chief  Executive
Officer since August 2001.  Prior  thereto,  Mr. Levy served as President  since
June 1993, as Executive Vice President and Treasurer since May 1991, and as Vice
President for Business  Operations  and Treasurer  since October 1988.  For more
than ten years prior to joining  the  Company,  Mr.  Levy,  a  certified  public
accountant,   was   employed   in  various   executive   capacities,   including
Vice-President,  by Griffon  Corporation.  Mr Levy also  serves as a Director of
NetWolves Corporation.

Rear Admiral  Edward K. Walker,  Jr. (Ret.) was  appointed  Vice Chairman of the
Board in June 2006.  Rear  Admiral  Walker  served as the  Director of Corporate
Strategy for Resource Consultants, Inc., a privately held corporation supporting
the Department of Defense and other  government  agencies,  after his retirement
from the United States Navy in 1988 until 2000. Prior to his retirement from the
United  States Navy,  Rear Admiral  Walker  served for 34 years in various naval
officer positions,  including Commander of the Naval Supply Systems Command, and
Chief of Supply Corps. He holds a Bachelor's Degree from the United States Naval
Academy  and  Master's  Degree  in  Business   Administration  from  The  George
Washington University.

Dr. Edward A. Bogucz is currently  Executive  Director of the New York Center of
Excellence in  Environmental  Systems,  a  university-industry  consortium  that
includes 12  universities  and research  institutions.  Previously,  Dr.  Bogucz
served as Dean of Engineering and Computer  Science at Syracuse  University from
1995 through 2003.  Dean Bogucz earned his  bachelor's  and doctoral  degrees in
mechanical  engineering  from  Lehigh  University  and a  Master's  Degree  from
Imperial  College,  University  of London.  His teaching and research  expertise
includes  fluid   dynamics,   energy   systems,   computational   methods,   and
multidisciplinary  analysis and design. As Dean, he led the strengthening of the
College of Engineering and Computer Science in selected areas,  including RF and
microwave devices,  information  fusion,  systems  assurance,  and environmental
technologies.

Rear Admiral  Robert M. Moore (Ret.) is a consultant  in business and  financial
management.  He is a retired Rear Admiral,  U.S. Navy. His 35-year career in the
Navy culminated in his last assignment in charge of the Navy's  worldwide supply
system. He holds a Bachelor's Degree from the University of Texas and a Master's
Degree in Business Administration from Harvard University.

Mr. John A. Thonet has been  Secretary  since January 2003,  and is President of
Thonet  Associates,  an  environmental  consulting  firm  specializing  in  land
planning  and  zoning  matters,  for the  past  ten  years.  Mr.  Thonet  is the
son-in-law of Mr. Blatt.

Carlos C. Campbell operates a consulting business in Reston, Virginia and serves
on the Board of Directors for Resource America, Inc, NetWolves Corporation,  and
Pico Holdings,  Inc.,  all publicly  traded  companies.  He is a veteran of nine
years as a Naval Flight  Officer and served in the  Administration  of President
Reagan as the Assistant Secretary for Economic  Development,  U.S. Department of
Commerce.

                                       32
<PAGE>
Executive Officers of the Registrant
<TABLE>
<CAPTION>
         Name         Age      Position
         ----         ---      ---------
<S>                   <C>     <C>
Myron Levy            66       Chairman of the Board, Chief Executive Officer,
                               and Director
John M. Kelley        53       President
Kevin J. Purcell      48       Vice President and Chief Financial Officer
-------------
</TABLE>
John M. Kelley was appointed  President in August 2003,  and served as Executive
Vice President since July 2002. Prior thereto,  Mr. Kelley served as Senior Vice
President  since  July  2000  and  as  Vice   President/Director   of  Corporate
Communications  since  March 2000.  Mr.  Kelley  joined us in  December  1998 as
Director of Investor Relations.  Prior to joining Herley, Mr. Kelley had fifteen
years of banking  experience,  most recently  serving as Vice President at First
Capital  Bank.  Mr.  Kelley  earned his  Bachelor of Science  Degree in Business
Administration  from the  University  of Arizona,  Tucson, Arizona with Graduate
Degree Studies at UCLA.

Kevin J. Purcell was appointed  Vice  President and Chief  Financial  Officer in
June  2006.  Prior to  joining  Herley,  Mr.  Purcell  served as Vice  President
Finance,  Contracts and Compliance for Smiths Aerospace LLC,  Customer  Services
Americas.  Previously,  Mr. Purcell served other  companies in senior  financial
positions  including  Vice  President  and  CFO,  Controller  and  Director.  In
addition,  he worked for a number of years in the Government Contractor Advisory
Services  group of KPMG.  Mr.  Purcell  received his B.B.A.  degree in financial
accounting from Iona College and his M.B.A.  degree from Pepperdine  University.
He is a Certified Public Accountant and a Certified Management Accountant.

Committees of the Board of Directors

     Audit Committee and Audit Committee Financial Expert

The Board has a standing Audit Committee. The Board has affirmatively determined
that each director who serves on the Audit Committee is independent, as the term
is defined by applicable Nasdaq and Securities and Exchange  Commission  ("SEC")
rules. During 2006, the Audit Committee of the Board of Directors of the Company
consisted of Edward K. Walker (Chairman), Robert M. Moore, and Edward A. Bogucz.
The members of the audit committee have substantial  experience in assessing the
performance of companies,  gained as members of the Company's board of directors
and audit  committee,  as well as by  serving  in  various  capacities  in other
companies or governmental agencies. As a result, they each have an understanding
of financial  statements.  However,  none of them keep current on all aspects of
generally accepted accounting  principles.  Accordingly,  the board of directors
does not consider  any of them to be a financial  expert as that term is defined
in applicable  regulations.  Nevertheless,  the board of directors believes that
they competently  perform the functions required of them as members of the audit
committee and, given their backgrounds,  it would not be in the best interest of
the  Company to replace any of them with  another  person to qualify a member of
the audit committee as a financial expert.

The Audit  Committee  regularly  meets with our  independent  registered  public
accounting firm outside the presence of management.

     Compensation Committee

Our Compensation Committee annually establishes,  subject to the approval of the
Board of Directors and any applicable employment agreements,  the salaries which
will be paid to our executive  officers  during the coming year, and administers
our stock-based benefit plans. The Compensation  Committee currently consists of
Edward A. Bogucz, Chairman, Edward K. Walker and Robert M. Moore. Each member of
the Compensation Committee is a director who is not employed by us or any of our
affiliates, and our independent directors under NASDAQ listing standards.

     Nominating Committee

Our Nominating  Committee  currently  consisting of Carlos  Campbell,  Chairman,
Edward K. Walker, and Edward A. Bogucz, each of whom is an independent director,
identifies  individuals  qualified to become Board  members,  recommends  to the
Board  nominees to fill  vacancies in membership of the Board as they occur and,
prior to each Annual Meeting of Shareholders, recommends a slate of nominees for
election as Directors at such meeting.

     Corporate Governance Committee

Our Corporate  Governance  Committee,  currently  consisting of Robert M. Moore,
Chairman,  Edward K. Walker and Carlos Campbell,  each of whom is an independent
                                       33
<PAGE>
director,  monitors  developments in corporate  governance  principles and other
corporate governance matters and makes recommendations to the Board of Directors
regarding the adoption of additional corporate governance principles.

Compliance  with  Section  16(a)  of  The  Securities  Exchange  Act  of  1934 -
Beneficial Ownership Reporting Compliance

Section  16(a)  of the  Securities  Exchange  Act of  1934  requires  directors,
executive  officers and persons who beneficially own more than 10% of our common
stock  (collectively,  "Reporting Persons") to file initial reports of ownership
and reports of changes in ownership of our common stock with the  Securities and
Exchange  Commission.  Reporting  Persons  are  required by SEC  regulations  to
furnish us with copies of all Section 16(a) reports they file. To our knowledge,
based  solely on our review of the copies of such  reports  received  or written
representations  from  certain  Reporting  Persons  that no other  reports  were
required,  we believe that during  fiscal 2006,  all  Reporting  Persons  timely
complied with all applicable filing requirements.

Corporate Governance - Code of Ethics

We have adopted a Corporate Code of Business Ethics (the "Code") that applies to
all employees,  including our principal  executive officer,  principal financial
officer,  and  directors  of the  Company.  The Code is  broad  in scope  and is
intended to foster  honest and ethical  conduct,  including  accurate  financial
reporting,  compliance with laws and the like. If any substantive amendments are
make to the Code or if there is any  grant of  waiver,  including  any  implicit
waiver,  from a provision  of the Code to our Chief  Executive  Officer or Chief
Financial Officer,  we will disclose the nature of such amendment or waiver in a
report on Form 8-K.

Item 11.  Executive Compensation

The  following  table  sets forth the annual  and  long-term  compensation  with
respect to our  Chairman,  Chief  Executive  Officer,  and our other most highly
compensated  executive  officers other than the Chief Executive Officer who were
serving as executive  officers at the end of the last completed fiscal year, and
certain former executive officers as required under SEC rules (collectively, the
"Named  Executive  Officers")  for services  rendered for the fiscal years ended
July 30, 2006, July 31, 2005 and August 1, 2004.

                           Summary Compensation Table
<TABLE>
<CAPTION>
                               Annual Compensation (1)                           Long-Term Compensation
                     --------------------------------------------         -----------------------------------
Name and                                                                      Securities
Principal              Fiscal                                                 Underlying            All Other
Position               Year        Salary (2)        Bonus (3)                 Options             Compensation
--------               ------      ----------        ---------                ----------           ------------
<S>                     <C>       <C>                <C>                       <C>                 <C>
Lee N. Blatt            2006      $ 856,544          $  636,503                                    $    8,400 (5)
Former Chairman of      2005        824,830             650,131                200,000 (4)              6,150
the Board (6)           2004        787,950           1,207,680                                         6,500

Myron Levy              2006      $ 685,755          $  477,377                                    $   12,972 (5)
Chairman of             2005        660,363             487,598                200,000 (4)             10,722
the Board and           2004        630,851             987,010                                        11,072
Chief Executive
Officer (6)

John M. Kelley          2006      $ 250,016          $   25,000                                    $    9,228 (5)
President               2005        250,016                 -                   50,000 (4)              6,836
                        2004        227,884              35,000                                         6,741

William R. Wilson       2006      $ 240,011          $      -                                      $    9,948 (5)
Former Chief            2005        240,011                 -                   25,000 (4)              7,698
Operating Officer (7)   2004        214,528              80,000                                         8,048

Kevin J. Purcell        2006      $  29,616          $      -                   25,000 (4)          $       -
Chief Financial
Officer (8)
--------
<FN>
(1)  Does not  include  Other  Annual  Compensation  because  amounts of certain
     perquisites  and other non-cash  benefits  provided by us do not exceed the
     lesser of $50,000 or 10% of the total annual compensation disclosed in this
     table for the respective officer.
(2)  Amounts set forth  herein  include cost of living  adjustments  for Messrs.
     Blatt and Levy under employment contracts.
                                       34
<PAGE>
(3)  Represents  for  Messrs.  Blatt  and  Levy  incentive   compensation  under
     employment  agreements.  Bonuses for all other employees are  discretionary
     bonuses.
(4)  Consisting  of the following  options  issued in June 2006 for the right to
     purchase  our  Common  Stock at a price of  $19.38  to Kevin J.  Purcell  -
     25,000;  options  issued in May 2005 for the right to  purchase  our Common
     Stock at a price of $17.98:  Lee N. Blatt - 200,000,  Myron Levy - 200,000,
     John M. Kelley - 40,000, and William Wilson - 20,000; and options issued in
     December  2004 for the right to  purchase  our  Common  Stock at a price of
     $19.83: John M. Kelley - 10,000, and William R. Wilson - 5,000.
(5)  All Other Compensation  includes: (a) group term life insurance as follows:
     $4,572 for Mr. Levy,  $828 for Mr. Kelley,  and $1,548 for Mr. Wilson,  and
     (b) contributions to our 401(k) Plan as a pre-tax salary deferral of $8,400
     for each of Messrs. Blatt, Levy, Wilson, and Kelley.
(6)  Lee N. Blatt served as Chairman of the Board until his  resignation on June
     8, 2006.  On October 12, 2006 Mr. Blatt  accepted the terms of an agreement
     with  us  terminating  his  employment  agreement.  Following  Mr.  Blatt's
     resignation as Chairman of the Board, Myron Levy, former Vice Chairman, was
     elected Chairman and Adm. Edward K. Walker was named Vice Chairman.
(7)  Mr. Wilson served as Chief Operating Officer and Vice President from August
     2003 until  February  2006. On February 23, 2006 Mr. Wilson  entered into a
     consulting  agreement  with us effective  March 1, 2006 and  terminating on
     December 31, 2006.
(8)  Kevin Purcell was appointed Vice President and Chief  Financial  Officer on
     June 5, 2006 at an annual rate of compensation of $220,000.
</FN>
</TABLE>
Option Grants in Last Fiscal Year

The following table sets forth certain information concerning stock options
granted to the named executive officers during fiscal 2006.
<TABLE>
<CAPTION>
                                                      Individual Grants
                        ----------------------------------------------------------------------------------------------
                         Number of                                                     Potential Realized Value at
                        Securities      % of Total                                     Assumed Annual Rates of
                        Underlying    Options Issued    Exercise                       Stock Price Appreciation
                         Options      to Employees in    Price      Expiration                  Option Term (3)
Name                    Granted(1)    Fiscal Year(2)     ($/Sh)        Date             0%       5%          10%
----                    ----------    --------------     ------        ----             --       --          ---

<S>                       <C>               <C>         <C>           <C>             <C>       <C>        <C>
Kevin J. Purcell          25,000            32          $ 19.38       9/02/11         $ 0.00    $141,510   $314,764
--------
<FN>
(1)  Options  issued in fiscal  2006  were at 100% of the  closing  price of our
     common  stock on the date of issue  and vest as  follows:  one fifth of the
     options  vest  one  year  from  date of  grant  and  one  fifth  each  year
     thereafter.
(2)  Total options issued in fiscal 2006 to all employees were for 79,000 shares
     of common stock.
(3)  The amounts  under the columns  labeled  "5%" and "10%" are  included by us
     pursuant  to  certain  rules  promulgated  by the  Commission  and  are not
     intended  to  forecast  future  appreciation,  if any,  in the price of the
     common  stock.  Such  amounts  are based on the  assumption  that the named
     persons hold the options for the full term of the options. The actual value
     of the options will vary in accordance  with the market price of the common
     stock.  The column headed "0%" is included to demonstrate  that the options
     were  issued with an exercise  price  greater  than or equal to the trading
     price of the  Common  Stock so that the  holders  of the  options  will not
     recognize any gain without an increase in the stock price,  which  increase
     benefits all stockholders commensurately.
</FN>
</TABLE>
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values

     The following table sets forth stock options  exercised  during fiscal 2006
and all  unexercised  stock options held by the named  executive  officers as of
July 30, 2006.
<TABLE>
<CAPTION>
                                                                                       Value of Unexercised
                                                      Number of Unexercised                In the-Money
                       Shares                           Options at Fiscal                Options at Fiscal
                     Acquired on       Value                Year-End                       Year-End (2)
Name                 Exercise(#)  Realized($)(1)   Exercisable    Unexercisable    Exercisable    Unexercisable
----                 -----------  --------------   -----------    -------------    -----------    -------------
<S>                <C>             <C>              <C>              <C>             <C>              <C>
Lee N. Blatt          -                -            1,301,000          -             $ 869,198        -
Myron Levy            -                -            1,075,000          -               466,748        -
John M. Kelley     12,000          $ 131,708           87,000          -                27,150        -
William R. Wilson     -                -               45,000          -                  -           -
Kevin J. Purcell      -                -                  -          25,000               -           -

                                       35
<PAGE>
-------
<FN>
(1)  Values are  calculated by  subtracting  the exercise price from the trading
     price of the common stock as of the exercise date.
(2)  Based  upon the  closing  price of the  common  stock of $10.87 on July 30,
     2006.
</FN>
</TABLE>
Employment Agreements

     Lee N. Blatt entered into an employment agreement with us, dated as of July
29,  2002  which was to expire  December  31,  2011,  subject to  extension  for
additional one-year periods annually each January 1 with a final expiration date
of December 31, 2015 (as amended December 9, 2003).  The agreement  provided for
an  annual  salary  as of July  30,  2006  at the  rate  of  $856,542  and for a
semi-annual  cost of living  adjustment  based on the consumer price index.  The
agreement also provided for incentive compensation at 4% in the aggregate of our
pretax income. Incentive compensation earned for fiscal year ended July 30, 2006
was $636,503.  At the end of the employment period, the agreement provided for a
five-year  consulting  period  at an  annual  compensation  rate  equivalent  to
one-half of Mr.  Blatt's  annual  salary in effect at the end of the  employment
period,  subject to annual cost of living  adjustments.  Mr. Blatt's  employment
agreement was terminated  effective  October 12, 2006 as a condition to entering
into an administrative agreement with the Department of the Navy.

     Myron Levy entered into an employment  agreement  with us, dated as of July
29, 2002 which expires  December 31, 2011,  subject to extension for  additional
one-year  periods  annually  each  January  1 with a  final  expiration  date of
December 31, 2015 (as amended December 9, 2003).  The agreement  provides for an
annual  salary as of July 30, 2006 at the rate of $685,758  and  provides  for a
semi-annual  cost of living  adjustment  based on the consumer price index.  The
agreement also provides for incentive compensation at 3% in the aggregate of our
pretax income. Incentive compensation earned for fiscal year ended July 30, 2006
was $477,377.  At the end of the employment period, the agreement provides for a
ten-year consulting period at an annual compensation rate equivalent to one-half
of Mr.  Levy's  annual  salary in effect  at the end of the  employment  period,
subject to annual cost of living adjustments.

     The  employment  agreement  with Mr. Levy  provides  for  certain  payments
following  death or disability,  and also provides that, in the event there is a
change in control,  as defined, he has the option to terminate the agreement and
receive  a  lump-sum  payment  equal to the sum of the  salary  payable  for the
remainder  of the  employment  term,  plus the  annual  incentive  (based on the
average of the three highest annual  incentive  awarded during the ten preceding
years) for the remainder of the employment term. As of July 30, 2006, the amount
payable in the event of such termination would be approximately $7,592,000.

     John M. Kelley  entered into an employment  agreement  with us, dated as of
June 7, 2006 which expires June 6, 2009.  The  agreement  provides for an annual
salary as of July 30,  2006 at the rate of  $250,000,  subject  to review by the
Board of  Directors,  plus an  annual  bonus at the  discretion  of the Board of
Directors.  In addition,  Mr. Kelley has entered into a severance agreement with
us which  provides  that in the event of a change in our  control,  as  defined,
prior to September 30, 2008, he is entitled to two years' base salary.

     Kevin J. Purcell entered into an employment  agreement with us, dated as of
June 7, 2006 which expires June 6, 2009.  The  agreement  provides for an annual
salary as of July 30,  2006 at the rate of  $220,000,  subject  to review by the
Board of  Directors,  plus an  annual  bonus at the  discretion  of the Board of
Directors.  In addition, Mr. Purcell has entered into a severance agreement with
us which  provides  that in the event of a change in our  control,  as  defined,
prior to June 10, 2008, he is entitled to two years' base salary.

     Six other  officers have  severance  agreements  providing for an aggregate
lump sum  payment of  $1,980,000  through  September  30, 2008 in the event of a
change of control as defined in the agreements.

Directors' Compensation

     Directors who are our  employees  receive no  additional  compensation  for
serving as Directors.  Directors who are not our employees receive an annual fee
of  $15,000  and a fee of $1,500 for each  interim  board of  directors  meeting
attended.  The Corporate Governance Committee Chairman receives an annual fee of
$12,500,  and other members of the Corporate Governance Committee receive $5,000
annually.  The Audit Committee  Chairman receives an annual fee of $25,000,  and
other members of the Audit Committee receive $10,000 annually.  The Compensation
Committee  Chairman  receives an annual fee of $7,500,  and other members of the
Compensation   Committee  receive  $5,000  annually.  The  Nominating  Committee
Chairman  receives an annual fee of $7,500,  and other members of the Nominating
Committee  receive  $5,000  annually.  We also  reimburse  each Director for the
reasonable expenses incurred in attending meetings of the Board of Directors and
committee meetings.

                                       36
<PAGE>
Board of Directors Interlocks and Insider Participation

     In fiscal 2006,  our  Compensation  Committee  consisted  of Dr.  Edward A.
Bogucz,  and Messrs.  Edward K. Walker,  Jr., and Robert M. Moore. None of these
persons  were  our  officers  or  employees  during  fiscal  2006  nor  had  any
relationship requiring disclosures in this Annual Report.

Indemnification Agreements

     We have entered into separate indemnification  agreements with our officers
and directors.  We have agreed to provide indemnification with regard to certain
legal  proceedings so long as the  indemnified  officer or director has acted in
good  faith  and in a manner  he or she  reasonably  believed  to be in,  or not
opposed to, our best interests and with respect to any criminal proceeding,  had
no reasonable cause to believe his or her conduct was unlawful.  We only provide
indemnification  for expenses,  judgments,  fines and amounts paid in settlement
actually incurred by the relevant officer or director,  or on his or her behalf,
arising out of proceedings brought against such officer or director by reason of
his or her corporate status.

Item 12.  Security  Ownership of Certain  Beneficial  Owners and  Management and
     Related Stockholder Matters

     The following  table sets forth the  beneficial  ownership of shares of our
common  stock  as of  September  30,  2006 of (i)  each  person  known  by us to
beneficially  own 5% or more of the shares of  outstanding  common stock,  based
solely on filings with the Securities and Exchange Commission,  (ii) each of our
executive  officers and directors,  and (iii) all of our executive  officers and
directors as a group. Except as otherwise indicated, all shares are beneficially
owned, and investment and voting power is held by the persons named as owners.
<TABLE>
<CAPTION>
                                                           Common Stock                      % of Outstanding
Name of Beneficial Owner                            Beneficially Owned (1) (2)                   Shares
------------------------                            --------------------------            -----------------------
<S>                                                            <C>                                <C>
Myron Levy                                                     1,531,615                          10.3%
John M. Kelley                                                   104,423                            *
Kevin J. Purcell (3)                                              -                                 *
Carlos C. Campbell                                                25,000                            *
John A. Thonet (4)                                               118,038                            *
Adm. Edward K. Walker, Jr. (Ret.)                                 58,500                            *
Dr. Edward A. Bogucz                                              25,075                            *
Adm. Robert M. Moore (Ret.)                                       25,000                            *
Lee N. Blatt (5)                                               1,598,898                          10.5%
Dimensional Fund Advisors, Inc. (6)                            1,206,050                           8.7%
Lotsoff Capital Management (7)                                   880,707                           6.4%
Third Avenue Management, Inc. (8)                              1,774,147                          12.8%
Directors and executive
  officers  as a group
  (8 persons)                                                  1,887,651                          12.4%
<FN>
---------
 * Indicates ownership of less than one percent.

(1)  No officer or director owns more than one percent of the outstanding shares
     of common stock  unless  otherwise  indicated.  Ownership  represents  sole
     voting and investment power.
(2)  Includes beneficial ownership of the following number of shares that may be
     acquired  within 60 days of September  30, 2006  pursuant to stock  options
     awarded under our stock option plans:
</FN>
</TABLE>
<TABLE>
              <S>                           <C>               <C>                                    <C>
              Myron Levy                    1,075,000         Adm. Edward K. Walker, Jr.                57,000
              John M. Kelley                   87,000         Dr. Edward A. Bogucz                      25,000
              Carlos C. Campbell               25,000         Adm. Robert M. Moore                      25,000
              John A. Thonet                   97,500         Directors and executive
                                                               officers as a group                   1,391,500
</TABLE>
(3)  Mr.  Purcell was appointed Vice  President and Chief  Financial  Officer in
     June 2006.
(4)  Does not include 155,998 shares, owned by Mr. Thonet's children, Hannah and
     Rebecca  Thonet,  and 31,287 shares owned by his wife,  Kathi  Thonet.  Mr.
     Thonet disclaims beneficial ownership of these shares.
(5)  Includes  beneficial  ownership  of  1,301,000  shares that may be acquired
     within 60 days of  September  30, 2006  pursuant to stock  options  awarded
     under our  stock  option  plans,  172,300  shares  held in the name of Mrs.
     Blatt,  96,799 shares held in the Blatt Family  Charitable Trust and 28,799
     shares  held in Mr.  Blatt's  individual  retirement  account  ("IRA").  On
     September  26,  2006,  as  required  under the terms of the  Administrative
     Agreement  with the  Department of the Navy, Mr Blatt entered into a voting

                                       37
<PAGE>
     trust  agreement  wherein sole voting power to the  1,301,000  shares under
     stock  options held by Mr. Blatt and the 28,799  shares held in his IRA was
     granted to our  Chairman,  Myron Levy. Does not  include an  aggregate  of
     431,773 shares owned by family members,  including  Hannah Thonet,  Rebecca
     Thonet, Kathi Thonet, Randi Rossignol,  Max Rossignol,  Henry Rossignol and
     Allyson Brenner, of which Mr. Blatt disclaims beneficial ownership.
(6)  Address is 1299 Ocean Avenue, Santa Monica, CA 90401.
(7)  Address is 20 North Clark Street, 34th Floor, Chicago, IL 60602.
(8)  Address is 622 Third Avenue, New York, NY 10017

Equity Compensation Plan Information

     The  following  table sets forth the indicated  information  as of July 30,
2006 with respect to our equity compensation plans:
<TABLE>
<CAPTION>
                                                                                                  (c)
                                               (a)                                       Number of securities
                                              Number                                     Remaining available
                                          of securities                  (b)             for future issuance
                                         to be issued upon       Weighted-average            under equity
                                            exercise of          exercise price of        compensation plans
                                       outstanding options,    outstanding options,      (excluding securities
Plan category                           warrants and rights     warrants and rights    reflected in column (a))
-------------                           -------------------     -------------------    ------------------------
<S>                                            <C>                       <C>                          <C>
Equity compensation
Plans approved by
security holders                               2,481,273                 13.19                        25,779

Equity compensation
plans not approved
by security holders                            1,008,807                 18.24                       218,700

Total                                          3,490,080                 14.65                       244,479
</TABLE>
         The following information is provided about our stock option plans:

     2006 New Employee  Stock Option  Plan.  The 2006 New Employee  Stock Option
Plan covers 250,000 shares of common stock.  Options  granted under the plan are
non-qualified stock options. Under the terms of the plan, the exercise price for
options  granted  under  the plan will be the fair  market  value at the date of
grant.  The nature and terms of the options to be granted are  determined at the
time of grant by the  compensation  committee  or the  board of  directors.  The
options  expire no later  than ten  years  from the date of  grant,  subject  to
certain  restrictions.  Options for 33,000 shares were granted during the fiscal
year ended July 30, 2006 and are outstanding at July 30, 2006.

     2003 Stock Option Plan. The 2003 Stock Option Plan covers  1,000,000 shares
of common stock. Options granted under the plan are non-qualified stock options.
Under the terms of the plan,  the exercise  price of options  granted  under the
plan will be the fair market value at the date of grant. The nature and terms of
the  options  to be  granted  are  determined  at  the  time  of  grant  by  the
compensation committee or the board of directors. If not specified,  100% of the
shares can be exercised one year after the date of grant. The options expire not
later  than ten years from the date of grant,  subject to certain  restrictions.
Options for 16,300  shares were  granted  under this plan during the fiscal year
ended July 30, 2006.  At July 30, 2006,  options to purchase  968,600  shares of
common stock were outstanding under this plan.

     2000 Stock Option Plan. The 2000 Stock Option Plan covers  1,500,000 shares
of common stock. Options granted under the plan are non-qualified stock options.
Under the terms of the plan,  the exercise  price of options  granted  under the
plan will be the fair market value at the date of grant. The nature and terms of
the  options  to be  granted  are  determined  at  the  time  of  grant  by  the
compensation committee or the board of directors. If not specified,  100% of the
shares can be exercised one year after the date of grant. The options expire not
later  than ten years from the date of grant,  subject to certain  restrictions.
Options for 18,000  shares were  granted  under this plan during the fiscal year
ended July 30, 2006. At July 30, 2006,  options to purchase  1,290,900 shares of
common stock were outstanding under this plan.

     1998 Stock Option Plan. The 1998 Stock Option Plan covers  2,250,000 shares
of common stock.  Options  granted under the plan may be incentive stock options
qualified under Section 422 of the Internal Revenue Code of 1986, as amended, or
non-qualified stock options.  Under the terms of the plan, the exercise price of
options  granted  under  the plan will be the fair  market  value at the date of
grant.  Prices for incentive  stock options  granted to employees who own 10% or
more of our stock are at least  110% of market  value at the date of grant.  The
                                       38
<PAGE>
nature  and terms of the  options to be granted  are  determined  at the time of
grant by the compensation committee or the board of directors. If not specified,
100% of the  shares  can be  exercised  one year  after the date of  grant.  The
options  expire  not later  than ten years  from the date of grant,  subject  to
certain restrictions.  Non-qualified stock options for 9,000 shares were granted
under this plan during the fiscal year ended July 30,  2006.  At July 30,  2006,
options to purchase 1,032,292 shares of common stock were outstanding under this
plan.

     1997 Stock Option Plan. The 1997 Stock Option Plan covers  2,500,000 shares
of common stock.  Options  granted under the plan may be incentive stock options
qualified under Section 422 of the Internal Revenue Code of 1986, as amended, or
non-qualified stock options.  Under the terms of the plan, the exercise price of
options  granted  under  the plan will be the fair  market  value at the date of
grant.  Prices for incentive  stock options  granted to employees who own 10% or
more of our stock are at least  110% of market  value at the date of grant.  The
nature  and terms of the  options to be granted  are  determined  at the time of
grant by the compensation committee or the board of directors. If not specified,
100% of the  shares  can be  exercised  one year  after the date of  grant.  The
options  expire  not later  than ten years  from the date of grant,  subject  to
certain restrictions.  Non-qualified stock options for 2,700 shares were granted
under this plan during the fiscal year ended July 30,  2006.  At July 30,  2006,
options to purchase 158,081 shares of common stock were  outstanding  under this
plan.

     1996 Stock  Option  Plan.  The 1996 Stock Option Plan which has now expired
with respect to the granting of new options  covers  1,000,000  shares of common
stock.  Options which have been granted under the plan are  non-qualified  stock
options. Under the terms of the plan, the exercise prices of the options granted
under the plan were at the fair market  value at the date of grant.  The options
expire  not later  than ten  years  from the date of  grant.  At July 30,  2006,
non-qualified  options to purchase 7,007 shares of common stock were outstanding
under this plan.

Employee Savings Plan

     We maintain an Employee  Savings Plan ("Plan") which  qualified as a thrift
plan under Section  401(k) of the Internal  Revenue Code.  This Plan, as amended
and  restated,  allows  employees  to  contribute  between  2% and 30% of  their
salaries to the Plan. For the Plan year  beginning  August 1, 2005, the Plan was
amended to be considered a "Safe Harbor" plan, where a contribution will be made
to  eligible  participants  in an  amount  equal to 100% of the  amount  of each
participant's  elective  deferral that does not exceed 3% of compensation,  plus
50% of the amount of the elective deferral that exceeds 3% of compensation up to
a maximum  contribution of 5% of compensation.  Under the Safe Harbor provision,
all  contributions  are 100% vested when made.  Additional  contributions can be
made by us, depending on profits.  The aggregate  benefit payable to an employee
is dependent upon the employee's rate of contribution, the earnings of the fund,
and the length of time such employee  continues as a participant.  We recognized
expenses of approximately  $1,773,000 (including  approximately $727,000 related
to the acquisitions of MSI, ICI, and RSS), $1,038,000  (including  approximately
$268,000  related to the  acquisitions of MSI, ICI, and RSS), and $618,000 under
the Plan for the 52 weeks ended July 30, 2006, July 31, 2005 and August 1, 2004,
respectively.  For the year ended July 30, 2006, $8,400 was contributed by us to
this plan for each of Messrs.  Blatt,  Levy, Wilson, and for Mr. Kelley. A total
of $72,601 was contributed for all officers and directors as a group.

Item 13.  Certain Relationships and Related Transactions.

     Effective  October  12,  2006  and as a  condition  to  entering  into  the
Administrative  Agreement  with the  Department of the Navy (see Note A.1),  the
Company  entered  into an  agreement  (the  "Agreement")  with  Lee N.  Blatt to
terminate the Employment Agreement between the Company and Mr. Blatt dated as of
July 29, 2002 and modified on December 9, 2003. Under the terms of the Agreement
Mr. Blatt will receive a lump sum payment of $9,461,528  payable $3,000,000 upon
the effective  date of the Agreement and  sixty-four  (64)  consecutive  monthly
payments  of  $100,000  commencing  on  January  1, 2007 and a final  payment of
$61,528 on May 1, 2012 as evidenced by a Promissory Note dated effective October
12,  2006.  In addition  Mr. Blatt will receive his bonus of $636,503 for fiscal
year 2006,  and shall be  entitled to receive  medical  care  reimbursement  and
insurance,  including life  insurance,  in accordance with the original terms of
his Employment Agreement. The Agreement also provides that all outstanding stock
options  previously  issued  to  Mr.  Blatt  which  are  all  vested  and  fully
exercisable  shall continue to be exercisable by him or, following his death, by
his designated  beneficiaries,  on or before the expiration date of the specific
option.  In the event of a "change of  control" of the Company as defined in the
Employment Agreement all remaining payments due under the Promissory Note become
immediately due and payable.

     In connection  with the move of the Amityville  facilities of GMC in fiscal
1999,  the Company  entered into a 10 year lease  agreement  with a  partnership
owned by the children of certain officers of the Company. The lease provides for
initial minimum annual rent of $312,000  subject to escalation of  approximately
4%  annually  throughout  the 10 year term.  Additionally,  in March  2000,  The
Company  entered  into  another  10 year  lease  with the same  partnership  for
additional  space.  The  initial  minimum  annual  rent of $92,000 is subject to
escalation of approximately 4% annually.

                                       39
<PAGE>
Item 14.  Principal Accountant Fees and Services.

Marcum & Kliegman LLP is our independent  registered  public accounting firm and
performed the audit of our  consolidated  financial  statements for fiscal years
2006, 2005 and 2004. BDO SEIDMAN, LLP, our former independent  registered public
accounting  firm,  informed  us on July 27,  2006 that they had  resigned as our
auditors. In addition, by letter dated August 14, 2006 BDO informed us that they
were withdrawing  their opinion on our financial  statements for the fiscal year
ended July 31,  2005.  The  following  table sets forth  estimated  fees for the
audits of the fiscal  years ended July 30, 2006 and July 31, 2005  performed  by
Marcum & Kliegman LLP:
<TABLE>
<CAPTION>
                                              2006             2005
                                              ----             ----
                  <S>                     <C>               <C>
                  Audit Fees (1)          $ 475,000         $ 225,000
<FN>
---------------
(1)  Audit Fees includes fees for professional  services  provided in connection
     with the audits of our  financial  statements,  the review of our quarterly
     financial statements,  Sarbanes-Oxley 404 related services,  consents,  and
     audit services  provided in connection  with other  statutory or regulatory
     filings. All such services were pre-approved by the Audit Committee.
</FN>
</TABLE>
Marcum & Kliegman LLP was engaged on July 27,  2006,  and  accordingly,  did not
render any other services  during either 2006 or 2005. Fees for the audit of the
fiscal year ended August 1, 2004,  which was  performed  subsequent  to July 27,
2006, are estimated at $200,000.

The Audit Committee has sole authority to appoint, determine funding for, retain
and oversee our  independent  auditors and to pre-approve all audit services and
permissible non-audit services. The Audit Committee has delegated to Adm. Walker
the authority to pre-approve audit-related and non-audit services not prohibited
by law to be performed by our independent  registered public accounting firm and
associated  fees,  provided that he reports any pre-approval of audit-related or
non-audit  related  services  and fees to the full Audit  Committee  at its next
regular meeting.

Marcum  &  Kliegman  LLP  did not  render  any  services  related  to  financial
information systems design and implementation during fiscal years 2006 and 2005.

                                       40
<PAGE>
PART IV

Item 15.  Exhibits and Financial Statement Schedules

(a)  Exhibits

3.1  Certificate  of  Incorporation,  as  amended  (Exhibit  3(a)  of  Form  S-1
     Registration Statement No. 2-87160).
3.2  By-Laws, as amended  August 7, 2001 (Exhibit 3.2  of Annual Report  on Form
     10-K for the fiscal year ended July 29, 2001).
10.1 1996 Stock Option Plan  (Exhibit 10.1 of Annual Report on Form 10-K for the
     fiscal year ended July 28, 1996).
10.2 1997 Stock Option Plan  (Exhibit 10.1 of Report on Form 10-Q dated June 10,
     1997).
10.3 1998 Stock Option Plan  (Exhibit 10.3 of Annual Report on Form 10-K for the
     fiscal year ended August 1, 1999).
10.4 2000 Stock Option Plan (Exhibit 4.1 of Report on Form S-8 dated October 12,
     2001).
10.5 2003 Stock Option Plan  (Exhibit 10.1 of Report on Form 10-Q dated June 11,
     2003).
10.6 Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated
     as of July 29, 2002.  (Exhibit  10.5 of Annual  Report on Form 10-K for the
     fiscal year ended July 28, 2002).
10.7 Employment  Agreement between Herley Industries,  Inc. and Myron Levy dated
     as of July 29, 2002.  (Exhibit  10.6 of Annual  Report on Form 10-K for the
     fiscal year ended July 28, 2002).
10.8 Agreement  and Plan of  Reorganization  dated as of July 8, 1997  among the
     Company,   Metraplex  Acquisition  Corporation  and  Metraplex  Corporation
     (Exhibit 2.1 of Registration Statement Form S-3 dated September 4, 1997).
10.9 Agreement  and Plan of Merger  dated as of August 21,  1998  among  General
     Microwave  Corp.,  Eleven  General  Microwave  Corp.,   Shareholders,   GMC
     Acquisition  Corporation  and  Registrant  (Exhibit 1 of Schedule 13D dated
     August 28, 1998).
10.10 Lease Agreement dated September 1, 1999 between  Registrant and RSK Realty
     LTD.  (Exhibit 10.8 of Annual Report on Form 10-K for the fiscal year ended
     August 1, 1999).
10.11 Loan Agreement dated June 19, 2002 among the Registrant, Allfirst Bank and
     Fulton Bank.  (Exhibit  10.10 of Annual  Report on Form 10-K for the fiscal
     year ended July 28, 2002).
10.12 Amendment  (dated May 2, 2003) to Loan Agreement dated June 19, 2002 among
     the  Registrant,  Manufacturers  and Traders  Trust  Company,  successor in
     interest to Allfirst Bank, and Fulton Bank. (Exhibit 10.12 of Annual Report
     on Form 10-K for the fiscal year ended August 3, 2003).
10.13 Asset Purchase  Agreement dated as of February 1, 2000 between  Registrant
     and Robinson Laboratories,  Inc. (Exhibit 10.2 of Form 10-Q dated March 13,
     2000).
10.14 Asset Purchase  Agreement dated as of October 12, 2000 between  Registrant
     and American  Microwave  Technology  Inc.  (Exhibit 10.1 of Form 10-Q dated
     December 12, 2000).
10.15 Asset Purchase Agreement dated as of March 29, 2004 between Registrant and
     Communication Techniques, Inc. (Exhibit 10.15 of Annual Report on Form 10-K
     for the fiscal year ended August 1, 2004).
10.16 Lease Agreement dated March 1, 2000 between  Registrant and RSK Realty LTD
     (Exhibit 10.13 of Annual Report on Form 10-K for the fiscal year ended July
     30, 2000).
10.17 Common Stock  Purchase  Agreement  dated as of September  20, 2002 between
     Registrant and EW Simulation Technology,  Limited. (Exhibit 10.17 of Annual
     Report on Form 10-K for the fiscal year ended July 28, 2002).
10.18 Trust Indenture dated as of October 19, 2001 between Registrant,  and East
     Hempfield Township Industrial  Development  Authority and Allfirst Bank, as
     Trustee.  (Exhibit  10.18 of Annual Report on Form 10-K for the fiscal year
     ended July 28, 2002).
10.19 Amendment  (dated  April 2, 2004) to Loan  Agreement  dated June 19,  2002
     among the Registrant, Manufacturers and Traders Trust Company, successor in
     interest to Allfirst Bank, and Fulton Bank. (Exhibit 10.19 of Annual Report
     on Form 10-K for the fiscal year ended August 1, 2004).
10.20 Asset Purchase  Agreement dated as of September 1, 2004 between Registrant
     and Reliable System Services Corp.  (Exhibit 10.20 of Annual Report on Form
     10-K for the fiscal year ended August 1, 2004).
10.21 Amendment  dated December 9, 2003 to Employment  Agreement  between Herley
     Industries,  Inc. and Myron Levy dated as of July 29, 2002.  (Exhibit 10.21
     of Annual Report on Form 10-K for the fiscal year ended August 1, 2004).
10.22 Amendment  dated December 9, 2003 to Employment  Agreement  between Herley
     Industries, Inc. and Lee N. Blatt dated as of July 29, 2002. (Exhibit 10.22
     of Annual Report on Form 10-K for the fiscal year ended August 1, 2004).
10.23 Common  Stock  Purchase  Agreement  dated as of February  1, 2005  between
     Registrant and Micro Systems,  Inc.  (Exhibit 2.1 of Form 8K dated February
     7, 2005).
10.24 Common  Stock  Purchase  Agreement  dated as of  April  12,  2005  between
     Registrant  and  Innovative  Concepts,  Inc.  (Exhibit 2.1 of Form 8K dated
     April 18, 2005).
10.25 Amendment (dated June 9, 2005) to Loan Agreement dated June 19, 2002 among
     the  Registrant,  Manufacturers  and Traders  Trust  Company,  successor in
     interest to AllFirst  Bank,  and Fulton  Bank.  (Exhibit  10.1 of Form 10-Q
     dated June 10, 2005).
10.26 2006 New Employee Stock Option Plan.
10.27 Employment Agreement between Herley Industries, Inc. and John Kelley dated
     as of June 7, 2006.
                                       41
<PAGE>
10.28 Employment Agreement between Herley Industries,  Inc. and Kevin J. Purcell
     dated as of June 7, 2006. (Form 8-K dated June 8, 2006).
10.29 Amendment  (dated  March 9, 2006) to Loan  Agreement  dated June 19,  2002
     among the Registrant, Manufacturers and Traders Trust Company, successor in
     interest to AllFirst Bank, and Fulton Bank.
10.30 Administrative  Agreement between the Department of the Navy, on hehalf of
     the Department of Defense,  and Herley  Industries,  Inc.  (Exhibit 10.1 of
     Form 8K dated October 12, 2006).
10.31 Agreement  between  Herley  Industries,  Inc.  and Lee N. Blatt  effective
     October 12, 2006. (Exhibit 10.2 of Form 8K dated October 12, 2006).
23.1 Consent of Marcum & Kliegman LLP.
31.1 Certifications  pursuant to Rules 13a-14(a) as adopted  pursuant to Section
     302 of the Sarbanes-Oxley Act of 2002.
32.1 Certifications  pursuant to 18 U.S.C.  Section 1350 as adopted  pursuant to
     Section 906 of the Sarbanes-Oxley Act of 2002.

(b)  Financial Statements

     (1)  See Index to Consolidated Financial Statements at Page F-1.

     (2)  Schedule II - Valuation and Qualifying  Accounts filed as part of this
          Form 10-K at page 44.

                                       42
<PAGE>
SIGNATURES:

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on October 30, 2006.

                             HERLEY INDUSTRIES, INC.

                             By:           /S/ Myron Levy
                                            ------------------------------------
                                               Myron Levy, Chairman of the Board

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been  signed  below on  October  30,  2006 by the  following  persons in the
capacities indicated:


By:    /S/  Myron Levy                  Chairman of the Board,
   -----------------------------
      Myron Levy                        Chief Executive Officer and Director
                                        (Principal Executive Officer)

By:    /S/ Kevin J. Purcell             Vice President and
   -----------------------------
      Kevin J. Purcell                  Chief Financial Officer
                                        (Principal Financial Officer)

By:    /S/  John A. Thonet              Secretary and Director
   -----------------------------
      John A. Thonet

By:    /S/  Carlos C. Campbell          Director
   -----------------------------
      Carlos C. Campbell

By:    /S/  Edward K. Walker, Jr.       Director
   -----------------------------
      Edward K. Walker, Jr.

By:    /S/ Robert M. Moore              Director
   -----------------------------
      Robert M. Moore

By:    /S/ Edward A. Bogucz             Director
   -----------------------------
      Edward A. Bogucz

                                       43
<PAGE>

Schedule II - Valuation and Qualifying Accounts (in thousands)
<TABLE>
<CAPTION>
              Column A                  Column B           Column C                  Column D     Column E
              --------                  --------           Additions                  Amount     ----------
                                                    -------------------------        written
                                       Balance at   Charged to                         off       Balance at
                                        beginning    costs and                       against       end of
             Description                of period    expenses           Other        reserve       period
             -----------               ----------   ----------          -----        -------     ----------
<S>                                        <C>          <C>             <C>            <C>           <C>
Valuation accounts deducted
    from assets to which they
    apply:

July 30, 2006:
Inventory                                   $ 4,492     $ 1,475  $           -         $ 1,391       $ 4,576

July 31, 2005:
Inventory                                   $ 3,938       $ 804  $           -           $ 250       $ 4,492

August 1, 2004:
Inventory                                   $ 2,739       $ 859  $       1,241 (1)       $ 901       $ 3,938
<FN>
(1) Represents  valuation  reserves  acquired  through the acquisition of CTI of
$715 and a  reclassification  of $526  previously  included  as an offset in raw
material inventory.
</FN>
</TABLE>
All other  Schedules  have been omitted since they are either not required,  not
applicable,  or the  information is otherwise  included in this Annual Report on
Form 10-K.

                                       44
<PAGE>
Item 8.  Financial Statements and Supplementary Data


                             HERLEY INDUSTRIES, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                            Page

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                      F-2

FINANCIAL STATEMENTS:

 Consolidated Balance Sheets as of July 30, 2006 and July 31, 2005           F-3

 Consolidated Statements of Income for the fifty-two weeks ended
  July 30, 2006, July 31, 2005 and August 1, 2004                            F-4

 Consolidated Statements of Shareholders' Equity for the fifty-two weeks
  ended July 30, 2006, July 31, 2005 and August 1, 2004                      F-5

 Consolidated Statements of Cash Flows for the fifty-two weeks ended
  July 30, 2006, July 31, 2005 and August 1, 2004                            F-6

 Notes to Consolidated Financial Statements                                  F-7

                                     F-1

<PAGE>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Audit Committee of the
Board of Directors and Shareholders of
Herley Industries, Inc.

We  have  audited  the  accompanying   consolidated  balance  sheets  of  Herley
Industries,  Inc. and Subsidiaries  (the "Company") as of July 30, 2006 and July
31,  2005,  and the related  consolidated  statements  of income,  shareholders'
equity and cash flows for the fifty-two (52) weeks ended July 30, 2006, July 31,
2005 and August 1, 2004.  Our  audits  also  included  the  financial  statement
schedule as of and for the  fifty-two  (52) weeks ended July 30, 2006,  July 31,
2005 and  August 1, 2004  listed  in the  index at Item 15.  These  consolidated
financial  statements and financial statement schedule are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
consolidated  financial statements and financial statement schedule based on our
audits.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and  perform  the  audit  to  obtain  reasonable  assurance  about  whether  the
consolidated  financial statements are free of material  misstatement.  An audit
also includes  examining,  on a test basis,  evidence supporting the amounts and
disclosures in the financial  statements,  assessing the  accounting  principles
used and  significant  estimates made by  management,  as well as evaluating the
overall financial statement  presentation.  We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects,  the consolidated financial position of Herley
Industries, Inc. and Subsidiaries as of July 30, 2006 and July 31, 2005, and the
consolidated results of its operations and its cash flows for the fifty-two (52)
weeks ended July 30, 2006,  July 31, 2005 and August 1, 2004 in conformity  with
accounting principles generally accepted in the United States of America.  Also,
in our opinion,  the related financial  statement  schedule,  when considered in
relation  to the  basic  consolidated  financial  statements  taken  as a  whole
presents fairly, in all material aspects, the information set forth therein.

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight Board (United States),  the effectiveness of the Company's
internal  control over  financial  reporting  as of July 30, 2006,  based on the
criteria  established  in Internal  Control-Integrated  Framework  issued by the
Committee of Sponsoring  Organizations of the Treadway Commission and our report
dated,  October 27,  2006,  expressed  an  unqualified  opinion on  management's
assessment of the effectiveness of the Company's internal control over financial
reporting  and an  unqualified  opinion on the  effectiveness  of the  Company's
internal control over financial reporting.

/s/ Marcum & Kliegman LLP
-------------------------

Marcum & Kliegman LLP
Melville, New York
October 27, 2006


                                      F-2
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                        (In thousands, except share data)
<TABLE>
<CAPTION>
                                                                                         July 30,         July 31,
                                                                                          2006             2005
                                                                                       ------------     ------------
<S>                                                                                  <C>              <C>
                            ASSETS
Current Assets:
          Cash and cash equivalents                                                  $      22,303    $      20,331
          Trade accounts receivable                                                         30,600           27,258
          Costs incurred and income recognized in excess
             of billings on uncompleted contracts                                           13,926           16,058
          Other receivables                                                                    769            1,414
          Inventories, net                                                                  52,909           51,590
          Deferred income taxes and other                                                    4,932            3,782
                                                                                       ------------     ------------
                                   Total Current Assets                                    125,439          120,433
Property, Plant and Equipment, net                                                          30,478           29,461
Goodwill                                                                                    73,612           70,831
Intangibles, net of accumulated amortization of $3,468
          in 2006 and $1,680 in 2005                                                        19,989           20,554
Other Assets                                                                                 1,932              744
                                                                                       ------------     ------------
                                                                                     $     251,450    $     242,023
                                                                                       ============     ============
          LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
          Current portion of long-term debt                                          $         630    $         797
          Accounts payable and accrued expenses                                             21,503           23,678
          Billings in excess of costs incurred and
              income recognized on uncompleted contracts                                       555              538
          Income taxes payable                                                               3,395            3,760
          Accrual for contract losses                                                        2,959              630
          Accrual for warranty costs                                                           986              799
          Advance payments on contracts                                                      3,323            1,888
                                                                                       ------------     ------------
                                   Total Current Liabilities                                33,351           32,090
Long-term Debt                                                                               5,948            5,000
Other Long-term Liabilities                                                                  1,265            1,042
Deferred Income Taxes                                                                        7,416            6,254
                                                                                       ------------     ------------
                                                                                            47,980           44,386
                                                                                       ------------     ------------
Commitments and Contingencies
Shareholders' Equity:
          Common stock, $.10 par value; authorized 20,000,000 shares;
            issued 14,660,716 and outstanding 13,862,149 in 2006
            and issued and outstanding 14,389,625 in 2005                                    1,466            1,439
          Additional paid-in capital                                                       113,418          109,118
          Retained earnings                                                                 96,286           85,932
          Treasury stock, 798,567 common shares, at cost                                    (9,044)          -
          Accumulated other comprehensive income                                             1,344            1,148
                                                                                       ------------     ------------
                                   Total Shareholders' Equity                              203,470          197,637
                                                                                       ------------     ------------
                                                                                     $     251,450    $     242,023
                                                                                       ============     ============
</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                      F-3
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                      (In thousands except per share data)
<TABLE>
<CAPTION>

                                                                           Fifty-two weeks ended
                                                         ---------------------------------------------------------
                                                             July 30,            July 31,            August 1,
                                                               2006                2005                2004
                                                         -----------------    ----------------    ----------------
<S>                                                    <C>                  <C>                 <C>
Net sales                                              $          176,268   $         151,415   $         122,154
                                                         -----------------    ----------------    ----------------
Cost and expenses:
       Cost of products sold                                      127,921             106,441              79,505
       Selling and administrative expenses                         34,966              30,305              23,047
                                                         -----------------    ----------------    ----------------
                                                                  162,887             136,746             102,552
                                                         -----------------    ----------------    ----------------

       Income from operations                                      13,381              14,669              19,602
                                                         -----------------    ----------------    ----------------

Other income (expense), net:
       Investment income                                              840                 934                 674
       Interest expense                                              (319)               (286)               (326)
       Foreign exchange gain (loss)                                   431                (291)               (194)
                                                         -----------------    ----------------    ----------------
                                                                      952                 357                 154
                                                         -----------------    ----------------    ----------------

       Income before income taxes                                  14,333              15,026              19,756
Provision for income taxes                                          3,979               4,245               6,083
                                                         -----------------    ----------------    ----------------

       Net income                                      $           10,354   $          10,781   $          13,673
                                                         =================    ================    ================

Earnings per common share - Basic                      $       .72          $       .75         $       .97
                                                         =================    ================    ================

       Basic weighted average shares                          14,463              14,310              14,105
                                                         =================    ================    ================

Earnings per common share - Diluted                    $       .69          $       .72         $       .92
                                                         =================    ================    ================

       Diluted weighted average shares                        15,097              14,969              14,896
                                                         =================    ================    ================
</TABLE>

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

                                      F-4
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
    Fifty-two weeks ended July 30, 2006 and July 31, 2005, and August 1, 2004
                        (In thousands except share data)
<TABLE>
<CAPTION>
                                                                                                          Accumulated
                                                                     Additional                              Other
                                               Common Stock           Paid-in     Retained     Treasury   Comprehensive
                                           Shares        Amount       Capital     Earnings       Stock    Income (loss)   Total
                                         ------------   ----------   ----------   ----------   ---------- -------------  --------
<S>                                       <C>        <C>               <C>           <C>          <C>           <C>    <C>
Balance at August 3, 2003                 13,969,151 $      1,397      104,551       61,478           -          (184) $   167,242

Exercise of stock options                    251,357           25        2,433                                               2,458
Tax benefit upon exercise of stock options                                 687                                                 687
                                         ------------   ----------   ----------   ----------   ----------   ----------   ----------
     Subtotal                             14,220,508        1,422      107,671       61,478           -          (184)     170,387
                                                                                                                         ----------

Net income                                                                           13,673                                 13,673
Other comprehensive income (loss), net of tax:
    Unrealized gain on
        available-for-sale securities                                                                              49           49
   Unrealized (loss) on interest rate swap                                                                        (23)         (23)
   Foreign currency translation gain                                                                            1,414        1,414
                                                                                                                         ----------
Comprehensive income                                                                                                        15,113
                                         ------------   ----------   ----------   ----------   ----------   ----------   ----------
Balance at August 1, 2004                 14,220,508 $      1,422      107,671       75,151            -        1,256 $    185,500

Exercise of stock options                    329,349           33        3,501                                               3,534
Tax benefit upon exercise of stock options                                 658                                                 658
Purchase of 160,232 shares of treasury stock                                                      (2,728)                   (2,728)
Retirement of treasury shares               (160,232)         (16)      (2,712)                    2,728                     -
                                         ------------   ----------   ----------   ----------   ----------   ----------   ----------
     Subtotal                             14,389,625        1,439      109,118       75,151            -        1,256      186,964
                                                                                                                         ----------

Net income                                                                           10,781                                 10,781
Other comprehensive income (loss), net of tax:
    Unrealized (loss) on
        available-for-sale securities                                                                              (1)          (1)
   Unrealized gain on interest rate swap                                                                           18           18
   Foreign currency translation (loss)                                                                           (125)        (125)
                                                                                                                         ----------
Comprehensive income                                                                                                        10,673
                                         ------------   ----------   ----------   ----------   ----------   ----------   ----------
Balance at July 31, 2005                  14,389,625 $      1,439      109,118       85,932        -            1,148 $    197,637

Exercise of stock options                    271,091           27        3,144                                               3,171
Stock option compensation                                                  453                                                 453
Tax benefit upon exercise of stock options                                 703                                                 703
Purchase of 798,567 shares of treasury stock                                                      (9,044)                   (9,044)
                                         ------------   ----------   ----------   ----------   ----------   ----------   ----------
     Subtotal                             14,660,716        1,466      113,418       85,932       (9,044)       1,148      192,920
                                                                                                                         ----------

Net income                                                                           10,354                                 10,354
Other comprehensive income, net of tax:
   Unrealized gain on interest rate swap                                                                           33           33
   Foreign currency translation gain                                                                              163          163
                                                                                                                         ----------
Comprehensive income                                                                                                        10,550
                                         ------------   ----------   ----------   ----------   ----------   ----------   ----------

Balance at July 30, 2006                  14,660,716 $      1,466      113,418       96,286       (9,044)       1,344 $    203,470
                                         ============   ==========   ==========   ==========   ==========   ==========   ==========

</TABLE>
     The accompanying notes are an integral part of these consolidated financial
     statements.

                                      F-5
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
<TABLE>
<CAPTION>
                                                                  Fifty-two weeks ended
                                                                  ---------------------
                                                             July 30,    July 31,    August 1,
                                                               2006        2005        2004
                                                             ---------   ----------  ----------
<S>                                                       <C>         <C>          <C>
Cash flows from operating activities:
      Net Income                                          $    10,354 $     10,781 $    13,673
                                                             ---------   ----------  ----------
      Adjustments to reconcile net income to
         net cash provided by operating activities:
           Depreciation and amortization                        7,096        5,683       4,244
           Stock-based compensation expense                       453        -           -
           Excess tax benefit from exercises of
              stock options                                      (703)       -           -
           Foreign exchange (gain) loss                           (74)         (20)        753
           Inventory valuation reserve charges                  1,475          804         859
           Gain on sale of marketable securities                -              (22)      -
           Gain on sale of fixed assets                         -               (8)      -
           Equity in income of limited partnership                (52)         (54)        (10)
           (Increase) decrease in deferred tax assets            (959)         403        (316)
           Increase (decrease) in deferred tax liabilities      1,147        1,397        (109)
           Changes in operating assets and liabilities:
               Trade accounts receivable                       (3,342)       2,590      (6,923)
               Costs incurred and income recognized
                 in excess of billings on uncompleted
                 contracts                                      2,132       (1,626)     (7,250)
               Other receivables                                  645         (576)        251
               Inventories, net                                (2,794)      (2,515)     (6,665)
               Deferred income taxes and other                    157         (430)         31
               Accounts payable and accrued expenses           (1,988)         925       3,431
               Billings in excess of costs incurred and
                 income recognized on uncompleted contracts        17       (1,596)      1,303
               Income taxes payable                               338        2,306         108
               Accrual for contract losses                       (175)        (500)       (240)
               Advance payments on contracts                    1,435       (4,827)        324
               Other, net                                         157          253         146
                                                             ---------   ----------  ----------
                    Total adjustments                           4,965        2,187     (10,063)
                                                             ---------   ----------  ----------

           Net cash provided by operating activities           15,319       12,968       3,610
                                                             ---------   ----------  ----------

Cash flows from investing activities:
      Acquisition of businesses, net of cash acquired           -          (51,407)    (14,914)
      Acquisition of technology license                        (1,256)      (2,300)      -
      Proceeds from sale of securities                          -              165       -
      Proceeds from sale of fixed assets                        -               17          19
      Partial distribution from limited partnership               111          109          55
      Capital expenditures                                     (6,227)      (5,404)     (5,884)
                                                             ---------   ----------  ----------
           Net cash used in investing activities               (7,372)     (58,820)    (20,724)
                                                             ---------   ----------  ----------

Cash flows from financing activities:
      Borrowings under bank line of credit                     16,500        -           -
      Proceeds from exercise of stock options, net              3,171        3,534       2,458
      Excess tax benefit from exercises of stock options          703        -           -
      Payments of long-term debt                                 (805)        (804)       (686)
      Payments under bank line of credit                      (16,500)       -           -
      Purchase of treasury stock                               (9,044)      (2,728)      -
                                                             ---------   ----------  ----------
           Net cash (used in) provided by financing activities (5,975)           2       1,772
                                                             ---------   ----------  ----------

           Net increase (decrease) in cash and cash equivalents 1,972      (45,850)    (15,342)

Cash and cash equivalents at beginning of period               20,331       66,181      81,523
                                                             ---------   ----------  ----------

Cash and cash equivalents at end of period                $    22,303 $     20,331 $    66,181
                                                             =========   ==========  ==========
Supplemental cash flow information:
      Financing of computer software and maintenance      $     1,627
                                                             =========
</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements.
                                      F-6
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1.   Nature of Operations and Recent Events
     --------------------------------------
     The Company, a Delaware corporation,  is engaged in research,  engineering,
     product development, and manufacturing of complex microwave radio frequency
     (RF)  and  millimeter  wave  components  and  subsystems  for  defense  and
     commercial customers worldwide.

     In connection with the legal matter  discussed in Note F "Litigation,"  the
     Company was notified that certain of its operations had been suspended from
     receiving  new  contract  awards from the U. S.  Government.  The  affected
     operations   included  facilities  in  Lancaster,   Pennsylvania;   Woburn,
     Massachusetts;   Chicago,   Illinois  and  the   Company's   subsidiary  in
     Farmingdale,  New York.  The  Chicago,  Illinois  location is a  two-person
     marketing  office.  The result of this suspension was that these facilities
     were not  solicited  for or awarded new  contracts  or contract  extensions
     without special  exceptions,  pending the outcome of the legal proceedings.
     The  suspended  facilities  were  permitted to receive  contract  awards or
     subcontracts  from the Federal  Government if the head of the agency stated
     in writing the  compelling  reason to do so. A  significant  portion of the
     Company's  business is received  under  contracts  where the Company is the
     only qualified supplier on critical defense programs.

     Effective  October 12, 2006,  the Company  entered  into an  Administrative
     Agreement  with the  Department of the Navy, on behalf of the Department of
     the Defense that requires the Company,  among other things,  to implement a
     comprehensive  program of  compliance  reviews,  audits and  reports  for a
     period of three  years or until  settlement  or  adjudication  of the legal
     matter referenced above,  whichever is later,  unless shortened or extended
     by written agreement of the parties.  In addition,  the Company is required
     to sever its  relationship  with Mr. Lee N. Blatt,  former  Chairman of the
     Board of Directors, as an employee or consultant to the Company. In return,
     the  Navy,  on behalf of the  Department  of  Defense  has  terminated  the
     suspension and debarment of the Company from receiving new contract  awards
     from the U.S. Government.

     The Company's facilities which were not included in the action and who were
     free at all times to contract with the U.S.  Government  are our facilities
     in Whippany, New Jersey (Herley-CTI);  Jerusalem  (Herley-Israel);  McLean,
     Virginia  (Innovative  Concepts,  Inc.); Fort Walton Beach,  Florida (Micro
     Systems,  Inc.  and  Herley-RSS)  and  Farnborough,   U.K.  (EW  Simulation
     Technology, Limited).

     Effective  October  12,  2006  and as a  condition  to  entering  into  the
     Administrative  Agreement with the Department of the Navy noted above,  the
     Company  entered into an agreement (the  "Agreement")  with Lee N. Blatt to
     terminate the Employment  Agreement between the Company and Mr. Blatt dated
     as of July 29, 2002 and  modified  on December 9, 2003.  Under the terms of
     the Agreement Mr. Blatt will receive payments totaling  $9,461,528  payable
     $3,000,000  upon the effective  date of the Agreement and  sixty-four  (64)
     consecutive  monthly payments of $100,000 commencing on January 1, 2007 and
     a final  payment of $61,528 on May 1, 2012 as evidenced  by a  non-interest
     bearing  Promissory Note dated effective  October 12, 2006 (the "Promissory
     Note"). In addition Mr. Blatt will receive his bonus of $636,503 for fiscal
     year 2006, and shall be entitled to receive medical care  reimbursement and
     insurance,  including life insurance, in accordance with the original terms
     of  his  Employment  Agreement.   The  Agreement  also  provides  that  all
     outstanding  stock  options  previously  issued to Mr.  Blatt which are all
     vested and fully  exercisable  shall  continue to be exercisable by him or,
     following  his death,  by his  designated  beneficiaries,  on or before the
     expiration date of the specific option.  On September 26, 2006, as required
     under the terms of the Administrative  Agreement with the Department of the
     Navy,  Mr Blatt entered into a voting trust  agreement  wherein sole voting
     power to 1,301,000  shares under stock options held by Mr. Blatt and 28,799
     shares held in his IRA was granted to the Company's Chairman,  Myron Levy .
     In the event of a "change  of  control"  of the  Company  as defined in the
     Employment  Agreement all remaining  payments due under the Promissory Note
     become immediately due and payable.  Costs in connection with the Agreement
     will be recorded in the Company's  consolidated financial statements in the
     first quarter ended October 29, 2006.

     The Company had been advised by BDO SEIDMAN,  LLP  ("BDO"),  the  Company's
     former independent  registered public accountants,  that, due to their need
     to  complete   review   procedures  in  connection   with  an   independent
     investigation  of the  allegations  by outside  counsel,  BDO was unable to
     complete its review of the interim  consolidated  financial  statements for
     the quarter ended April 30, 2006 by the due date of the Company's Form 10-Q

                                      F-7
<PAGE>
     in accordance with  established  professional  standards and procedures for
     conducting  such  reviews,  which  review is required  by Rule  10-01(d) of
     Regulation S-X. BDO subsequently on July 27, 2006 informed the Company that
     they had resigned as the Company's auditors.  In addition,  by letter dated
     August 14,  2006 BDO  informed  the  Company  that it was  withdrawing  its
     opinion on the  Company's  financial  statements  for the fiscal year ended
     July 31, 2005.

     At a meeting held on July 27, 2006, the Company's Audit Committee  accepted
     the resignation of BDO and approved the engagement of Marcum & Kliegman LLP
     as the Company's independent registered public accountants. In addition, on
     August 16, 2006,  the Audit  Committee  approved the engagement of Marcum &
     Kliegman LLP to also act as its  independent  auditors for the fiscal years
     ended July 31, 2005 and August 1, 2004. The interim consolidated  financial
     statements  for the quarter  ended April 30, 2006 were reviewed by Marcum &
     Kliegman LLP, and the Company's Form 10-Q was filed on September 14, 2006.

     By letter dated June 16, 2006, the Company  received  written  notification
     from  Nasdaq that since the Form 10-Q filed by the Company on June 14, 2006
     had not been reviewed by its  accountants  and did not include the required
     certifications,  the Company was not in compliance  with  Marketplace  Rule
     4310(c) (14).  Accordingly,  the Company was informed  that its  securities
     would be delisted  from The Nasdaq  Stock  Market.  On June 22,  2006,  the
     Company  requested  a hearing  which was held on August 3, 2006.  By letter
     dated August 16,  2006,  the Company  received  written  notification  from
     Nasdaq that the Company's request for continued listing on The Nasdaq Stock
     Market  had been  granted,  subject to the  Company's  filing of a complete
     amended Form 10-Q by September 15, 2006. The Company filed the amended Form
     10-Q on September 14, 2006 and received  written  notification on September
     18,  2006 from Nasdaq that since it has  demonstrated  compliance  with all
     Nasdaq  Marketplace  Rules,  the  Nasdaq  Listing  Qualification  Panel has
     determined  to continue  the  listing of the  Company's  securities  on The
     Nasdaq Global Market.

     On  June  15,  2006,  the  Company  announced  a  resumption  of the  stock
     repurchase  program initially  announced in October 2002 covering 1,000,000
     shares of common stock of the Company and subsequently  expanded on May 30,
     2003 to cover  2,000,000  shares of common  stock.  As of July 30, 2006 the
     Company has  acquired an  aggregate of  approximately  1,898,000  shares of
     common  stock under this program of which  798,567 and 160,232  shares were
     acquired during fiscal 2006 and 2005 at an aggregate cost of  approximately
     $9,044,000 and $2,728,000, respectively.

2.   Fiscal Year
     -----------
     The Company's  fiscal year ends on the Sunday closest to July 31.  Normally
     each fiscal year consists of fifty-two  weeks,  but every five or six years
     the fiscal year will consist of fifty-three weeks.

3.   Basis of Financial Statement Presentation
     -----------------------------------------
     The  consolidated  financial  statements  include  the  accounts  of Herley
     Industries, Inc. and its subsidiaries,  all of which are wholly-owned.  All
     significant  intercompany accounts and transactions have been eliminated in
     consolidation.  The presentation of financial statements in conformity with
     accounting  principles  generally  accepted in the United  States  requires
     management  to make  estimates  and  assumptions  that affect the  reported
     amounts of assets and liabilities  and disclosure of contingent  assets and
     liabilities as of the date of the financial  statements as well as revenues
     and  expenses  during the period.  Actual  results  could differ from those
     estimates.

4.   Cash and Cash Equivalents
     -------------------------
     The Company  considers all liquid  investments with an original maturity of
     three  months or less at the date of  acquisition  to be cash  equivalents.
     Short-term  investments  are  recorded at the  amortized  cost plus accrued
     interest  which  approximates  market value.  The Company limits its credit
     risk to an  acceptable  level  by  evaluating  the  financial  strength  of
     institutions  at which  significant  investments  are made and  based  upon
     credit ratings.

5.   Concentration of Credit Risk/Trade Accounts Receivable
     ------------------------------------------------------
     Financial  instruments which potentially subject the Company to credit risk
     consist  primarily of trade accounts  receivable.  Accounts  receivable are
     principally from the U.S.  Government,  major U.S. Government  contractors,
     several  foreign  governments,  and  domestic  customers  in  the  defense,
     aerospace and medical industries. Credit is extended based on an evaluation
     of the  customer's  financial  condition  and  generally  collateral is not
     required.  In many  cases,  irrevocable  letters of credit  accompanied  by
     advanced  payments  are  received  from  foreign  customers,  and  progress
     payments  are  received  from  domestic  customers.  The  Company  performs
     periodic  credit  evaluations  of its customers and maintains  reserves for
     potential  credit losses.  As of July 30, 2006 and July 31, 2005, a reserve
     for doubtful accounts of $283,000 and $130,000,  respectively are reflected
     in the  consolidated  balance  sheets as a  deduction  from trade  accounts

                                      F-8
<PAGE>
     receivable.  The write off of  uncollectible  accounts  receivable over the
     years has been immaterial.

6.   Inventories
     -----------
     Inventories, other than inventory costs relating to long-term contracts and
     programs, are stated at lower of cost (principally first-in,  first-out) or
     market.  Inventory  costs relating to long-term  contracts and programs are
     stated at the actual production costs, including factory overhead,  reduced
     by  amounts  identified  with  revenue  recognized  on units  delivered  or
     progress  completed.  Inventory  costs relating to long-term  contracts and
     programs  are  reduced  by any  amounts in excess of  estimated  realizable
     value.

7.   Property, Plant and Equipment
     -----------------------------
     Property,  plant  and  equipment  are  stated  at  cost.  Depreciation  and
     amortization are provided  principally by the straight-line method over the
     estimated  useful lives of the related assets.  Leasehold  improvements are
     amortized  over the shorter of their  economic  lives or the lease term, as
     defined in paragraph  5(f) of Statement of Financial  Accounting  Standards
     ("SFAS")  No.13,  "Accounting for Leases." Rent holidays and scheduled rent
     increases  under operating  leases are recognized on a straight-line  basis
     over the lease term,  including the rent holiday period, in accordance with
     paragraph 2 of Financial  Accounting  Standards  Board  ("FASB")  Technical
     Bulletin  85-3 (as  amended).  Gains and  losses  arising  from the sale or
     disposition  of property,  plant and  equipment are included in income from
     operations.

8.   Goodwill and Other Intangible  Assets
     -------------------------------------
     Goodwill is tested for  impairment in accordance  with SFAS No. 142 using a
     fair value approach applied to the Company's one reporting unit. Impairment
     charges are  recognized  for amounts  where the reporting  unit's  goodwill
     exceeds its fair  value.  An annual  impairment  test is  performed  in the
     fourth quarter of each fiscal year. Any future  impairment of goodwill will
     be  charged  to  operations.  The  Company  amortizes  the  cost  of  other
     intangibles  over their  estimated  useful  lives.  Amortizable  intangible
     assets may also be tested  for  impairment  if  indications  of  impairment
     exist.

     The Company  obtained a fair market  value  appraisal  of the Company by an
     independent  investment banking firm. Based on this appraisal,  the Company
     has  determined  that no impairment  in the carrying  value of goodwill has
     occurred at July 30, 2006.

     The change in the carrying  amount of goodwill for the years ended July 30,
     2006 and July 31, 2005, is principally  based upon the fair value of assets
     acquired and liabilities  assumed  related to the  acquisitions of RSS, MSI
     and ICI (as defined in Note B) in fiscal 2005, as follows (in thousands):
<TABLE>
            <S>                                                 <C>

            Balance at August 1, 2004                            $ 35,165
               Goodwill acquired during the period (2)             35,793
               Foreign currency translation adjustment (1)           (155)
               Other adjustments                                       28
                                                                 ---------
            Balance at July 31, 2005                             $ 70,831
               Change in fair value of liabilities assumed
                  in connection with the ICI acquisition (Note B)   2,504
               Foreign currency translation adjustment (1)            277
                                                                 --------
            Balance at July 30, 2006                             $ 73,612
                                                                 ========
     ---------
<FN>

(1)  Related to the acquisition of EWST in fiscal 2003 (See Note B).
(2)  Related to the  acquisitions  of RSS,  MSI and ICI in fiscal 2005 (See Note
     B).
</FN>
</TABLE>
                                      F-9
<PAGE>
     Intangibles consist of the following (in thousands):
<TABLE>
<CAPTION>
                                                                    July 30,        July 31,  Estimated
                                                                      2006            2005    useful life
                                                                      ----            ----    -----------
         <S>                                                         <C>            <C>       <C>
         Trademarks (acquired with MSI and ICI)                       $2,800          $2,800  Indefinite
         Technology (acquired with EWST, MSI and ICI)                 12,421          12,421  10-15 years
         Technology license acquired from Xytrans                      3,556           2,300  (see below)
         Drawings                                                        800             800  15 years
         Patents                                                         568             568  14 years
         Backlog                                                       3,125           3,125  2-5 years
         Non-compete agreement                                            31              31  5 years
         Foreign currency translation adjustment                         156             189
                                                                     -------        -------
                                                                      23,457          22,234
         Accumulated amortization                                      3,468           1,680
                                                                    -------         -------
                                                                    $ 19,989        $ 20,554
                                                                    ========        ========
</TABLE>
     The Company entered into a license and development agreement  ("agreement")
     on April  7,  2005 to  license  millimeter  wave  technology  for  military
     applications from Xytrans, Inc. Xytrans focuses on providing high-frequency
     transceiver  and outdoor  unit design for the  wireless  broadband  network
     market. The technology acquired includes exclusive access to a portfolio of
     patents  and  trade  secrets  that  improve  the  cost and  performance  of
     millimeter wave subsystems that are used in weapons and radar systems.

     In January  2005,  the Company had made a deposit  payment of $1,000,000 in
     connection with this proposed transaction.  The deposit payment was secured
     by a note receivable,  which was cancelled upon execution of the agreement.
     The  agreement   provided  for  an  additional   payment  on  execution  of
     $1,000,000,  and  for  certain  additional  contingent  payments,  of up to
     $4,500,000.  These  contingent  payments  are subject to  achievement  of a
     series of development  milestones on a U.S. Government missile program, and
     /or receipt by the Company of a single contract award using millimeter wave
     technology valued at a minimum of $6,000,000,  amongst other  requirements.
     The agreement also provides for the payment of royalties ranging from 1% to
     4% of sales of products  including  relevant  millimeter  wave  technology,
     starting at the  earliest  January 1, 2006,  and  generally  ending 4 years
     later. No royalties have been earned or paid as of July 30, 2006.

     Xytrans  achieved  several of the  development  milestones  on the  missile
     program discussed above and the Company made additional contingent payments
     totaling  $1,500,000.  Additional  development costs as a result of a scope
     change were paid in the net amount of $56,000. A final milestone payment of
     $178,700 was made in August 2006.  No further  contingent  payments are due
     under the  agreement.  At the  commencement  of sales of products using the
     millimeter  wave  technology,  the Company will begin to amortize the costs
     associated  with  this  agreement  over  the  estimated  economic  life  of
     approximately eight years.

     Amortization  expense  related to Intangibles for the fifty-two weeks ended
     July 30,  2006,  July 31,  2005  and  August  1,  2004,  was  approximately
     $1,788,000, $928,000 and $349,000, respectively.

     Estimated aggregate  amortization  expense for each of the next five fiscal
     years is as follows (in thousands):
<TABLE>
                               <S>         <C>
                               2007        1,828
                               2008        1,822
                               2009        1,821
                               2010        1,540
                               2011        1,260
</TABLE>
                                      F-10
<PAGE>
9.   Marketable Securities
     ---------------------
     The Company  accounts  for its  investments  in  marketable  securities  in
     accordance with SFAS No. 115,  "Accounting for Certain  Investments in Debt
     and   Equity   Securities."    Management    determines   the   appropriate
     classification  of debt  securities at the time of purchase and reevaluates
     such  designation  as of each  balance  sheet  date.  Debt  securities  are
     classified as held-to-maturity when the Company has the positive intent and
     ability to hold the securities to maturity.  Marketable  equity  securities
     and debt  securities not classified as  held-to-maturity  are classified as
     available-for-sale.  Available-for-sale  securities  are  carried  at  fair
     market value with net  unrealized  holding  gains or losses,  net of income
     taxes,  reported as a separate component of other  comprehensive  income or
     loss.  Realized  gains  and  losses  and  declines  in value  judged  to be
     other-than-temporary are included in other income (expense),  net. The cost
     of securities sold is based on the specific identification method. Interest
     and dividends on securities are included in other income.

10.  Other Investments
     -----------------
     The Company is a limited partner in a non-marketable limited partnership in
     which it owns approximately a 10% interest. The investment is accounted for
     under the equity method (See Note D).


11.  Revenue and Cost Recognition
     ----------------------------
     The Company generally  recognizes revenue when products are shipped and the
     customer  takes  ownership  and  assumes  risk of loss,  collection  of the
     relevant  receivable  is probable,  persuasive  evidence of an  arrangement
     exists and the sales  price is fixed or  determinable.  It is the policy of
     the U.S. Government to ensure that (a) its contracts include inspection and
     other quality  requirements,  including  warranty clauses when appropriate,
     that are determined  necessary to protect the  Government's  interest;  (b)
     supplies  tendered  by  contractors  meet  contract  requirements;  and (c)
     Government  contract  quality  assurance  is  conducted  before  acceptance
     (except as otherwise provided in the Federal Acquisition  Regulations),  by
     or under the  direction of  Government  personnel.  The Company,  as a U.S.
     Government  contractor,  is required to control the quality of its products
     and to tender to the Government  only those products that meet the contract
     requirements.  Accordingly,  the  Company's  Government  contracts  include
     provisions  that require its products to pass quality  inspection  prior to
     acceptance by the  Government.  Except for contracts that are accounted for
     using the  percentage of completion  method of  accounting,  revenue is not
     recognized  until the products  pass quality  inspection  and generally not
     until customer acceptance.  In the event the Government's acceptance occurs
     at destination, revenue is recognized at shipment if it can be demonstrated
     that the delivered  products meet all of the  specified  criteria  prior to
     customer  acceptance.  Payments  received  from  customers  in  advance  of
     products  delivered  are recorded as advance  payments on  contracts  until
     earned.  Most of our customer  contracts are firm,  fixed price  contracts,
     providing for a predetermined fixed price for the products sold, regardless
     of the costs  incurred.  A certain  percentage of revenues are derived from
     long-term,  fixed  price  contracts.  Revenues  and  estimated  profits are
     recognized on these contracts using the percentage of completion  method of
     accounting  and are  based  on  estimated  completion  to date  (the  total
     contract amount multiplied by the percentage of performance, based on total
     costs  incurred  in  relation  to  total  estimated  cost  at  completion).
     Prospective  losses on long-term  contracts are based upon the  anticipated
     excess of manufacturing costs over the selling price of the remaining units
     to be  delivered  and are  recorded in the period when first  determinable.
     Actual  losses  could  differ  from those  estimated  due to changes in the
     ultimate manufacturing costs and contract terms.

     Contract  costs  include  all  direct  material  and labor  costs and those
     indirect  costs  related to  contract  performance.  Selling,  general  and
     administrative costs are charged to expense as incurred.

12.  Product Development
     -------------------
     The Company's primary efforts are focused on engineering design and product
     development  activities  rather  than  pure  research.  The  cost of  these
     development   activities,   including   employees'   time   and   prototype
     development, net of amounts paid by customers, was approximately $9.1, $5.0
     and $5.4  million in fiscal 2006,  2005,  and 2004,  respectively,  and are
     included  in cost of  products  sold.  The amounts  paid by  customers  are
     included in net sales and was approximately  $21.2, 5.3 and $5.7 million in
     fiscal 2006, 2005 and 2004, respectively.

                                      F-11
<PAGE>
13.  Income Taxes
     ------------
     Income  taxes  are  accounted  for  by  the  asset/liability   approach  in
     accordance with SFAS No. 109, "Accounting for Income Taxes." Deferred taxes
     represent the expected future tax consequences when the reported amounts of
     assets and  liabilities  are recovered or paid.  They arise from  temporary
     differences  between the  financial  reporting  and tax bases of assets and
     liabilities  and are  adjusted  for  changes in tax laws and tax rates when
     those changes are enacted.  The provision for income taxes  represents  the
     total of income taxes paid or payable for the current year, plus the change
     in deferred taxes during the year.

14.  Stock-Based Compensation
     ------------------------
     The Company has various  fixed stock  option  plans which are  described in
     Note M that  provide for the grant of stock  options to eligible  employees
     and directors.

     Effective  August 1, 2005, the Company  adopted the fair value  recognition
     provisions of SFAS No. 123(R),  "Share-Based Payment" ("SFAS 123(R)") using
     the modified  prospective  application  method.  This standard requires the
     Company to measure the cost of employee  services  received in exchange for
     equity share  options  granted  based on the  grant-date  fair value of the
     options.  The cost is recognized as compensation expense over the requisite
     service period for each separately  vesting  portion of the options.  Under
     the modified prospective application method,  compensation cost included in
     operating   expenses  in  the  fifty-two  weeks  ended  July  30,  2006  is
     approximately $453,000 and includes: (a) compensation cost of stock options
     granted  prior  to but not yet  vested  as of  August  1,  2005  (based  on
     grant-date  fair value  estimated in accordance with the provisions of SFAS
     123) and (b) compensation  cost for all options granted  subsequent to July
     31, 2005 (based on grant-date  fair value  estimated in accordance with the
     new  provisions of SFAS 123(R)).  Operating  income and income before taxes
     for the fiscal year 2006 were reduced by  approximately  $453,000 while net
     income was reduced by  approximately  $322,000 or  approximately  $0.02 per
     basic and diluted share.

     Income tax benefits  relating to the exercise of stock  options  during the
     fifty-two  weeks  ended  July 30,  2006,  July 31,  2005 and August 1, 2004
     amounted to approximately  $703,000,  $658,000 and $687,000,  respectively.
     Commencing  in fiscal 2006,  the income tax benefits  are  classified  as a
     financing  cash inflow in the  Company's  Consolidated  Statements  of Cash
     Flows.  Prior to the adoption of SFAS  123(R),  the Company  presented  all
     income tax benefits  related to  stock-based  compensation  as an operating
     cash inflow.

     As of July 30, 2006,  there were 3,490,080 stock options  outstanding.  The
     aggregate value of unvested  options,  as determined  using a Black-Scholes
     option  valuation  model  was  approximately  $812,000  (net  of  estimated
     forfeitures).  During the fifty-two  weeks ended July 30, 2006, the Company
     granted  79,000   non-qualified  stock  options,   with  a  fair  value  of
     approximately  $568,000.  Options for 272,429  shares of common  stock were
     exercised,  and 52,021 options were  forfeited  during the year. New option
     grants  made after July 31,  2005,  as well as option  grants  issued on or
     prior to that date, have been valued using a Black-Scholes option valuation
     model.

     In April 2005, the Company's Board of Directors, upon recommendation of the
     Board's  Compensation  Committee,  approved the accelerated  vesting of all
     unvested and  "out-of-the-money"  stock  options  outstanding  as of May 2,
     2005. As a result of this action, options to purchase approximately 307,000
     shares of the Company's  common stock that would  otherwise  have vested at
     various times within the next four years became fully vested.  The decision
     to  accelerate  the vesting,  which the Company  believes to be in the best
     interest of the Company and its  shareholders,  was made in lieu of certain
     discretionary cash bonuses,  and to reduce compensation  expense that would
     be recorded in future  periods  following  the  Company's  adoption of SFAS
     123(R).  The Board of Directors  further  believes that the acceleration is
     consistent with the Company's  overall equity  compensation  approach which
     includes a reduced use of stock options. The SFAS 123 pro forma stock-based
     compensation costs of approximately  $2,770,000 (net of taxes) for the year
     ended July 31, 2005 in the table below  includes a charge of  approximately
     $540,000 (net of taxes) as a result of the acceleration.

     Prior to adopting SFAS 123(R) on August 1, 2005, the Company's equity based
     employee  compensation  expense  under the various  stock  option plans was
     accounted  for under the  recognition  and  measurement  principles  of APB
     Opinion No. 25,  "Accounting  for Stock Issued to  Employees",  and related
     interpretations. Under the modified prospective application method, results
     for  prior  periods  have not been  restated  to  reflect  the  effects  of
     implementing SFAS 123(R). Therefore, for the fiscal years 2005 and 2004, no
     option based employee  compensation cost is reflected in net income, as all
     options  granted  under  those  plans had an  exercise  price  equal to the
     underlying  common stock price on the date of grant.  The  following  table
     which  is  presented  for  comparative  purposes,  provides  the pro  forma
     information  as  required  by SFAS No.  148,  "Accounting  for  Stock-Based

                                      F-12
<PAGE>
     Compensation-Transition  and Disclosure, an amendment of FASB Statement No.
     123," and  illustrates  the effect on net income  and  earnings  per common
     share for the  periods  presented  as if the  Company  had applied the fair
     value  recognition  provisions  of SFAS  No.  123 to stock  based  employee
     compensation prior to August 1, 2005:
<TABLE>
<CAPTION>
                                             2005         2004
                                          -----------  -----------

     <S>                                   <C>          <C>
     Net income  -  as reported            $ 10,781     $ 13,673
     Deduct: total stock-based employee
      compensation expense determined
      under fair value based method for all
      awards, net of related tax effects     (2,770)        (570)
                                          ---------  -----------
     Net income  -  pro forma               $ 8,011     $ 13,103
                                          =========  ===========

     Earnings per share  -  as reported
          Basic                             $0.75        $0.97
          Diluted                            0.72         0.92
     Earnings per share  - pro forma
          Basic                             $0.56        $0.93
          Diluted                            0.54         0.88
</TABLE>
     The weighted  average fair value of stock options on the date of grant, and
     the  assumptions  used to estimate the fair value of stock  options  issued
     during the periods presented using the Black-Scholes option valuation model
     are as follows:
<TABLE>
<CAPTION>
                                                                   2006         2005         2004
                                                                   ----         ----         ----
              <S>                                                 <C>           <C>          <C>
              Weighted average fair value of options granted      $ 7.19        $ 4.00       $ 7.87
              Expected life (years)                                 3.53          3.69         4.14
              Expected volatility                                    .44           .44          .48
              Risk-free interest rate                               4.3%          3.8%         2.8%
              Expected dividend yield                               zero          zero         zero
</TABLE>
     The expected life of options granted during the periods  presented above is
     based on the Company's  historical  share option exercise  experience using
     the historical expected term from vest date. The expected volatility of the
     options  granted  is  determined  using  historical  volatilities  based on
     historical  stock prices.  The risk-free  interest rate is determined using
     the yield available for zero-coupon U.S. Government issues with a remaining
     term equal to the expected life of the options.  The Company has never paid
     a dividend, and as such the dividend yield is zero.

15.  Foreign Currency Translation
     ----------------------------
     Financial   statements  of  foreign  subsidiaries  are  prepared  in  their
     respective  functional currencies and translated into United States dollars
     at the  current  exchange  rates for assets and  liabilities  and a monthly
     average rate during the year for revenues, costs and expenses. Net gains or
     losses resulting from the translation of foreign  financial  statements are
     charged  or  credited  directly  to  the  'Foreign  currency   translation'
     component of "Accumulated other  comprehensive  income" in the accompanying
     consolidated  statements of  shareholders'  equity.  Transaction  gains and
     losses  resulting  from  transactions  entered  into under  contracts  in a
     currency other than the subsidiary's  functional currency are accounted for
     on a transactional basis as a credit or charge to operations.

16.  Derivatives
     -----------
     The Company  recognizes all derivatives on the balance sheet at fair value.
     On the  date  the  derivative  instrument  is  entered  into,  the  Company
     generally designates the derivative as either (1) a hedge of the fair value
     of a recognized asset or liability,  or of an unrecognized  firm commitment
     ("fair value hedge") or (2) a hedge of a forecasted  transaction  or of the
     variability  of cash flows to be received or paid  related to a  recognized
     asset or  liability  ("cash  flow  hedge").  The  Company  entered  into an
     interest  rate swap in October 2001 with a bank,  which it  recognized as a
     cash  flow  hedge.  Changes  in the  fair  value  of a  derivative  that is
     designated  as, and meets all the required  criteria for, a cash flow hedge
     are  recorded  in  accumulated  other   comprehensive   income  (loss)  and
     reclassified  into earnings as the underlying hedged item affects earnings.

                                      F-13
<PAGE>
17.  Comprehensive Income
     --------------------
     The Company reports comprehensive income in the Consolidated  Statements of
     Shareholders' Equity, which includes net income,  unrealized gain (loss) on
     available-for-sale  securities,  unrealized  gain (loss) on  interest  rate
     swap, and foreign currency  translation gain (loss),  net of related income
     taxes.  Substantially all the amount included in other comprehensive income
     relates to the effects of foreign exchange translation gains and losses.

18.  New Accounting Pronouncements
     -----------------------------
     In September 2006, the FASB issued SFAS No. 157, "Fair Value  Measurements"
     ("SFAS  157").  SFAS 157 defines fair value,  establishes  a framework  for
     measuring  fair value in  generally  accepted  accounting  principles,  and
     expands  disclosures  about  fair  value  measurements.   It  codifies  the
     definitions  of fair  value  included  in other  authoritative  literature;
     clarifies and, in some cases, expands on the guidance for implementing fair
     value measurements; and increases the level of disclosure required for fair
     value  measurements.   Although  SFAS  157  applies  to  (and  amends)  the
     provisions of existing  authoritative  literature,  it does not, of itself,
     require any new fair value  measurements,  nor does it establish  valuation
     standards. SFAS 157 is effective for financial statements issued for fiscal
     years  beginning  after November 15, 2007, and interim periods within those
     fiscal years.  This  statement  will be effective for the Company's  fiscal
     year  beginning  August 2008.  We will evaluate the impact of adopting SFAS
     157 but do not expect that it will have a material  impact on the Company's
     consolidated financial position, results of operations or cash flows.

     In September  2006,  the staff of the  Securities  and Exchange  Commission
     issued  Staff  Accounting  Bulletin  No.  108 ("SAB  108")  which  provides
     interpretive  guidance on how the effects of the  carryover  or reversal of
     prior year misstatements should be considered in quantifying a current year
     misstatement. SAB 108 becomes effective in fiscal 2007. Adoption of SAB 108
     is not  expected to have a material  impact on the  Company's  consolidated
     financial position, results of operations or cash flows.

     In June  2006,  the FASB  issued  Interpretation  No. 48,  "Accounting  for
     Uncertainty  in  Income  Taxes (as  amended)  - an  interpretation  of FASB
     Statement  No.  109"  ("FIN  48").  FIN 48  clarifies  the  accounting  for
     uncertainty  in  income  taxes  recognized  in  an  enterprise's  financial
     statements in accordance with SFAS No. 109,  "Accounting for Income Taxes",
     and prescribes a recognition  threshold and  measurement  attribute for the
     financial statement  recognition and measurement of a tax position taken or
     expected  to be taken in a tax  return.  FIN 48 also  provides  guidance on
     derecognition,   classification,  interest  and  penalties,  accounting  in
     interim periods,  disclosure and transition. FIN 48 is effective for fiscal
     years  beginning  after December 15, 2006. The Company is in the process of
     analyzing  the  impact of FIN 48,  which is  required  to be adopted by the
     first quarter of fiscal 2008.

     In March 2006, the FASB issued SFAS No. 156,  "Accounting  for Servicing of
     Financial  Assets,  an amendment of FASB  Statements No. 140" ("SFAS 156").
     SFAS 156  requires  that  servicing  assets and  servicing  liabilities  be
     recognized at fair value,  if  practicable,  when the Company enters into a
     servicing agreement. This new standard will be effective as of the start of
     the Company's  first fiscal year that begins after  September 15, 2006. The
     Company does not expect the adoption of SFAS 156 to have a material  impact
     on its  consolidated  financial  position,  results of  operations  or cash
     flows.

     In February  2006,  the FASB issued SFAS No. 155,  "Accounting  for Certain
     Hybrid Financial  Instruments"  ("SFAS 155"), an amendment of SFAS Nos. 133
     and  140.  SFAS 155  permits  a fair  value  remeasurement  for any  hybrid
     financial  instrument  that contains an embedded  derivative that otherwise
     would  require  bifurcation;   clarifies  which  interest-only  strips  and
     principal-only strips are not subject to the requirements of Statement 133;
     establishes a requirement to evaluate  interests in  securitized  financial
     assets to identify interests that are freestanding  derivatives or that are
     hybrid financial  instruments that contain an embedded derivative requiring
     bifurcation;  clarifies that  concentrations  of credit risk in the form of
     subordination  are not embedded  derivatives;  and amends  Statement 140 to
     eliminate  the  prohibition  on a  qualifying  special-purpose  entity from
     holding a derivative  financial  instrument  that  pertains to a beneficial
     interest  other than  another  derivative  financial  instrument.  This new
     standard will be effective for all financial instruments acquired or issued
     after the  beginning of the  Company's  first fiscal year that begins after
     September 15, 2006. The Company does not expect the adoption of SFAS 155 to
     have a material impact on its consolidated  financial position,  results of
     operations or cash flows.

     In May 2005,  the FASB issued SFAS No. 154,  "Accounting  Changes and Error
     Corrections" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20 "Accounting
     Changes" and SFAS No. 3 "Reporting  Accounting Changes in Interim Financial
     Statements."  SFAS 154  requires  that a  voluntary  change  in  accounting

                                      F-14
<PAGE>

     principle  be  applied  retrospectively  with all  prior  period  financial
     statements  presented  on  the  new  accounting  principle,  unless  it  is
     impracticable  to do so. SFAS 154 also provides that a correction of errors
     in previously issued financial statements should be termed a "restatement."
     This new standard will be effective for  accounting  changes and correction
     of errors for fiscal years  beginning  after December 15, 2005. The Company
     does not expect that the  adoption of SFAS 154 will have a material  impact
     on its  consolidated  financial  position,  results of  operations  or cash
     flows.

     In March 2005, the FASB issued FASB  Interpretation No. 47, "Accounting for
     Conditional  Asset Retirement  Obligations - An  Interpretation of SFAS No.
     143." This Interpretation provides additional guidance as to when companies
     should  record  the  fair  value of a  liability  for a  conditional  asset
     retirement  obligation  when there is  uncertainty  about the timing and/or
     method of settlement of the obligation. This Interpretation is effective no
     later  than  the end of  fiscal  years  ending  after  December  15,  2005.
     Management adopted this Interpretation effective July 30, 2006. Adoption of
     FASB  Interpretation No. 47 did not have a material impact on the Company's
     consolidated financial position, results of operations or cash flows.

     In March  of 2005,  the SEC  issued  Staff  Accounting  Bulletin  No.  107,
     "Share-Based  Payment" ("SAB 107"),  which provides  interpretive  guidance
     related to the  interaction  between  SFAS 123(R) and certain SEC rules and
     regulations,  as well as  provides  the SEC  staff's  views  regarding  the
     valuation of share-based payment arrangements. The Company has incorporated
     SAB 107 in the implementation and adoption of SFAS 123(R).

     In December 2004, the FASB issued SFAS No. 123(R),  "Share Based  Payment,"
     which  is  a  revision  of  SFAS  No.  123,  "Accounting  for  Stock  Based
     Compensation" ("SFAS 123(R)"). SFAS 123(R) is effective for publicly traded
     companies  for annual  periods  beginning  after June 15, 2005,  supersedes
     Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
     Employees," and amends SFAS No. 95,  "Statement of Cash Flows."  Management
     adopted this standard on August 1, 2005.  See Note A-14 for a discussion of
     the impact on the consolidated  financial  position,  results of operations
     and cash flows of the Company upon adoption of SFAS 123(R).

NOTE B - ACQUISITIONS

     The  Company  entered  into an  agreement  as of March 29,  2004 to acquire
     certain  assets  and the  business,  subject to the  assumption  of certain
     liabilities, of Communication Techniques, Inc. for $14,914,000 in cash. The
     business operates as a wholly-owned subsidiary of the Company,  Herley-CTI,
     Inc.  ("CTI").  The  results  of  operations  of CTI  are  included  in the
     consolidated  financial  statements  from  March  29,  2004.  CTI  designs,
     develops  and  produces   signal   generation   components  and  integrated
     assemblies  for  digital   radio,   satellite   communications,   test  and
     instrumentation  and datacom  applications.  CTI also recently  developed a
     fast frequency  changing direct  synthesizer  which, when combined with the
     capabilities  of  Herley-Israel,  puts  the  Company  at the  forefront  of
     producing broadband microwave sources for radar, communication,  electronic
     warfare and microwave test systems.

     The Company  entered  into an agreement as of September 1, 2004 to purchase
     the  majority of the assets and assume the majority of the  liabilities  of
     Reliable System Services  Corporation of Melbourne,  Florida for $3,725,000
     in cash, plus acquisition  costs of approximately  $28,000.  The results of
     operations  are  included in the  consolidated  financial  statements  from
     September 1, 2004.  The Company  operates  the  business as a  wholly-owned
     subsidiary under the name Herley-RSS, Inc. ("RSS"). RSS was acquired by the
     Company in order to capitalize on its  synergies  with the Company's  other
     product  lines,  particularly  in "over the  horizon"  command  and control
     (C(2)) systems for drones and targets.  RSS designs,  develops and produces
     satellite-based  command and control systems for prime defense  contractors
     and  entities  worldwide.  The Company  closed the  facility in  Melbourne,
     Florida in August 2006, and moved the RSS  operations  into the Fort Walton
     Beach facility.

     The Company entered into an agreement as of February 1, 2005 to acquire all
     of the capital stock of Micro  Systems,  Inc.  ("MSI"),  Fort Walton Beach,
     Florida for payments of $21,473,328 in cash, plus acquisition costs accrued
     of approximately  $16,000, and the assumption of certain  liabilities.  The
     results of  operation  of MSI are  included in the  consolidated  financial
     statements  from February 1, 2005. MSI was acquired by the Company in order
     to capitalize on its synergies  with the Company's  legacy  product  lines,
     consolidate   operations,   add  additional   engineers  and  increase  its
     capabilities  in the area of control  avionics and target control  systems.
     MSI is a market  leader in the design  and  manufacturing  of  command  and
     control  systems for  operation  of unmanned  aerial,  seaborne  and ground
     targets and missiles.

     The Company entered into an agreement as of April 1, 2005 to acquire all of
     the capital stock of Innovative Concepts,  Inc. ("ICI"),  McLean,  Virginia
     for cash payments of  $24,378,330,  the assumption of certain  liabilities,
     and a cash advance of $3,250,000  for the  repayment of debt  assumed.  The

                                      F-15
<PAGE>

     results of  operations  of ICI are included in the  consolidated  financial
     statements  from April 1, 2005. ICI was acquired by the Company in order to
     capitalize  on its tactical  data link  technology  for exchange of digital
     information.  ICI has a  successful  history of  developing  and  providing
     wireless   communications   technology  and  real-time   embedded  systems,
     software,  hardware  and  high-speed  processing  in support of the defense
     industry.

     All of the  acquisitions  completed  by the  Company are  accounted  for in
     accordance  with the provisions of SFAS No. 141,  "Business  Combinations,"
     which  requires that all business  combinations  be accounted for using the
     purchase method.

     For the four  acquisitions  outlined above, the allocation of the aggregate
     purchase price (net of cash acquired of approximately $1,463,000), based on
     a review of the fair value of the assets acquired and liabilities  assumed,
     is as follows (in thousands):
<TABLE>
<CAPTION>

                        Company acquired:                             CTI           RSS            MSI             ICI
                        -----------------
                        Effective Date:                             March 29,    September 1,   February 1,       April 1,
                        --------------                                2004          2004           2005            2005
                                                                      ----          ----           ----            ----
                        <S>                                         <C>              <C>           <C>            <C>
                        Current assets                              $ 2,861          $ 483         $1,534         $8,759
                        Property, plant and equipment                 1,492             72          2,038            681
                        Other assets                                      -              -              1              -
                        Intangible assets                             3,200              -          4,400         10,200
                        Goodwill                                      8,753          3,456         15,148         19,693
                        Current liabilities                          (1,392)          (258)        (2,436)       (12,364)
                                                                     ------          -----         ------         ------
                        Aggregate purchase price                   $ 14,914        $ 3,753       $ 20,685       $ 26,969
                                                                     ======          =====         ======         ======
</TABLE>
     The Company  adjusted its valuation of the assets  acquired and liabilities
     assumed in the acquisition of ICI in accordance with the provisions of SFAS
     No.  141  during  the  second  quarter  of fiscal  2006.  Accordingly,  the
     Company's  consolidated  financial  statements  reflect  an  adjustment  of
     $2,504,000  to the reserve for  contract  losses  relating to a contract in
     ICI's  backlog  at the date of  acquisition  that  consisted  of an initial
     production order and four additional  options  exercisable  unilaterally by
     the customer. Although the customer had not exercised any options as of the
     date of acquisition,  the Company had a contractual obligation to honor the
     terms and conditions of the contract  including the  discounted  pricing in
     the  contract  options,  with  a high  probability  of  the  options  being
     exercised, resulting in the estimated losses under the contract. Two of the
     options have been exercised to date.

     Goodwill  resulting from these  acquisitions  is based on the excess of the
     amounts paid over the estimated fair value of the net assets acquired,  and
     is tax deductible.

     Unaudited  pro  forma  financial  information  for the  three  acquisitions
     completed by the Company in fiscal 2005 as if the acquisitions had occurred
     on August 4, 2003 is as follows (in thousands except per share amounts):
<TABLE>
<CAPTION>
                                                                          2005         2004
                                                                          ----         ----
              <S>                                                      <C>          <C>
              Net sales                                                $ 173,223    $ 158,584
              Net income                                                  10,374       13,654
              Net income per common share:
                  Basic                                                   $ 0.72       $ 0.97
                  Diluted                                                 $ 0.69       $ 0.92
              Weighted shares outstanding
                  Basic                                                   14,310       14,105
                  Diluted                                                 14,969       14,896
</TABLE>
                                      F-16
<PAGE>
NOTE C - INVENTORIES

     The major components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>

                                                                      July 30,         July 31,
                                                                        2006             2005
                                                                        ----             ----
         <S>                                                         <C>               <C>
         Purchased parts and raw materials                           $ 27,191          $ 23,695
         Work in process                                               29,597            34,151
         Finished products                                              3,270             2,296
                                                                      -------           -------
                                                                       60,058            60,142
           Less:
              Allowance for obsolete and slow moving inventory          4,576             4,492
              Unliquidated progress payments                            2,573             4,060
                                                                      -------           -------
                                                                     $ 52,909          $ 51,590
                                                                       ======            ======
</TABLE>

NOTE D - OTHER INVESTMENTS

     In July 1994, the Company  invested  $1,000,000  for a limited  partnership
     interest in M.D. Sass  Municipal  Finance  Partners-I,  a Delaware  limited
     partnership.  The objectives of the  partnership are the  preservation  and
     protection of its capital and the earning of income through the purchase of
     certificates  or other  documentation  that evidence liens for unpaid local
     taxes on parcels of real property.  At July 30, 2006 and July 31, 2005, the
     percentage of ownership was  approximately  10%. The Company's  interest in
     the partnership may be transferred to a substitute  limited  partner,  upon
     written notice to the managing  general  partners,  only with the unanimous
     consent of both general partners at their sole discretion.  The partnership
     is in the process of being  liquidated and accordingly the Company received
     partial  distributions  of  approximately  $111,000 and  $109,000  from the
     partnership in fiscal 2006 and 2005,  respectively.  The net annualized pre
     tax  return  on  investment   in  the   partnership   since   inception  is
     approximately  9.9%. As of July 30, 2006, the Company's limited partnership
     interest had a carrying value of  approximately  $3,200 based on the equity
     method of accounting.

NOTE E - PROPERTY, PLANT AND EQUIPMENT

     Property,   plant  and   equipment  are  comprised  of  the  following  (in
thousands):
<TABLE>
<CAPTION>

                                               July 30,        July 31,       Estimated
                                                 2006            2005        Useful Life
                                               -------         --------      -----------
<S>                                             <C>             <C>          <C>
Land                                            $ 4,006        $  4,006
Building and building improvements               12,221          12,011      10-40 years
Machinery and equipment                          51,827          46,402       5-8  years
Furniture and fixtures                            3,199           2,962       5-10 years
Automobiles                                          18              18        3   years
Leasehold improvements                            2,988           2,649       5-10 years
                                             --------------  -------------
                                                 74,259          68,048
Less accumulated depreciation                    43,781          38,587
                                             --------------  -------------
                                                $30,478        $ 29,461
                                             ==============  =============
</TABLE>

     Depreciation  charges  totaled  approximately  $5,208,000,  $4,655,000  and
     $3,796,000 in fiscal 2006, 2005 and 2004, respectively.

                                      F-17
<PAGE>
NOTE F - COMMITMENTS AND CONTINGENCIES

     Leases
     ------

     The  Company  leases  office,  production  and  warehouse  space as well as
     computer equipment and automobiles under  non-cancelable  operating leases.
     Rent expense for the fifty-two weeks ended July 30, 2006, July 31, 2005 and
     August 1, 2004, was  approximately  $3,960,000,  $2,834,000 and $1,749,000,
     respectively.  Minimum annual rentals under non-cancelable operating leases
     are as follows (in thousands):
<TABLE>
<CAPTION>
                                                           Amount
                                                           ------
                    <S>                                   <C>
                    Year ending fiscal 2007               $ 3,244
                                       2008                 3,197
                                       2009                 2,775
                                       2010                 2,129
                                       2011                 2,164
                                     Future                 2,233
                                                            -----
                                                         $ 15,742
                                                           ======
</TABLE>
     Employment and Severance Agreements
     -----------------------------------

     The Company has employment  agreements  with the  Chairman/Chief  Executive
     Officer and former  Chairman of the Company which expire December 31, 2011,
     subject to extension for additional  one-year periods annually each January
     1 with a final expiration date of December 31, 2015 (as amended December 9,
     2003). The agreements  provide for aggregate annual salaries as of July 31,
     2006 of $1,542,300 and provide for a semi-annual cost of living  adjustment
     based  on the  consumer  price  index.  The  agreements  also  provide  for
     incentive  compensation  at 7% in the  aggregate  of  pretax  income of the
     Company. Incentive compensation in the amount of $1,114,000, $1,138,000 and
     $2,214,000  was  charged to expense in fiscal  years  2006,  2005 and 2004,
     respectively.   The  agreement  with  the  Company's  former  Chairman  was
     terminated as discussed below.

     The agreements also provide that, in the event there is a change in control
     of the Company, as defined, the executives have the option to terminate the
     agreements  and receive a lump-sum  payment  equal to the sum of the salary
     payable for the remainder of the employment  term,  plus the annual bonuses
     (based on the average of the three highest  annual  bonuses  awarded during
     the ten preceding  years) for the remainder of the  employment  term. As of
     July 31, 2006, the amount payable in the event of such termination would be
     approximately  $17,243,000.  The  agreements  also  provide for  consulting
     periods,  one for five and one for ten years,  at the end of the employment
     period at an annual compensation  equivalent to one-half of the executive's
     annual salary at the end of the employment  period,  subject to annual cost
     of living adjustments.

     Effective  October  12,  2006  and as a  condition  to  entering  into  the
     Administrative  Agreement  with the  Department  of the Navy,  the  Company
     entered  into an  agreement  with  Lee N.  Blatt,  former  Chairman  of the
     Company, to terminate the Employment  Agreement between the Company and Mr.
     Blatt dated as of July 29, 2002 and  modified on December 9, 2003 (see Note
     A.1).

     In addition,  certain  executive  officers of the Company  have  employment
     agreements  which  expire  June 6,  2009  providing  for  aggregate  annual
     salaries as of July 30, 2006 of $590,000.

     An  employment  contract of a retired  executive  provides for a consulting
     period which became effective October 1, 1998, and terminates  December 31,
     2010 at the annual rate of compensation of $100,000.

     Several officers and key employees of the Company have severance agreements
     providing for an aggregate  lump-sum  payment of  approximately  $3,320,000
     through  September  30,  2008 in the  event of a change in  control  of the
     Company  as  defined  in  the  agreements.  Several  other  employees  have
     severance agreements,  in the event of termination of employment except for
     cause,  expiring at various dates from December 2006 through February 2008,
     providing for an aggregate payment as of July 30, 2006 of $1,910,000.

     Litigation
     ----------

     As previously  reported,  there has been a continuing  investigation by the
     U.S.  Attorneys' Office in Pennsylvania which, inter alia, involves pricing
     under  contracts  with the U.S.  Department of Defense  relating to voltage
     control oscillators and powerheads.  The contracts aggregate  approximately
     $3.9 million in total revenue.
                                      F-18
<PAGE>
     On June 6, 2006,  an  indictment  was returned  against the Company and Lee
     Blatt, its former Chairman. No other officer or director of the Company was
     named in the indictment.  The indictment alleges 29 counts of violations of
     the wire fraud statute (18 U.S.C.  Section 1343), 2 counts of violations of
     the  obstruction  of a federal audit statute (18 U.S.C.  Section  1516),  1
     count of violating the major fraud  against the United  States  statute (18
     U.S.C.  Section  1031),  3 counts of violating the false  statements to the
     government statute (18 U.S.C. Section 1001) and a notice of forfeiture. The
     Company  believes that no criminal conduct has occurred and will vigorously
     contest the charges. If convicted, Mr. Blatt and the Company could be fined
     up to  approximately  $13 million each and the Company could be required to
     forfeit  approximately  $2.9  million paid under the  contracts.  Under the
     terms of an  indemnification  agreement  with Mr.  Blatt,  the  Company has
     agreed to provide  indemnification with regard to certain legal proceedings
     so long as he has acted in good faith and in a manner believed to be in, or
     not opposed to, the  Company's  best  interest with respect to any criminal
     proceeding and had no reasonable cause to believe his conduct was unlawful.

     In June and July 2006,  the Company was served  with  several  class-action
     complaints  against the  Company and certain of its  officers in the United
     States District Court for the Eastern District of Pennsylvania.  The claims
     are made under  Section 10(b) and 20(a) of the  Securities  Exchange Act of
     1934 and Rule 10b-5 thereunder. In July 2006, the Company and its directors
     were also served with a derivative  complaint for breach of fiduciary  duty
     brought pursuant to Rule 23.1 of the Federal Rules of Civil Procedure.  The
     complaints  relate to the  Company's  indictment  in the  matter  discussed
     above.   In   addition,   in  June  2006,   the  Company  was  notified  by
     representatives  of the United  States  Attorney's  Office for the  Eastern
     District of  Pennsylvania,  Civil  Division,  that they  intended to file a
     civil lawsuit against the Company  pursuant to inter alia, the False Claims
     Act, 31 U.S.C. Section 3729 et. seq.  The  Company  entered  into a Tolling
     Agreement on June 21, 2006, and does not  anticipate  any further  activity
     related  to this  potential  claim  until  after the trial of the  criminal
     matter mentioned above.

     The Company believes it has substantial  defenses to the charges alleged in
     the indictment and intends to vigorously defend against these allegations.

     In accordance with SFAS No. 5, "Accounting for  Contingencies," the Company
     determines  whether an  estimated  loss from a loss  contingency  should be
     accrued  by  assessing  whether  a  loss  is  deemed  probable  and  can be
     reasonably estimated. Litigation is inherently unpredictable and due to the
     uncertainty of the outcome of the matters  discussed above, the Company has
     concluded  that it is currently not probable that a loss has been incurred.
     Accordingly,  no accrual has been recorded in the accompanying consolidated
     financial  statements.  If an  unfavorable  ruling  were  to  occur  in any
     specific period,  there exists the possibility of a material adverse impact
     on the results of operations for that period.

     In  connection  with the Robinson  Laboratories,  Inc.  ("RLI")  litigation
     settled in 2005, by Order Dated  February 17, 2005, the Company was awarded
     $2.1 million for attorneys' fees. The judgment has not been paid by RLI and
     the  receivable  for this  award  has not been  recorded  in the  Company's
     consolidated financial statements because RLI has no assets.

     The Company is involved in various other legal proceedings and claims which
     arise in the ordinary course of its business. While any litigation contains
     an element of  uncertainty,  management  believes  that the outcome of such
     litigation  will  not  have a  material  adverse  effect  on the  Company's
     financial position or results of operations.

     Stand-by Letters of Credit
     --------------------------

     The Company  maintains a letter of credit  facility in connection  with the
     revolving credit agreement with two banks that provides for the issuance of
     stand-by  letters of credit and  requires  the payment of a fee of 1.0% per
     annum of the amounts  outstanding under the facility.  The facility expires
     March 31, 2008. At July 30, 2006,  stand-by  letters of credit  aggregating
     approximately  $10,285,000 were  outstanding  under this facility (See Note
     H).

                                      F-19
<PAGE>
NOTE G - INCOME TAXES

     Income tax expense consisted of the following (in thousands):
<TABLE>
<CAPTION>
                                    52 weeks ended
                          -------------------------------------
                            July 30,    July 31,   August 1,
                              2006       2005       2004
                              ----       ----       ----
<S>                       <C>        <C>        <C>
Current
           Federal        $    3,036 $    2,772 $     5,514
           State                 350        344         549
           Foreign               375         30         431
                            ---------   --------  ----------
                               3,761      3,146       6,494
Deferred
           Federal               225        992        (372)
           State                  24         94         (44)
           Foreign               (31)        13           5
                            ---------   --------  ----------
                                 218      1,099        (411)
                            ---------   --------  ----------
                          $    3,979 $    4,245 $     6,083
                            =========   ========  ==========
</TABLE>
     The Company paid income taxes of approximately  $3,407,000,  $546,000,  and
     $5,496,000 in fiscal 2006, 2005, and 2004, respectively. The following is a
     reconciliation of the U. S. statutory income tax rate and the effective tax
     rate on pretax income:
<TABLE>
<CAPTION>
                                                52 weeks ended
                                        -----------------------------
                                         July 30,  July 31,  August 1,
                                           2006      2005      2004
                                           ----      ----      ----
<S>                                        <C>      <C>       <C>
Statutory income tax rate                  35.0%     35.0%    35.0%
State income taxes, net of
   Federal income tax benefit               1.8       1.9      1.7
Benefit of extra territorial income        (1.4)     (1.1)    (1.4)
Non-deductible expenses                     0.9       0.7      0.6
Benefit of foreign and
   foreign-source income                   (4.5)     (1.0)    (3.9)
Research and development credits           (1.3)     (5.7)    (1.0)
Tax exempt interest                        (1.2)     (1.3)      -
Manufacturing deduction                    (0.6)       -        -
Other, net                                 (0.9)     (0.2)    (0.2)
                                       --------- --------- ---------
   Effective tax rate                      27.8%     28.3%    30.8%
                                       ========= ========= =========
</TABLE>
     Income taxes have not been  provided on  undistributed  earnings of foreign
     subsidiaries. If remitted as dividends, these earnings could become subject
     to  additional  tax. The  Company's  intention is to reinvest  non-remitted
     earnings of subsidiaries  outside the United States  permanently.  The U.S.
     research and  development  credit  expired on December 31, 2005 and has not
     been  extended  by  Congress.  The credit  taken in fiscal 2006 is based on
     qualified research expenditures through December 31, 2005.

                                      F-20
<PAGE>
     The tax effects of significant  items comprising  deferred income taxes are
     as follows (in thousands):
<TABLE>
<CAPTION>
                                        July 30, 2006                  July 31, 2005
                                   ------------------------      -----------------------
                                   Deferred      Deferred        Deferred      Deferred
                                     Tax            Tax             Tax           Tax
                                    Assets      Liabilities       Assets      Liabilities
                                   -----------  -----------       -----       -----------
<S>                               <C>           <C>               <C>         <C>
Intangibles                       $   -         $ 4,393          $   -        $  3,060
Accrued vacation pay                  562           -                396           -
Accrued bonus                         201           -                318           -
Warranty costs                        476           -                279           -
Inventory                           1,668           -              1,348           -
Depreciation                          -           3,023              -           3,194
Contract losses                        95           -                 69           -
Net operating loss
   carry-forwards                     628           -                230           -
Other                                 115           -                146           -
                               -------------  ------------    ------------  ------------
                                  $ 3,745       $ 7,416          $ 2,786       $ 6,254
                               =============  ============    ============  ============
</TABLE>
     As of  July  30,  2006,  the  Company  has  available  net  operating  loss
     carry-forwards  for state income tax purposes of  approximately  $5,917,000
     with expiration dates from 2022 through 2026.

NOTE H- LONG-TERM DEBT

     Long-term debt is summarized as follows (in thousands):
<TABLE>
<CAPTION>

                                                             July 30,       July 31,
                                             Rate             2006           2005
                                       ---------------        ----           ----
<S>                                    <C>                   <C>             <C>
Revolving loan facility (a)            6.75% and 7.20%       $ -             $  -
Mortgage note (b)                      7.43%                  2,330           2,431
Industrial Revenue Bonds (c)           4.07%                  2,590           2,700
Note payable (d)                       6.75%                  1,626             -
Note for acquired business (e)         1.80%                    -               586
Other                                                            32              80
                                                          ----------   -------------
                                                              6,578           5,797
Less current portion                                            630             797
                                                          ----------   -------------
                                                             $5,948          $5,000
                                                          ==========   =============
</TABLE>
(a)  In June 2002, the Company entered into a new $50 million  Revolving  Credit
     Loan  Agreement,  which  includes  provision  for the  issuance of stand-by
     letters of credit,  with two banks on an unsecured  basis which may be used
     for  general  corporate  purposes,  including  business  acquisitions.  The
     revolving  credit  facility  requires  the  payment of  interest  only on a
     monthly basis and payment of the outstanding principal balance on March 31,
     2008 (as  amended).  The  Company may elect to borrow up to a maximum of $5
     million with interest  based on the Federal Funds Target Rate plus a margin
     of 1.50% to 1.80%, or up to a maximum of $45 million with interest based on
     LIBOR plus a margin of 1.35% to 1.65%. The applicable incremental margin is
     based on the ratio of total  liabilities  to tangible  net worth,  as those
     terms are defined in the  agreement.  The Federal Funds Target Rate and the
     LIBOR rate was 5.25% and 5.40%, respectively,  at July 30, 2006. There is a
     fee of 15 basis points per annum on the unused  portion of the  $45,000,000
     LIBOR based portion of the credit facility payable quarterly.  There are no
     borrowings under the line at July 30, 2006 and July 31, 2005.

     The agreement contains various financial covenants,  including, among other
     matters,  minimum  tangible net worth,  total  liabilities  to tangible net
     worth,  debt service  coverage and  restrictions on other  borrowings.  The
     Company is in  compliance  with all such  financial  covenants  at July 30,
     2006.


                                      F-21
<PAGE>
(b)  The mortgage loan is for a term of ten years  commencing  February 16, 1999
     with fixed monthly principal and interest installments of $23,359 including
     interest  at a  fixed  rate  of  7.43%,  and is  based  upon a  twenty-year
     amortization.  The loan is secured by a mortgage on the Company's  land and
     building   in   Lancaster,   Pennsylvania   having  a  net  book  value  of
     approximately $1,764,000.

     The  mortgage  note  agreement   contains  various   financial   covenants,
     including,  among other matters,  the  maintenance  of specific  amounts of
     tangible net worth,  debt to tangible net worth,  debt service coverage and
     restrictions  on other  borrowings.  The Company is in compliance  with all
     such  financial  covenants at July 30, 2006. In connection  with this loan,
     the Company paid  approximately  $45,000 in financing costs. Such costs are
     included in Other Assets in the accompanying consolidated balance sheets at
     July 30, 2006 and July 31, 2005,  and are being  amortized over the term of
     the loan (10 years).

(c)  On October 19, 2001, the Company  received  $3,000,000 in proceeds from the
     East Hempfield  Township  Industrial  Development  Authority  Variable Rate
     Demand/Fixed Rate Revenue Bonds Series of 2001 (the "Bonds"). The Bonds are
     due in varying  annual  installments  through  October 1, 2021. The initial
     installment  of $95,000 was paid  October 1, 2002 and  increases  each year
     until the final payment of $225,000 in 2021. The interest rate on the Bonds
     is reset weekly at the prevailing  market rate of the BMA Municipal  Index.
     The initial rate of interest was 2.1%, which,  after giving effect to a ten
     year  interest  rate swap  agreement  (See Note O)  becomes a fixed rate of
     4.07%.  The interest  rate at July 30, 2006 was 3.71%.  The bond  agreement
     requires a sinking fund payment on a monthly basis to fund the annual Bonds
     redemption  installment.   Proceeds  from  the  Bonds  were  used  for  the
     construction of a 15,000 square foot expansion of the Company's  facilities
     in Lancaster, Pennsylvania, and for manufacturing equipment.

     The Bonds are secured by a letter of credit expiring October 18, 2011 and a
     mortgage  on the related  properties  pledged as  collateral.  The net book
     value of the land and  building  covered by the  mortgage is  approximately
     $1,697,000 at July 30, 2006.

(d)  In June 2006, the Company  entered into a loan agreement with DeLage Landen
     Financial  Services,  Inc. through  Microsoft  Capital  Corporation for the
     principal  sum of  $1,626,501.  The note is payable in  thirty-six  monthly
     payments of approximately  $45,181  including imputed interest at 6.75% per
     annum.  Proceeds  of the loan were used to  license  certain  software  and
     related maintenance fees from Microsoft Corporation.

(e)  In connection  with the  acquisition  of EWST as of September 1, 2002,  the
     Company issued a note for 1,000,000 Pounds Sterling,  including interest at
     1.8%,  payable in annual  installments of 333,334 Pounds Sterling beginning
     October 1, 2003. The note was paid in full on October 1, 2005.

The Company  paid  interest in 2006,  2005 and 2004 of  approximately  $291,000,
$304,000 and $314,000, respectively.

Future payments required on long-term debt are as follows (in thousands):
<TABLE>
<CAPTION>
                          Fiscal year ending during:  Amount
                                     <S>                  <C>
                                     2007                 $ 630
                                     2008                   779
                                     2009                 2,772
                                     2010                   265
                                     2011                   135
                                    Future                1,997
                                                          -----
                                                        $ 6,578
                                                          =====
</TABLE>
                                      F-22
<PAGE>
NOTE I - ACCOUNTS PAYABLE AND ACCRUED EXPENSES

     Accounts payable and accrued expenses include the following (in thousands):
<TABLE>
<CAPTION>
                                              July 30,    July 31,
                                                2006        2005

<S>                                         <C>         <C>
Accounts payable                            $   10,039  $   13,756
Accrued payroll, bonuses and related costs       5,563       5,010
Accrued commissions                              1,525       1,643
Accrued royalties                                   46          37
Accrued legal and accounting fees                  639         533
Accrued rent expense                             1,448         996
Unearned income                                     38          56
Other accrued expenses                           2,205       1,647
                                              ---------   ---------
                                            $   21,503  $   23,678
                                              =========   =========
</TABLE>


NOTE J - EMPLOYEE BENEFIT PLANS

     In August 1985,  the Board of Directors  approved an Employee  Savings Plan
     ("Plan")  which  qualified  as a thrift  plan under  Section  401(k) of the
     Internal Revenue Code. This Plan, as amended and restated, allows employees
     to  contribute  between 2% and 30% of their  salaries to the Plan.  For the
     Plan year beginning August 1, 2005, the Plan was amended to be considered a
     "Safe  Harbor"  plan,  where  a  contribution  will  be  made  to  eligible
     participants in an amount equal to 100% of the amount of each participant's
     elective deferral that does not exceed 3% of compensation,  plus 50% of the
     amount of the elective  deferral  that exceeds 3% of  compensation  up to a
     maximum  contribution  of  5%  of  compensation.   Under  the  Safe  Harbor
     provision,  all contributions are 100% vested when made. Additional Company
     contributions  can be made  depending  on profits.  The  aggregate  benefit
     payable to an  employee is  dependent  upon his rate of  contribution,  the
     earnings of the fund,  and the length of time such employee  continues as a
     participant.   The  Company  has  recognized   expenses  of   approximately
     $1,773,000 (including approximately $727,000 related to the acquisitions of
     MSI, ICI and RSS), $1,038,000 (including  approximately $268,000 related to
     the  acquisitions of MSI, ICI and RSS), and $618,000 under the Plan for the
     fifty-two  weeks  ended July 30,  2006,  July 31,  2005 and August 1, 2004,
     respectively.  The Company also  contributed to a similar plan through EWST
     whereby the Company matches employee elective contributions up to a maximum
     of 5% of  compensation.  Expenses  recognized for 2006,  2005 and 2004 were
     approximately $55,900, $60,600 and $72,000, respectively.

     The  Company's   Israeli   subsidiary   provides  for  employee   severance
     liabilities pursuant to the Israeli severance pay law and labor agreements.
     The Company's liability is fully provided for by monthly payments deposited
     with  insurers  and by a reserve  established  by the  Company to cover the
     portion  of this  liability  not  covered  by the  Company's  deposits.  In
     addition  to  recognizing  an  expense  for the  funding  to the  insurance
     programs for this severance obligation, the Company also records as expense
     the net increase in its unfunded  severance  liability.  The  liability for
     this  unfunded   severance   obligation  is  carried  in  Other   Long-Term
     Liabilities  on  the  accompanying  Consolidated  Balance  Sheets  and  was
     $1,265,000 and $1,042,000 at July 30, 2006 and July 31, 2005, respectively.
     The total  expense  recognized  for employee  severance  programs in Israel
     (both the funded and unfunded  portion of the  program)  was  approximately
     $223,000,  $110,000  and  $313,000  for fiscal  years 2006,  2005 and 2004,
     respectively.

NOTE K - RELATED PARTY TRANSACTIONS

     Effective  October  12,  2006  and as a  condition  to  entering  into  the
     Administrative  Agreement  with the  Department  of the Navy,  the  Company
     entered into an agreement  with Lee N. Blatt to  terminate  the  Employment
     Agreement  between the Company and Mr.  Blatt dated as of July 29, 2002 and
     modified on December 9, 2003 (See Note A.1).

     In  connection  with  the  move of the  Amityville  facilities  of  General
     Microwave  Corporation in fiscal 1999,  the Company  entered into a 10 year
     lease  agreement  with a  partnership  owned  by the  children  of  certain
     officers of the Company. The lease provides for initial minimum annual rent
     of $312,000 subject to escalation of  approximately 4% annually  throughout
     the 10 year term.  Additionally,  in March 2000,  the Company  entered into
     another 10 year lease with the same  partnership for additional  space. The
     initial  minimum  annual  rent of  $92,000  is  subject  to  escalation  of
     approximately 4% annually.


                                      F-23
<PAGE>
NOTE L - COMPUTATION OF PER SHARE EARNINGS

     The following  table shows the components  used in the calculation of basic
     earnings per share and earnings per share  assuming  dilution (in thousands
     except per share data):
<TABLE>
<CAPTION>
                                                           Fifty-two weeks ended
                                                  --------------------------------------------
                                                     July 30,       July 31,        August 1,
                                                       2006           2005            2004
                                                  -------------  -------------   -------------
     <S>                                               <C>            <C>             <C>
     Numerator:
Net Income                                             $10,354        $10,781         $13,673
                                                  =============  =============   =============

     Denominator:
Basic weighted-average shares                           14,463         14,310          14,105
Effect of dilutive securities:
     Employee stock options                                634            659             791
                                                  -------------  -------------   -------------
Diluted weighted-average shares                         15,097         14,969          14,896
                                                  =============  =============   =============

Stock options not included in computation                1,722            807               4
                                                  =============  =============   =============
</TABLE>
     The number of stock options not included in the  computation of diluted EPS
     relates to stock options having  exercise prices which are greater than the
     average market price of the common shares during the period, and therefore,
     are anti-dilutive. The options, which were outstanding as of July 30, 2006,
     expire at various dates through February 4, 2015.

NOTE M - SHAREHOLDERS' EQUITY

     The authorized shares of Common Stock of the Company are 20,000,000 shares.

     Summary of Stock Option Plans

     In August 2006,  the Board of Directors  ratified and approved the 2006 New
     Employee  Stock Option Plan which covers  250,000  shares of the  Company's
     common  stock.  Options  granted  under  the plan are  non-qualified  stock
     options.  Under the  terms of the  plan,  the  exercise  price for  options
     granted  under the plan will be the fair market value at the date of grant.
     The nature and terms of the  options to be granted  are  determined  at the
     time of grant by the Compensation Committee or the Board of Directors.  The
     options  expire no later than ten years from the date of grant,  subject to
     certain restrictions. Options for 33,000 shares were granted under the plan
     during the fiscal year ended July 30, 2006.  Options for 217,000  shares of
     common stock are available for grant under the plan as of July 30, 2006.

     In March 2003,  the Board of Directors  approved the 2003 Stock Option Plan
     which  covers  1,000,000  shares of the  Company's  common  stock.  Options
     granted under the plan are non-qualified stock options.  Under the terms of
     the plan, the exercise price for options granted under the plan will be the
     fair market value at the date of grant. The nature and terms of the options
     to be  granted  are  determined  at the time of  grant by the  Compensation
     Committee or the Board of Directors.  The options  expire no later than ten
     years from the date of grant, subject to certain restrictions.  Options for
     16,300 and  993,500  shares were  granted  under the plan during the fiscal
     years ended July 30, 2006 and July 31, 2005, respectively.  No options were
     granted  under this plan during  fiscal year ended August 1, 2004.  Options
     for 1,700 shares of common stock are  available for grant under the plan as
     of July 30, 2006.

     In September  2000,  the Board of Directors  approved the 2000 Stock Option
     Plan which covers 1,500,000  shares of the Company's common stock.  Options
     granted under the plan are non-qualified stock options.  Under the terms of
     the plan, the exercise price for options granted under the plan will be the
     fair market value at the date of grant. The nature and terms of the options
     to be  granted  are  determined  at the time of  grant by the  Compensation
     Committee or the Board of Directors.  The options  expire no later than ten
     years from the date of grant, subject to certain restrictions.  Options for
     18,000 and 53,000  shares  were  granted  under the plan  during the fiscal
     years ended July 30, 2006 and July 31, 2005, respectively.  No options were
     granted  under this plan during  fiscal year ended August 1, 2004.  Options
     for 4,250 shares of common stock are  available for grant under the plan as
     of July 30, 2006.

                                      F-24
<PAGE>
     In April 1998,  the Board of Directors  approved the 1998 Stock Option Plan
     which  covers  2,250,000  shares of the  Company's  common  stock.  Options
     granted  under the plan may be  incentive  stock  options  qualified  under
     Section 422 of the  Internal  Revenue Code of 1986 or  non-qualified  stock
     options.  Under the  terms of the  plan,  the  exercise  price for  options
     granted  under the plan will be the fair market value at the date of grant.
     Prices for incentive stock options granted to employees who own 10% or more
     of the Company's  stock are at least 110% of market value at date of grant.
     The nature and terms of the  options to be granted  are  determined  at the
     time of grant by the Compensation Committee or the Board of Directors.  The
     options  expire no later than ten years from the date of grant,  subject to
     certain  restrictions.  Non-qualified  stock options for 9,000,  29,500 and
     40,000  shares were  granted  under this plan during the fiscal years ended
     July 30, 2006, July 31, 2005 and August 1, 2004, respectively.  Options for
     21,529  shares of common stock are available for grant under the plan as of
     July 30, 2006.

     In May 1997,  the Board of  Directors  approved  the 1997 Stock Option Plan
     which  covers  2,500,000  shares of the  Company's  common  stock.  Options
     granted  under the plan may be  incentive  stock  options  qualified  under
     Section 422 of the  Internal  Revenue Code of 1986 or  non-qualified  stock
     options.  Under the  terms of the  plan,  the  exercise  price for  options
     granted  under the plan will be the fair market value at the date of grant.
     Prices for incentive stock options granted to employees who own 10% or more
     of the Company's  stock are at least 110% of market value at date of grant.
     The nature and terms of the  options to be granted  are  determined  at the
     time of grant by the Compensation Committee or the Board of Directors.  The
     options  expire no later than ten years from the date of grant,  subject to
     certain  restrictions.  Non-qualified  stock  options for 2,700,  5,000 and
     7,500  shares were  granted  under this plan during the fiscal  years ended
     July 30, 2006, July 31, 2005 and August 1, 2004, respectively. There are no
     options available for grant under the plan.

     A summary of stock option  activity under all plans for the fifty-two weeks
     ended July 30, 2006, July 31, 2005 and August 1, 2004 is as follows:
<TABLE>
<CAPTION>
Non-Qualified Stock Options                                                       Weighted     Aggregate
                                                                                  Average      Intrinsic
                                               Number         Price Range         Exercise      Value (1)
                                             of shares         per share           Price      (in thousands)
                                             ---------         ---------           -----      --------------
<S>                                           <C>        <C>           <C>          <C>
Outstanding August 3, 2003                    3,298,227  $   4.06  -  19.52        $ 12.33
Granted                                          53,500     17.32  -  20.45        $ 19.38
Exercised                                      (253,598)     4.06  -  19.52        $ 9.88
Cancelled                                       (77,200)     8.38  -  17.67        $ 11.91
                                         ---------------    ---------------- ---------------
Outstanding August 1, 2004                    3,020,929  $   4.06  -  19.52        $ 12.33
Granted                                       1,081,000     17.98  -  19.94        $ 18.29
Exercised                                      (329,349)    16.54  -  20.60        $ 18.55
Cancelled                                       (37,050)     8.38  -  19.83        $ 17.08
                                         ---------------    ---------------- ---------------
Outstanding July 31, 2005                     3,735,530  $   4.06  -  20.45        $ 14.41
Granted                                          79,000     16.61  -  21.18        $ 19.11
Exercised                                      (272,429)     4.31  -  19.83        $ 11.73
Cancelled                                       (52,021)    17.98  -  20.45        $ 19.64
                                         ---------------    ---------------- ---------------
Outstanding July 30, 2006                     3,490,080  $   4.06  -  21.18        $ 14.65         $1,802
                                         ===============                                      =============
Exercisable July 30, 2006                     3,275,880                            $ 14.41         $1,802
                                         ===============                                      =============
Vested and expected to vest July 30, 2006     3,456,375                            $ 14.62         $1,802
                                         ===============                                      =============
<FN>
(1)  There are 2,143,900  vested  options with exercise  prices greater than the
     closing stock price of $10.87 as of July 30, 2006.
</FN>
</TABLE>
                                      F-25
<PAGE>
     Options  outstanding  and  exercisable  by price range as of July 30, 2006,
     with  expiration  dates  ranging from January 3, 2007 to May 2, 2015 are as
     follows:
<TABLE>
<CAPTION>
                                             Average            Weighted                            Weighted
     Range of Exercise        Number        Remaining            Average           Number            Average
           Prices          Outstanding    Contractual Life     Exercise Price    Exercisable     Exercise Price
     -----------------     -----------    ----------------     --------------    -----------     --------------
     <S>                     <C>              <C>                  <C>            <C>                  <C>
     $   4.06 - 10.46        1,124,980        3.64                 $  9.27        1,124,980            $  9.27
        10.50 - 17.50          680,100        4.68                 $ 13.35          663,100            $ 13.25
        17.98 - 17.98          844,000        6.15                 $ 17.98          708,800            $ 17.98
        18.57 - 19.66          714,500        5.00                 $ 19.49          677,000            $ 19.51
        19.83 - 21.18          126,500        4.04                 $ 19.98          102,000            $ 19.84
                        ---------------                      --------------   --------------   ----------------
     $ 4.06  -  21.18        3,490,080        4.74                 $ 14.65        3,275,880            $ 14.41
                        ===============                                       ==============
</TABLE>
     In April 2005, the Company's Board of Directors, upon recommendation of the
     Board's  Compensation  Committee,  approved the accelerated  vesting of all
     unvested and  "out-of-the-money"  stock  options  outstanding  as of May 2,
     2005. See Note A-14 of Notes to Consolidated Financial Statements.

NOTE N - SIGNIFICANT  SEGMENTS,  MAJOR  CUSTOMERS,  EXPORT SALES AND  GEOGRAPHIC
INFORMATION

     The Company's  chief  operating  decision  makers are  considered to be the
     Chairman/Chief   Executive   Officer  and  the  President.   The  Company's
     Chairman/Chief  Executive Officer and President  evaluate both consolidated
     and  disaggregated  financial  information,  primarily gross  revenues,  in
     deciding   how  to  allocate   resources   and  assess   performance.   The
     Chairman/Chief   Executive   Officer   and   President   also  use  certain
     disaggregated  financial  information for the Company's product groups. The
     Company does not determine a measure of operating income or loss by product
     group.  The  Company's  product  groups  have  similar  long-term  economic
     characteristics,  such as  application,  and are  similar in regards to (a)
     nature of products and production processes,  (b) type of customers and (c)
     method used to distribute products.  Accordingly, the Company operates as a
     single  integrated  business  and as such has one  operating  segment  as a
     provider of complex  microwave  radio  frequency (RF) and  millimeter  wave
     components and subsystems for defense and commercial  customers  worldwide.
     All of the Company's revenues result from sales of its products.

     Revenues  for fiscal  years 2006,  2005 and 2004 were as  follows:  defense
     electronics, $159,717,000, $138,071,000 and $113,172,000, respectively; and
     commercial   technologies,   $16,551,000,   $13,344,000,   and  $8,982,000,
     respectively.  Defense electronics revenues in fiscal 2006 include revenues
     of $43,386,000  attributable to the acquisitions of RSS, MSI and ICI during
     fiscal 2005,  compared to revenues of $25,769,000  in fiscal 2005.  Also in
     fiscal 2006,  defense  electronics  includes  revenues of  $6,660,000,  and
     commercial  technologies includes revenue of $8,798,000 attributable to the
     CTI  acquisition  in fiscal  2004.  In  fiscal  2005,  defense  electronics
     includes  revenues of  $6,660,000,  and  commercial  technologies  includes
     revenue of $8,633,000 attributable to the CTI acquisition (See Note B).

     Net sales  directly to the U.S.  Government  in fiscal 2006,  2005 and 2004
     accounted for  approximately  22%, 25% and 17% of net sales,  respectively.
     Approximately 67% of our net sales for fiscal 2006 and 65% of our net sales
     for fiscal 2005 were made to United  States  government  agencies and their
     contractors  and  subcontractors  for defense  programs.  Northrop  Grumman
     accounted  for  approximately  11% of net  sales in fiscal  2005.  No other
     customer  accounted for shipments of 10% or more of consolidated  net sales
     during the periods  presented.  Foreign  sales  amounted  to  approximately
     $41,817,000 (24%),  $40,460,000 (27%) and $39,716,000 (33%) in fiscal 2006,
     2005 and 2004, respectively.

                                      F-26
<PAGE>
     Geographic net sales based on place of contract performance were as follows
     (in thousands):
<TABLE>
<CAPTION>
                                                 2006             2005              2004
                                                 ----             ----              ----
                <S>                         <C>               <C>              <C>
                United States               $ 155,057         $ 131,326        $ 100,746
                Israel                         14,048            12,738           12,305
                England                         7,163             7,351            9,103
                                            ---------         ---------        ---------
                                            $ 176,268         $ 151,415        $ 122,154
                                              =======           =======          =======
</TABLE>

                                      F-27
<PAGE>
Net  property,  plant  and  equipment  by  geographic  area was as  follows  (in
thousands):
<TABLE>
<CAPTION>
                                                 2006             2005
                                                 ----             ----
                <S>                          <C>               <C>
                United States                $ 25,243          $ 24,318
                Israel                          4,654             4,376
                England                           581               767
                                             --------          --------
                                             $ 30,478          $ 29,461
                                               ======            ======
</TABLE>

NOTE O - DERIVATIVE FINANCIAL INSTRUMENTS

     In October 2001, the Company entered into an interest rate swap with a bank
     pursuant to which it exchanged  floating rate  interest in connection  with
     the Bonds  discussed  in Note H on a notional  amount of  $3,000,000  for a
     fixed  rate of 4.07% for a 10 year  period  ending  October  1,  2011.  The
     notional  amount  reduces each year in tandem with the annual  installments
     due on the Bonds.  The fixing of the interest rate for this period  offsets
     the Company's exposure to the uncertainty of floating interest rates on the
     Bonds,  and as such has been designated as a cash flow hedge.  The hedge is
     deemed to be highly effective and any ineffectiveness will be recognized in
     interest  expense in the reporting  period.  The fair value of the interest
     rate swap was a  liability  of  $30,000 as of July 30,  2006.  There was no
     material  hedge  ineffectiveness  related  to cash flow  hedges  during the
     period to be recognized in earnings. There was no gain or loss reclassified
     from accumulated other comprehensive income into earnings during the fiscal
     year ended July 30, 2006 as a result of the  discontinuance  of a cash flow
     hedge due to the  probability of the original  forecasted  transaction  not
     occurring.

NOTE P - FAIR VALUES OF FINANCIAL INSTRUMENTS

     The  following  methods  and  assumptions  were  used  by  the  Company  in
     estimating its fair value disclosures for financial instruments:

          Cash and cash equivalents: The carrying amount reported in the balance
          sheet for cash and cash equivalents approximated its fair value.

          Long-term  debt:  The fair value of the mortgage  note and  industrial
          revenue bonds (including the related interest rate swap) was estimated
          using  discounted cash flow analyses,  based on the Company's  current
          incremental   borrowing   rate  for   similar   types   of   borrowing
          arrangements.

     The carrying amounts and fair values of the Company's financial instruments
     are presented below (in thousands):
<TABLE>
<CAPTION>
                                                     July 30, 2006
                                       ---------------------------------------
                                         Carrying Amount           Fair Value
                                       --------------------    ---------------
<S>                                     <C>                    <C>
Cash and cash equivalents                $      22,303         $    22,303
Long-term debt                                   5,948              6,029
</TABLE>

                                      F-28
<PAGE>
NOTE Q - QUARTERLY RESULTS (UNAUDITED)

     The following is a summary of the unaudited quarterly results of operations
     for the  fifty-two  weeks  ended  July  30,  2006  and  July  31,  2005 (in
     thousands, except for per share data).
<TABLE>
<CAPTION>
2006                                      October 30,          January 29,         April 30,       July 30,
                                             2005                 2006               2006            2006
                                          -----------         -----------          ---------      ----------
<S>                                    <C>                          <C>               <C>            <C>
Net sales                              $         41,938             45,839            45,689         42,802
Gross profit                                     14,125             13,488            10,953          9,781

Net income                             $          3,975              3,964             1,702            713
                                                  =====              =====             =====            ===
Earnings per common share - Basic      $           0.28               0.27              0.12           0.05
                                                   ====               ====              ====           ====
Basic weighted average shares                    14,446             14,474            14,569         14,363
                                                 ======             ======            ======         ======
Earnings per common share - Diluted    $           0.26               0.26              0.11           0.05
                                                   ====               ====              ====           ====
Diluted weighted average shares                  15,240             15,091            15,398         14,828
                                                 ======             ======            ======         ======

2005                                       October 31,         January 30,          May 1,         July 31,
                                              2004                2005               2005            2005
                                          -----------          -----------         ---------      ----------
Net sales                              $         33,590             33,754            41,266         42,805
Gross profit                                     10,806              9,349            13,421         11,398

Net income                             $          3,553              2,077             3,627          1,524
                                                  =====              =====             =====          =====
Earnings per common share - Basic      $           0.25               0.14              0.25           0.11
                                                   ====               ====              ====           ====
Basic weighted average shares                    14,252             14,335            14,313         14,340
                                                 ======             ======            ======         ======
Earnings per common share - Diluted    $           0.24               0.14              0.24           0.10
                                                   ====               ====              ====           ====
Diluted weighted average shares                  14,936             15,044            14,936         14,952
                                                 ======             ======            ======         ======
</TABLE>
     The  gross  profit   margin  in  the  third  quarter  of  2006  was  24.0%.
     Contributing to the reduction versus previous quarters were (a) development
     cost overruns on certain contracts in excess of billings to customers,  (b)
     startup production costs on certain programs, (c) the cumulative effects of
     changes in contract costs estimates on certain programs accounted for under
     the  percentage   completion  method  of  accounting  and  (d)  engineering
     development costs in connection with the Xytrans license agreement.

     During the fourth  quarter of 2006 the gross profit  margin was 22.9%.  The
     margin was impacted by (a) high development  costs on certain key programs,
     (b) startup production costs on certain programs,  (c) an increase in lower
     margin  cost  reimbursable  contracts  at  one of our  facilities  and  (d)
     billable costs under a cost reimbursable contract that provided no margin.

     The third and fourth quarters of fiscal 2005 includes revenue  attributable
     to the acquisitions of MSI of $5,294,000 and $2,824,000,  respectively, and
     ICI of $3,401,000 and $8,389,000, respectively.

                                      F-29
<PAGE>

     The gross margin  percentage in the fourth  quarter of 2005 was  negatively
     impacted  due to  revisions  in total cost  estimates  on certain long term
     contracts at our EWST  subsidiary  which resulted in negative gross profit.
     In addition,  the gross  profit  margin also varies from quarter to quarter
     due to changes in product mix.

     Included in the  results of the third  quarter of fiscal 2005 is an accrual
     of  $260,000,  which was paid in the fourth  quarter of 2005 in  connection
     with the Robinson Labs litigation.

                                   **********


                                      F-30