<PAGE>
                                  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 [FEE REQUIRED]
                                   For the fiscal year ended August 3, 1997

                                                      OR
    [ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
             SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
             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.)

     10 Industry Drive, Lancaster, Pennsylvania                17603
     ------------------------------------------              ----------
     (Address of Principal Executive Offices )               (Zip Code)

     Registrant's telephone number, including area code:    (717) 397-2777
                                                            --------------

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

 Title of each class                      Name of Exchange on which registered
         None                                             None

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

                          Common Stock, $ .10 par value
                          -----------------------------
                                (Title of Class)

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 (ss.229.405 of this chapter) 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]

Based on the closing  sale price of $13.875 as of October 1, 1997 the  aggregate
market value of the voting stock held by  non-affiliates  of the  registrant was
$36,423,859.

The number of shares  outstanding of registrant's  common stock, $ .10 par value
as of October  1, 1997 was  4,539,729  (after a 4-for-3  stock  split  effective
September 30, 1997).

Documents incorporated by reference:
Registrant's  definitive  proxy statement to be filed pursuant to Regulation 14A
of the Securities Exchange Act of 1934.


<PAGE>

                                            HERLEY INDUSTRIES, INC.

                                               TABLE OF CONTENTS


                                                                           Page
PART I
       Item 1     Business                                                  1
       Item 2     Properties                                                8
       Item 3     Legal Proceedings                                         8
       Item 4     Submission of Matters to a Vote of Security Holders       8

PART II
       Item 5     Market for Registrant's Common Equity and Related
                     Stockholder Matters                                    9
       Item 6     Selected Financial Data                                   9
       Item 7     Management's Discussion and Analysis of Financial
                     Condition and Results of Operations                    10
       Item 8     Financial Statements and Supplementary Data               13
       Item 9     Changes in and Disagreements with Accountants on
                     Accounting and Financial Disclosure                    13
PART II
       Item 10    Directors and Executive Officers of the Registrant        13
       Item 11    Executive Compensation                                    13
       Item 12    Security Ownership of Certain Beneficial
                     Owners and Management                                  13
       Item 13    Certain Relationships and Related Transactions            13

PART IV
       Item 14    Exhibits, Financial Statement Schedules and Reports
                  on Form 8K                                                14

SIGNATURES                                                                  15

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES                   F-1


<PAGE>

PART I

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  the Company's  financial  position,  business  strategy and plans and
objectives   of   management   of  the  Company  for  future   operations,   are
forward-looking  statements.  When used in this  Annual  Report,  words  such as
"anticipate," "believe," "estimate," "expect," "intend" and similar expressions,
as they  relate  to the  Company  or its  management,  identify  forward-looking
statements.  Such  forward-looking  statements  are based on the  beliefs of the
Company's  management,  as well as assumptions made by and information currently
available to the Company's  management.  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,   technological   change  or
difficulties,   product   development   risks,   commercialization   and   trade
difficulties  and  general  economic  conditions.  Such  statements  reflect the
current  views of the Company with  respect to future  events and are subject to
these and other risks, uncertainties and assumptions relating to the operations,
results of  operations,  growth  strategy  and  liquidity  of the  Company.  All
subsequent  written  and oral  forward-looking  statements  attributable  to the
Company  or  persons  acting on its  behalf  are  expressly  qualified  in their
entirety by this paragraph.


Item 1.  Business

Herley  Industries,  Inc.  ("Herley"  or  the  "Company")  principally  designs,
manufactures and sells flight instrumentation  components and systems, primarily
to the U.S.  government,  foreign governments,  and aerospace companies.  Flight
instrumentation  products  include  command and control  systems,  transponders,
flight termination receivers,  telemetry transmitters and receivers,  pulse code
modulator   ("PCM")  encoders  and  decoders,   and  scoring   systems.   Flight
instrumentation  products are used to: (i) accurately  track the flight of space
launch  vehicles,   targets,  and  unmanned  airborne  vehicles  (UAV's),   (ii)
communicate between ground systems and the airborne vehicle, (iii) if necessary,
destroy the vehicle if it is veering from its planned trajectory, and (iv) train
troops and test weapons.

The  Company's  command  and control  systems  are used on training  and testing
ranges in the U. S. and foreign  countries.  The Company has an established base
of  approximately  100 command and control systems  installed  around the world,
which  are  either  shelter  mounted  or  portable  radar  units.   Herley  also
manufactures microwave devices used in its flight  instrumentation  products and
in connection with the radar and defense  electronic systems on tactical fighter
aircraft.

The Company has grown internally and through selected acquisitions.  As a result
of  acquisitions  made by the  Company in the past five  years,  the Company has
evolved  from a  components  to a systems  manufacturer  and has  broadened  its
interests to the commercial and  international  markets.  Since its inception in
1965,  the Company has designed and  manufactured  microwave  devices for use on
various tactical military  programs.  In June 1986, the Company acquired a small
engineering company, Mission Design, Inc., engaged in the design and development
of  transponders.  This  acquisition  enabled  the  Company  to enter the flight
instrumentation  business  beginning  with the design and  manufacture  of range
safety transponders.  In September 1992, the Company acquired  substantially all
of the  assets of  Micro-Dynamics,  Inc.  ("MDI") of  Woburn,  Massachusetts,  a
microwave  subsystem  designer  and  manufacturer.  In June  1993,  the  Company
acquired Vega Precision  Laboratories,  Inc. ("Vega") of Vienna,  Virginia,  and
moved the operations to Lancaster,  Pennsylvania in October 1993. In March 1994,
the Company  entered into an exclusive  license  agreement for the  manufacture,
marketing  and sale of the Multiple  Aircraft GPS  Integrated  Command & Control
(MAGIC2)  systems.  In July 1995,  the Company  acquired  certain assets and the
business  of  Stewart  Warner   Electronics  Corp.  of  Chicago,   Illinois,   a
manufacturer of high frequency  radio and IFF  interrogator  systems.  In August
1997,

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the Company acquired Metraplex Corporation ("Metraplex") of Frederick, Maryland,
which has enabled the Company to enter the  airborne  PCM and FM  telemetry  and
data acquisition systems market.

With these  recent  acquisitions,  the  Company has four  operating  facilities;
HERLEY-VEGA SYSTEMS ("HVS"),  operating in Lancaster,  Pennsylvania;  HERLEY-MDI
("MDI")  operating in Woburn,  Massachusetts,  Stewart  Warner  Electronics  Co.
("SWE") operating in Chicago,  Illinois;  and Metraplex Corporation operating in
Frederick,  Maryland.  In January 1996 the Company  created its Global  Security
Systems  ("GSS")  division,  a  marketing  group,  to  serve  the  international
marketplace.

Products

         Command and Control Systems (C 2S)

For over  thirty  years,  Vega  has been  manufacturing  products  in the  radar
enhancement  field. The Company's  command and control systems have been used to
fly remotely a large variety of unmanned  aerial  vehicles,  typically  aircraft
used as target  drones or Remotely  Piloted  Vehicles  ("RPVs") and some surface
targets.  Operations have been conducted by many users on the open ocean, remote
land masses, and instrumented test and training ranges.

The Company  believes  that its command and  control  systems are  currently  in
service  throughout  the world.  The  Company's  pulse-positioned-coded  ("PPC")
concept  enables  the use of  standard  radar  technology  to track and  control
unmanned vehicles. Using the radar beacon mode, PPC pulse groups are transmitted
and received  for transfer of command and  telemetry  data while  employing  the
location precision and advantages of radar techniques.

Command and control  systems  permit a ground  operator to fly a target or a UAV
through a pre-planned mission. That 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 C2S 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.

With the 1994  licensing of the MAGIC2  systems,  the Company has  increased the
selection of command and control  systems that it offers.  The 6104 TTCS (Target
Tracking  and  Control  System)  unit is a  reliable  line-of-sight  C2S with an
installed base of equipment worldwide. The Company's engineers and marketers are
now able to offer the MAGIC2 system as a supplement to, or replacement for, this
installed base of equipment.  The MAGIC2 affords over-the-horizon C2 S using GPS
guidance and control of multiple  targets from a single  ground  station.  Thus,
control of multiple  targets at increased  distances  represents  a  significant
product improvement.  The increasing demand for enhanced performance by the U.S.
Navy as well as foreign navies in littoral warfare  scenarios can be ideally met
by the use of the MAGIC2 system.

The new Model 6104 TTCS 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 system is delivered
with the necessary  command panels and graphics display software to operate with
a large variety of vehicles.  A basic TTCS  configuration  is normally  supplied
with a  standard  command  panel  and  the  software  peculiar  to one  vehicle.
Telemetry display software is embedded for the specified vehicle, and a magnetic
hard drive is supplied with a mission map prepared in accordance with a customer
supplied detailed map of the area.

Military  surveillance  operations  typically use UAVs, RPVs, or drones to avoid
the cost and risk of manned surveillance vehicles in the event of an accident or
if the vehicle is shot down. These  inexpensive  drones are controlled in flight
by a Company  C2 S,  which may be  mounted  in a trailer  that may be moved from
place to place by  helicopter  or truck.  The  Company  also  supplies  portable
command  and  control  systems  that are  mounted on tripods  that can be easily
transported by an operational  team. The portable units permit ready  deployment
in rugged terrain and may also be used on ships during open ocean exercises.

                                        2

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In recent years, teaming arrangements between prime military contractors and the
Company have increased.  Large companies bidding on major programs seek to align
themselves with parts and systems manufacturers such as the Company for economic
reasons  as well as for  the  technical  expertise  afforded  by such  alliance.
Teaming  arrangements with Tracor  Corporation and Northrop Grumman  Corporation
have  resulted  in  recent  awards  to the  Company  for C2 S in  Australia  and
Singapore  and  the  Company  is  presently   negotiating   additional   teaming
arrangements.

         Telemetry Systems

Missile,  UAV,  or target  testing on  domestic  and  international  test ranges
require  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 C2 S uplink to accomplish their
mission.  The Company has 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 key to the success of the mission.

In 1972 Metraplex  began  developing data encoding and  acquisition,  and signal
conditioning  equipment.  The Company  believes that  Metraplex is now a leading
manufacturer  of PCM and FM telemetry  and data  acquisition  systems for severe
environment  applications.  Metraplex  products are used  worldwide  for testing
space launch vehicle  instrumentation,  aircraft flight testing,  and amphibian,
industrial and automotive  vehicle testing.  A product  portfolio ranges in size
and  complexity  from  miniature   encoders  to  completely   programmable  data
acquisition systems.

The Company's recent  acquisition of Metraplex will allow the Company to offer a
complete  airborne  telemetry  system  package.  With the digital  experience of
Metraplex in data  encoding and  acquisition  elements  combined  with the radio
frequency capability of the Company in providing its telemetry  transmitters and
flight  termination  receivers,  the  Company can offer a full line of narrow or
wide band airborne  telemetry  systems to meet a wide variety of industry needs,
both domestically and internationally.

         Transponders

The Company manufactures a variety of expendable  transponders,  including range
safety,  identification friend or foe ("IFF"),  command and control, and 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
sends back a reply on a different frequency and signal level. This reply will be
a strong,  noise free signal upon which the tracking  radar can "lock",  and one
which is far superior to skin reflection tracking.

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),  the Herley  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.  The use of the transponder is far more effective than
simple skin reflection  tracking,  particularly under adverse weather conditions
after the launch.

IFF transponders, which are used in conjunction with the FAA 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

                                        3

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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  ("FTR") is  installed in a test  missile,  UAV,
target or a 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 destroy the vehicle.  A
Range Safety Officer ("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
harmlessly.  The FTR can be programmed  for complex  combinations  of audio tone
frequencies so that it will not accidentally  explode the vehicle,  but will not
fail to explode the vehicle when so commanded.

         Microwave Devices

Herley   manufactures   solid  state   microwave   devices  in  both  Lancaster,
Pennsylvania  and at its MDI  facility in Woburn,  Massachusetts  for use in its
transponders and in existing long-term  military  programs,  both as part of new
production and for spare parts and repair services.  These microwave devices are
used in a variety of radar,  communications and missile applications,  including
airborne and shipboard navigation and missile guidance systems.

At MDI,  the  Company  designs and  manufactures  complex  microwave  integrated
circuits ("MICs"),  which consist of sophisticated  assemblies that perform many
functions, primarily involving switching of microwave signals. MICs manufactured
by the Company are employed in many defense electronics military systems as well
as missile programs.

The Company also produces  receiver  protector  devices at MDI. 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.  With the
contraction  of the defense  business,  the Company  believes that it has only a
single competitor in this market.

In its Chicago  facility,  the Company designs and  manufactures  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.

New Product Development and Applications

The Company  believes that its growth depends on its ability to renew and expand
its  technology,  products,  and  design  and  manufacturing  processes  with an
emphasis on cost  effectiveness.  The Company's  primary  efforts are focused on
engineering design and product development activities rather than pure research.
A substantial portion of the Company's  development  activities have been funded
by the Company's customers.  Certain of the Company's officers and engineers are
involved  at various  times and in  varying  degrees  in these  activities.  The
Company's policy is to assign the required engineering and support people, on an
ad hoc basis, to new product development as needs and budgets require.  The cost
of  these  development  activities,  including  employees'  time  and  prototype
development, net of amounts paid by

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customers,  were approximately  $1,828,000,  $1,453,000,  and $970,000 in fiscal
1997, 1996, and 1995, respectively.

Over the past two years,  the Company has been seeking  commercial  applications
for its magnetron tube  capability.  In 1995,  the Company signed  agreements to
develop miniature  cost-effective  magnetron tubes,  using  electrode-less  high
density ("EHD") techniques,  for medical and industrial  lighting  applications.
The Company believes that its partner in this joint  engineering  program is one
of the largest  lighting  companies in the world.  Based on initial  engineering
results,  prototype tubes were designed,  manufactured and tested satisfactorily
to the  specifications  required.  The Company  and its  partner  are  currently
planning  limited  production of magnetron tubes to be used in an EHD industrial
lighting application.

The new products and systems that the Company plans to design,  manufacture  and
sell are data link systems, which encompass telemetry systems and telemetry data
encoders.  These  products are  currently  being sold by others to the Company's
existing  customers.  Together  with  transponders,  they comprise the principal
airborne flight instrumentation package for space launches. The Company believes
that  transponders  represent  approximately 5% to 10% of the total cost for the
flight   instrumentation   package  on  a  space  launch  vehicle.  The  Company
anticipates sales of these new products to commence April 1998.

         Telemetry Systems

Telemetry systems contain transmitters, amplifiers and receivers and provide the
means of  communication  between the control  tower,  the ground station and the
test or launch vehicle.  Telemetry systems are the equivalent of telephone links
between  the air and ground  portions of launch  vehicles  or test and  training
ranges.  The uplink  communication  to the airborne vehicle is transmitted via a
telemetry signal from the ground to the vehicle.  The telemetry signals are used
to command the airborne  vehicle  through its command control  transponder.  The
transponder will then change the flight control guidance system as directed. The
downlink signals from the airborne telemetry transmitter to the ground telemetry
receiver provide  tracking signals for range safety,  confirmation of the uplink
command and their implementation by the vehicle and compilation of the data from
on-board sensors gathered by the data encoder.

         Telemetry Data Encoders

Airborne  targets and flight test missiles  must have many  critical  parameters
simultaneously  monitored  from  the  ground  to  gain  the  data  required  for
verification of  satisfactory  performance or for  identification  of details of
hardware   requiring   design   improvements.   On-board   sensors  may  measure
temperature,  strain  levels,  vibration  level and  frequency,  acoustic  noise
levels, air pressure,  air velocity,  humidity and other parameters of interest.
The  function  of the  encoder  system is to convert the output of each of these
sensors  to a signal  form that may be  sequentially  sampled  by an  electronic
switch  (multiplexer) in a known sequence and rate so as to create a data stream
that may be transmitted to the ground by the telemetry system.

Government Contracts

A substantial part of the Company's sales are made to U.S.  government  agencies
or prime  contractors  or  subcontractors  on  military or  aerospace  programs.
Government  contracts  are  awarded  either on a  competitive  bid basis or on a
negotiated  sole  source  procurement  basis.  Contracts  awarded on a bid basis
involve several  competitors bidding on the same program with the contract being
awarded  based  upon  price and  ability  to  perform.  Negotiated  sole  source
procurement  is  utilized  if the  Company  is  deemed by the  customer  to have
developed  proprietary equipment not available from other parties or where there
is a very stringent delivery schedule.

All of the Company's  government  contracts are fixed price  contracts,  some of
which require  delivery over time periods in excess of one year.  With this type
of contract,  the Company agrees to deliver products at a fixed price except for
costs incurred because of change orders issued by the customer.


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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.  In  the  event  of  such  a  termination,  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 the Company under the contract to the date of termination plus
a fee based upon the work completed.

Marketing and Distribution

The Company's  marketing approach is to determine  customer  requirements in the
early stages of a program.  Marketing and  engineering  personnel  work directly
with the customer's  engineering  group to develop product  specifications.  The
Company  receives  its awards  based upon an  evaluation  of a number of factors
including  technical  ranking,  price,  overall capability and past performance.
Follow-up  contracts on the same program are normally  negotiated with customers
rather than being subject to a competitive bidding process.

Backlog

The Company's backlog of firm orders was approximately  $36,911,000 on August 3,
1997  ($26,135,000  in domestic  orders and  $10,776,000  in foreign  orders) as
compared to approximately  $23,770,000 on July 28, 1996 ($13,632,000 in domestic
orders  and  $10,138,000  in  foreign  orders).   Management   anticipates  that
approximately  $30,330,000 of the backlog will be shipped during the fiscal year
ending August 2, 1998. There can be no assurance that the Company's backlog will
result  in sales  in any  particular  period  or at all,  or that the  contracts
included in the backlog that result in sales will be profitable.

Manufacturing, Assembly and Testing

Flight  instrumentation  devices  manufactured  by the Company for  military and
space launch applications are subject to stringent testing procedures based upon
customer  requests.  All of such  testing  is  performed  by the  Company at its
Lancaster facility.

All  electronic  parts are  procured in  controlled  lots that are  subjected to
extensive  physical  inspection  and screening at Herley before use in products.
Physical inspection requires the use of high power microscopes and laser scanned
optical  comparators,   which  match  the  characteristics  of  the  part  under
inspection to previously stored images.

The testing of high reliability space equipment is performed by complex computer
controlled consoles that take measurements that continuously monitor and analyze
operating parameters. Flight instrumentation products are tested over their full
operating  temperature  range,  after which the  equipment  is  evaluated  under
combined vibration and temperature  cycling.  For initial design  qualification,
this  testing  may  extend  for  several   months  and  include   evaluation  of
electromagnetic  interference  behavior  (EMI),  ability to survive  pyrotechnic
shock   (simulating   explosive  charge   detonation  for  space  vehicle  stage
separation)  and the  combined  effects of  external  vacuum  with  heating  and
cooling.

Electronic components and other raw materials used in the Company's products are
purchased  by the  Company  from a large  number  of  suppliers  and all of such
materials are readily available from alternate sources.

The  Company  does not  maintain  any  significant  level of  finished  products
inventory.  Raw  materials are  generally  purchased for specific  contracts and
common  components  are purchased  for stock based on the  Company's  firm fixed
backlog.

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

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Competition

The flight  instrumentation  products which the Company manufactures are subject
to varied competition depending on the product and market served. Competition is
generally  based  upon  technology,  design,  price  and past  performance.  The
Company's  ability to compete for defense  contracts  depends,  in part,  on its
ability to offer better  design and  performance  than its  competitors  and its
readiness in  facilities,  equipment  and personnel to undertake to complete the
programs. In certain  products on programs, the Company believes that it is sole
source, which means that all work is directed to a single manufacturer. In other
cases,  there may be other  suppliers who have the capability to compete for the
programs  involved,  but they  can  only  enter or  reenter  the  market  if the
government  should  choose to reopen  the  particular  program  to  competition.
Competition  in follow-on  procurements  is generally  limited  after an initial
award  unless  the  original  supplier  has had  performance  problems.  Many of
Herley's  competitors are larger and may have greater  financial  resources than
the  Company.   Competitors   include  Aydin  Corporation,   L3  Communications,
Microsystems, Inc., AMP, Inc., and REMEC, Inc.

Employees

As of October 12, 1997, the Company employed 286 full-time  persons.  A total of
203 employees were engaged in manufacturing, 38 in engineering, 20 in marketing,
contract  administration  and field  services  and the  balance in  general  and
administrative  functions.  None  of the  Company's  employees  are  covered  by
collective   bargaining  agreements  and  the  Company  considers  its  employee
relations to be satisfactory.

The Company  believes  that its future  success  will  depend,  in part,  on its
continued ability to recruit and retain highly skilled technical, managerial and
marketing personnel.  To assist in recruiting and retaining such personnel,  the
Company has established competitive benefits programs, including a 401k employee
savings plan, and stock option plans.

Intellectual Property

The Company does not presently hold any  significant  patents  applicable to its
products.  In order to protect its  intellectual  property  rights,  the Company
relies on a  combination  of trade  secret,  copyright  and  trademark  laws and
certain employee and third-party  non-disclosure agreements, as well as limiting
access to and distribution of proprietary information. There can be no assurance
that the steps taken by the Company to protect its intellectual  property rights
will be adequate to prevent  misappropriation of the Company's  technology or to
preclude competitors from independently developing such technology. Trade secret
and copyright laws afford the Company limited protection. Furthermore, there can
be no assurance that, in the future,  third parties will not assert infringement
claims against the Company or with respect to its products for which the Company
has  indemnified  certain of its  customers.  Asserting the Company's  rights or
defending  against  third  party  claims  could  involve  substantial  costs and
diversion of resources,  thus  materially and adversely  affecting the Company's
business,  results of operations and financial  condition.  In the event a third
party were  successful in a claim that one of the Company's  products  infringed
its proprietary  rights, the Company would have to pay substantial  royalties or
damages,  remove that product from the marketplace or expend substantial amounts
to modify the product so that it no longer infringe such proprietary rights, any
of which could have a material adverse effect on the Company's business, results
of operations and financial condition.


                                        7

<PAGE>




Item 2.  Properties

The Company's properties are as follows:

                                                                Area      Owned
                                                              Occupied     or
Location                       Purpose of Property            (Sq. Ft.)  Leased
-----------------  ------------------------------------------ ---------  ------
Lancaster, PA (1)  Production, engineering, administrative     71,200    Owned
                   and executive offices
Woburn, MA         Production, engineering and administration  60,000    Owned

Chicago, IL        Production, engineering and administration   9,700    Leased

Frederick, MD      Production, engineering and administration  14,700    Leased

Lancaster, PA      Land held for expansion                     26 Acres  Owned
--------------
     (1) The Company's  executive offices occupy  approximately 4,000 sq. ft. of
space at this facility with  engineering and  administrative  offices  occupying
10,000 sq. ft. each.  The Company  believes that its facilities are adequate for
its current and presently anticipated future needs.

Item 3.  Legal Proceedings

The Company is not involved in any material legal proceedings.

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

        Not Applicable.


                                        8

<PAGE>



PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholders
        Matters

     (a)  The Company's Common Stock is traded in the over-the-counter  National
          Market System under the symbol HRLY.  The  following  table sets forth
          the high and low closing  sales price as reported by NASDAQ - National
          Market  System  for  the  Company's   Common  Stock  for  the  periods
          indicated.

                                                            Common Stock
                                                           High       Low
     Fiscal Year 1996
         First Quarter..................................    4.59      3.66
         Second Quarter.................................    6.19      3.84
         Third Quarter..................................    7.97      5.25
         Fourth Quarter.................................    9.19      6.00
     Fiscal Year 1997
         First Quarter..................................    7.97      6.19
         Second Quarter.................................   10.69      7.31
         Third Quarter..................................    8.91      6.09
         Fourth Quarter.................................   10.69      6.19

     The closing price on October 1, 1997 was $13.875.

     (b)  As of October 1, 1997, there were  approximately  1,000 record holders
          of the Company's Common Stock.
     (c)  There have been no cash  dividends  declared or paid by the Company on
          its Common Stock during the past two years. The above prices have been
          adjusted to give  effect to a 4-for-3  stock  split on  September  30,
          1997.

Item 6. Selected Financial Data

<TABLE>
<CAPTION>

                                                53 Weeks                     52 Weeks ended
                                                  Ended          ----------------------------------------
                                                August 3,     July 28,    July 30,     July 31,      August 1,
                                                   1997        1996         1995         1994          1993
                                                   ----        ----         ----         ----          ----
<S>                                           <C>          <C>          <C>          <C>          <C>

Net revenues                                  $32,195,168  29,001,404   24,450,267   30,508,211   21,334,985
Earnings (loss) from continuing operations    $ 4,803,659   3,668,956   (4,890,166)   1,861,429    1,391,098
Loss from discontinued operations             $     -           -            -            -       (2,463,642)
Cumulative effect of
      accounting change                       $     -           -            -            -        2,081,028
                                               ----------   ---------   ----------    ----------  ----------
Net income (loss)                             $ 4,803,659   3,668,956   (4,890,166)    1,861,429   1,008,484
                                               ==========   =========   ==========    ==========  ==========
Earnings (loss) per common
     and common equivalent share (1):
Continuing operations                              $ 1.01         .86         (.98)          .33         .26
Discontinued operations                               -            -            -             -         (.47)
Change in accounting                                  -            -            -             -          .40
                                                     ----        ----         ----          ----        ----
Net income (loss)                                  $ 1.01         .86         (.98)          .33         .19
                                                     ====        ====         ====          ====        ====

     (1) As adjusted to give effect to a 4-for-3 stock split effective September
30, 1997.

Total Assets                                  $39,257,186  42,508,942   42,229,282    53,752,454  58,813,878
Total Current Liabilities                     $ 9,813,376   7,559,306    9,973,866    10,217,598  14,369,213
Long-Term Debt net of current portion         $ 2,890,000  11,021,000   10,525,000    14,822,834  14,054,128
</TABLE>

                                        9

<PAGE>





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

Overview

The Company principally designs,  manufactures and sells flight  instrumentation
components and systems,  primarily to the U.S. government,  foreign governments,
and aerospace  companies.  Flight  instrumentation  products include command and
control  systems,   transponders,   flight  termination   receivers,   telemetry
transmitters  and  receivers,  PCM encoders and decoders,  and scoring  systems.
Flight instrumentation  products are used to: (i) accurately track the flight of
space launch  vehicles,  targets,  and UAVs,  (ii)  communicate  between  ground
systems and the airborne vehicle, (iii) if necessary,  destroy the vehicle if it
is veering from its planned trajectory, and (iv) train troops and test weapons.

Of the Company's total backlog of $36,911,000 at August 3, 1997,  $26,135,000 is
attributable  to domestic  orders and  $10,776,000  is  attributable  to foreign
orders.  Management  anticipates that  approximately  $30,330,000 of its backlog
will be shipped  during the  fiscal  year  ending  August 2, 1998.  The  Company
includes  in its backlog  only firm  orders for which it has  accepted a written
purchase  order.  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.  In the  event  of such a
termination, 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 the Company  under the  contract to the
date of termination plus a fee based upon work completed.

Substantially all of the Company's contracts are fixed price contracts,  wherein
sales and related costs are generally  recorded as deliveries are made. Many o f
these  contracts  include  options  exercisable  by the customer for  additional
products or systems at a fixed price.  Certain costs under long-term fixed price
contracts,  principally directly or indirectly with the U.S.  Government,  which
include   non-recurring   engineering,   are  deferred  until  these  costs  are
contractually  billable. The failure to anticipate technical problems,  estimate
costs accurately or control costs during a fixed price contract,  including with
respect  to any  option  for  additional  products  or  systems,  may reduce the
Company's  profitability  or cause a loss  under  the  contract.  Revenue  under
certain  long-term,  fixed  price  contracts,  principally  command  and control
shelters, is recognized using the percentage of completion method of accounting.
Revenues  recognized  on these  contracts  are based on estimated  completion to
date,  which is the total contract amount  multiplied by percent of performance,
based on direct labor costs. There were no long-term contracts of this nature as
of August 3, 1997 or July 28, 1996.  Losses,  if any, on contracts  are recorded
when first reasonably determined.

The Company  believes that its growth depends on its ability to renew and expand
its  technology,  products,  and  design  and  manufacturing  processes  with an
emphasis on cost  effectiveness.  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
$1,828,000,  $1,453,000  and  $970,000  in  fiscal  years  1997,  1996 and 1995,
respectively.  Costs of the  Company's  internally  funded  product  development
efforts are  included in the  Company's  operating  expenses as cost of products
sold. Revenue from customer funded product  development is included in net sales
and the related product  development costs also are included in cost of products
sold.

The  Company's  effective  tax rate for fiscal  1996 and 1997 was 2.7% and 9.1%,
respectively,  reflecting  the  utilization  of prior  year net  operating  loss
carryforwards and the reversal of a valuation allowance established in 1995. The
valuation allowance was established based on management's  uncertainty that past
performance would be indicative of future earnings.  In August 1997, the Company
established  a foreign  sales  corporation  as part of an overall  domestic  tax
strategy to reduce its effective  income tax rate. The Company  anticipates that
its effective income tax rate for fiscal 1998 will be approximately 34%.

                                       10

<PAGE>



Results of Operations

The  following  table sets forth for the  periods  indicated  certain  financial
information  derived from the  Company's  consolidated  statements of operations
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.



                                                 52 Weeks ended     53 Weeks
                                                ----------------      ended
                                               July 30,   July 28,  August 3,
                                                 1995       1996       1997
                                                 ----       ----       ----

Net sales                                       100.0 %    100.0 %    100.0 %

Cost of products sold                            74.1 %     68.3 %     64.5 %
                                                 -----      ----       ----
Gross profit                                     25.9 %     31.7 %     35.5 %
Selling and administrative expenses              20.7 %     20.1 %     19.5 %
                                                 -----      ----       ----
Income before unusual item                        5.2 %     11.6 %     16.0 %
Unusual item                                     22.3 %       -         -
                                                 -----      ----       ----

Operating income (loss)                         (17.1)%     11.6 %     16.0 %
                                                 -----      ----       ----

Other income (expense):
      Net gain (loss) on available-for-sale
        securities and other investments         (1.5)%      3.1 %      1.3 %
      Dividend and interest income                2.5 %      1.3 %      0.8 %
      Interest expense                           (3.9)%     (3.0)%     (1.7)%
                                                 -----      ----       -----
                                                 (2.9)%      1.4 %      0.4 %
                                                 -----      ----       -----

Income (loss) before income taxes               (20.0)%     13.0 %     16.4 %
Provision for income taxes                        0.0 %      0.4 %      1.5 %
                                                 -----      ----       ----

Net income (loss)                               (20.0)%     12.7 %     14.9 %
                                                 -----      ----       ----


     Fiscal 1997 Compared to Fiscal 1996

Net sales for the 53 weeks ended August 3, 1997 were  approximately  $32,195,000
compared to $29,001,000 for fiscal 1996. The sales increase of $3,194,000  (11%)
is primarily  attributable to an increase in the sales of flight instrumentation
products, including a Target Tracking Control System for the Republic of Korea.

Gross profit of 35.5% for the 53 weeks ended  August 3, 1997  exceeded the prior
year of 31.7% due to an increase of $2,842,000  in higher  margin  foreign sales
from  $6,556,000  in 1996 to  $9,398,000  in  1997,  as well as an  increase  in
absorption of fixed costs due to the higher sales volume.

Selling and  administrative  expenses for the 53 weeks ended August 3, 1997 were
$6,293,000  compared to  $5,832,000  for fiscal 1996, an increase of $461,000 of
which $360,000 was attributable to settlement and litigation costs involving two
class  action law suits,  $325,000  to  performance  incentives,  and $52,000 to
additional  travel  costs.  These  increases  were  offset  by  a  reduction  in
representative fees on foreign sales

                                       11

<PAGE>



of $205,000  (partially  due to a negotiated  decrease in the rate paid),  and a
reduction of $75,000 in personnel and related  expenses.  As a percentage of net
sales, selling and administrative expenses decreased from 20.1% in 1996 to 19.5%
in 1997.

Other income (expense) for the 53 weeks ended August 3, 1997 decreased  $265,000
from the prior year due to  decreases  in gains on the sale of  investments  and
dividend and interest income of $488,000 and $118,000, respectively, offset by a
decrease in interest expense of $341,000.

The  effective  tax rate in 1997  was  9.1%.  The  1997 and 1996 tax  provisions
reflect the utilization of prior year net operating loss carryforwards.  In 1995
a valuation  allowance had been provided to reduce  deferred tax assets to their
net realizable  value  primarily  based on  management's  uncertainty  that past
performance  would be  indicative  of  future  earnings.  In 1997 the  valuation
allowance was reversed through the deferred tax provision.  A determining factor
in assessing the change was the  cumulative  income in recent years.  See Note I
entitled "Income Taxes" to the Consolidated Financial Statements.

    Fiscal 1996 Compared to Fiscal 1995

Net sales for the 52 weeks  ended July 28, 1996 were  approximately  $29,001,000
compared to  $24,450,000  for fiscal  1995.  The sales  increase  of  $4,551,000
(18.6%) is  attributable  to an increase of  approximately  $5,845,000 in flight
instrumentation  products,  of which Stewart Warner Electronics Co., acquired in
July  1995,  contributed  $4,321,000,  offset by a  decrease  of  $1,294,000  in
microwave components.

Gross  profit of 31.7% for the 52 weeks ended July 28, 1996  exceeded  the prior
year of 25.9% due to an increase of $2,648,000  in higher  margin  foreign sales
from  $3,908,000  in 1995 to  $6,556,000  in  1996,  as well as an  increase  in
absorption of fixed costs due to the higher sales volume.

Selling and  administrative  expenses  for the 52 weeks ended July 28, 1996 were
$5,832,000  compared to  $5,072,000  for fiscal 1995, an increase of $760,000 of
which  $388,000 is  attributable  to  increased  representative  fees on foreign
sales,  an  increase of $233,000 in  personnel  and related  expenses  and other
expenses of  $46,000,  offset by a reduction  of $150,000 in the  provision  for
customer  disputed  charges,  and  decreases  in  group  insurance  of  $90,000,
depreciation of $69,000 and outside services of $48,000. The addition of Stewart
Warner Electronics Co. added $450,000 in selling and administrative  expenses in
fiscal 1996,  the specific  expenses of which are included in the above numbers.
As a percentage of net sales, selling and administrative expenses decreased from
20.7% in 1995 to 20.1% in 1996.

Income before  unusual items in 1996 was $3,370,882 as compared to $1,260,553 in
1995.  Included in unusual items in 1995 are settlement costs in connection with
certain  legal  actions of  $4,310,000,  legal  fees of  $829,000,  and  related
expenses of $308,000.

Other income (expense) for the 52 weeks ended July 28, 1996 increased $1,100,000
from the prior year due to net gains on available-for-sale  securities and other
long-term investments of $898,000 as compared to losses of $356,000 in 1995, and
a decrease in interest  expense of $88,000;  offset by  decreased  dividend  and
interest income of $242,000.

The  effective tax rate in 1996 was 2.7%.  The 1996 tax  provision  reflects the
utilization  of prior  year net  operating  loss  carryforwards.  No income  tax
benefit was recorded in 1995 due to an increase in the valuation allowance.  The
valuation  allowance was provided relating to that portion of net operating loss
carryforwards that management believed might expire unutilized.

Liquidity and Capital Resources

As of  August 3,  1997 and July 28,  1996,  working  capital  was  approximately
$10,662,000  and  $8,704,000,  respectively,  and the ratio of current assets to
current  liabilities  was 2.09 to 1 and 2.15 to 1,  respectively.  At  August 3,
1997, the Company had cash and cash equivalents of approximately $1,195,000.

                                       12

<PAGE>



As is customary  in the defense  industry,  inventory  is partially  financed by
advance  payments.  The  unliquidated  balance  of these  advance  payments  was
approximately $3,091,000 in 1997, and $1,480,000 in 1996.

Net cash provided from operations and investing  activities in 1997 and 1996 was
approximately  $3,647,000,  and  $6,159,000,   respectively.  Cash  provided  by
investing  activities  resulted  primarily  from  the  liquidation  of  all  the
available-for-sale  securities, and the sale of the Company's interest in the M.
D.  Sass   Re/Enterprise-II,   L.P.,  limited  partnership.   The  Company  used
approximately  $9,715,000 of these funds in financing  activities  primarily for
the net payment of  outstanding  bank debt of  $7,250,000,  and the  purchase of
treasury stock for $2,783,000.

The Company  maintains a revolving  credit facility with a bank for an aggregate
of $11,000,000,  which expires January 31, 1999. No borrowings were  outstanding
on this line at August 3, 1997. As of July 28, 1996,  the Company had borrowings
outstanding of $6,950,000.

During the fiscal year ended August 3, 1997 the Company  acquired 244,519 shares
of its outstanding  common stock for $2,782,686  through open market  purchases,
pursuant to a stock purchase plan to acquire up to 300,000  pre-split  shares of
Common  Stock,  which was  terminated  in June 1997.  The Company also  acquired
463,639   shares,    valued   at   $6,429,124   in   connection   with   certain
"stock-for-stock"  exercises of stock options by which certain employees elected
to surrender  "mature"  shares owned in  settlement  of the option  price.  Such
exercises  are treated as an exercise of a stock option and the  acquisition  of
treasury shares by the Company. See "Management Stock Plans."

The Company believes that presently anticipated future cash requirements will be
provided by internally generated funds and existing credit facilities.

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

PART III

The  information  required  by Part  III is  incorporated  by  reference  to the
Company's  definitive  proxy  statement in connection with its Annual Meeting of
Stockholders  scheduled  to be held in  December  1997,  to be  filed  with  the
Securities  and Exchange  Commission  within 120 days  following  the end of the
Company's fiscal year ended August 3, 1997.

                                       13

<PAGE>



PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(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 (Exhibit 3(b) of Form S-1  Registration  Statement No.
     2-87160).
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  (Eshibit 10.1 of Report on Form 10-Q dated June 10,
     1997).
10.3 Employment Agreement between Herley Industries, Inc. and Lee N. Blatt dated
     as of January 1, 1997  (Exhibit  10.2 of Report on Form 10-Q dated June 10,
     1997).
10.4 Employment  Agreement between Herley Industries,  Inc. and Myron Levy dated
     as of January 1, 1997  (Exhibit  10.3 of Report on Form 10-Q dated June 10,
     1997).
10.5 (a) Employment Agreement with Gerald I. Klein dated April 1, 1990, (Exhibit
         10.5 of Annual  Report  on Form 10-K for the  fiscal  year  ended  July
         31, 1990).
     (b)  Employment  Agreement  with  Gerald I.  Klein  dated  January 1, 1992,
          (Exhibit 10.7 of Form S-2 Registration Statement No. 33-44959).
     (c)  Modification  Agreement to Employment  Agreement  with Gerald I. Klein
          dated  November 30, 1992,  (Exhibit  10(b) of Report on Form 8-K dated
          November 30, 1992).
10.6 (a)  Revised Non-Negotiable  Promissory  Note of Lee N. Blatt dated June 2,
          1997 (Exhibit 10.4 of Report on Form 10-Q dated June 10, 1997).
     (b)  Revised Non-Negotiable Promissory Note of Gerald I Klein dated June 2,
          1997 (Exhibit 10.5 of Report on Form 10-Q dated June 10, 1997).
     (c)  Revised  Non-Negotiable  Promissory  Note of Myron  Levy dated June 2,
          1997 (Exhibit 10.6 of Report on Form 10-Q dated June 10, 1997).
10.7 Loan   Agreement   between   Registrant  and  Allstate   Municipal   Income
     Opportunities  Trust  (Exhibit  10.6 of Annual  Report on Form 10-K for the
     fiscal year ended July 31, 1989).
10.8 Asset   Purchase   Agreement   dated  as  of   September  1,  1992  between
     Micro-Dynamics, Inc. and Herley Industries, Inc. (Exhibit 7(c) of Report on
     Form 8-K dated October 22, 1992).
10.9 Stock  Purchase   Agreement  dated  as  of  June  1,  1993  between  Herley
     Industries,  Inc.,  Herley  Interim  Corp.,  Milton C.  Barnard,  Edward M.
     Webber,  Marvin Adler and Carlton Industries,  Inc. (Exhibit 7(c) of Report
     on Form 8-K dated June 18, 1993).
10.10 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).
11.  Computation of per share earnings.
23.  Consent of Independent Public Accountants.
27.  Financial Data Schedule (for electronic submission only).

(b)  Financial Statements

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

(c)  Reports on Form 8-K

     None

                                       14

<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 the 30th day of October, 1997.

                                  HERLEY  INDUSTRIES,  INC.


                                  By:        /S/  Lee N. Blatt
                                     -----------------------------------
                                     Lee N. Blatt, Chairman of the Board

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been  signed  below on  October  30,  1997 by the  following  persons in the
capacities indicated:


By: /S/  Lee N. Blatt
   ------------------                    Chairman of the Board
   Lee N. Blatt                           (Principal Executive Officer)

By: /S/  Myron Levy                      President and Director
   ----------------
   Myron Levy

By: /S/  Anello C. Garefino              Vice President Finance, CFO, Treasurer
   ------------------------              (Principal Financial Officer)
   Anello C. Garefino

By: /S/  David H. Lieberman              Director
   ------------------------
   David H. Lieberman

By: /S/  Thomas J. Allshouse             Director
   -------------------------
   Thomas J. Allshouse

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


                                       15

<PAGE>

Item 8.  Financial Statements and Supplementary Data


                             HERLEY INDUSTRIES, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                           Page

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................    F-2

FINANCIAL STATEMENTS:

    Consolidated Balance Sheets, August 3, 1997 and  July 28, 1996......    F-3

    Consolidated Statements of Operations for the 53 Weeks Ended
      August 3, 1997, and the 52 Weeks Ended  July 28, 1996
      and July 30, 1995.................................................    F-4

    Consolidated Statements of Shareholders' Equity for the 53 Weeks
       Ended August 3, 1997, and the 52 Weeks Ended July 28, 1996
       and July 30, 1995................................................    F-5

    Consolidated Statements of Cash Flows for the 53 Weeks Ended
       August 3, 1997, and the 52 Weeks Ended July 28, 1996 and
       July 30, 1995....................................................    F-6

    Notes to Consolidated Financial Statements..........................    F-7



Schedules have been omitted as not applicable.


















                                                F-1
<PAGE>




                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Board of Directors of
Herley Industries, Inc.


We  have  audited  the  accompanying   consolidated  balance  sheets  of  Herley
Industries,  Inc. and  Subsidiaries  as of August 3, 1997 and July 28, 1996, and
the related consolidated statements of operations, shareholders' equity and cash
flows for the 53 weeks  ended  August 3, 1997 , and the 52 weeks  ended July 28,
1996 and July 30, 1995. These financial statements are the responsibility of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
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 financial  statements  referred to above present fairly, in
all material respects, the consolidated financial position of Herley Industries,
Inc.  and  Subsidiaries  as of  August  3,  1997  and  July  28,  1996,  and the
consolidated  results of their  operations and their cash flows for the 53 weeks
ended August 3, 1997, and the 52 weeks ended July 28, 1996, and July 30, 1995 in
conformity with generally accepted accounting principles.



                                                     ARTHUR ANDERSEN LLP



Lancaster, PA
 September 19, 1997


                                       F-2
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

                                                        August 3,    July 28,
                                                          1997         1996
                                                       ----------   ----------
                       ASSETS

Current Assets:
        Cash and cash equivalents                     $ 1,194,650  $ 1,104,445
        Accounts receivable                             5,176,523    3,249,225
        Notes receivable-officers                       2,100,913    2,083,543
        Other receivables                                 152,148      124,992
        Inventories                                     9,790,382    8,010,687
        Deferred taxes and other                        2,061,066    1,689,988
                                                       ----------   ----------
                Total Current Assets                   20,475,682   16,262,880
Property, Plant and Equipment, net                     11,704,755   12,579,044
Intangibles, net of amortization of $1,133,750
        in 1997 and $861,650 in 1996                    4,308,136    4,580,236
Available-for-sale Securities                            -           4,912,387
Other Investments                                       1,313,502    3,000,000
Other Assets                                            1,455,111    1,174,395
                                                       ==========   ==========
                                                      $39,257,186  $42,508,942
                                                       ==========   ==========
        LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities:
        Current portion of long-term debt             $   335,000  $   300,000
        Note payable to related party                     846,000     -
        Accounts payable and accrued expenses           4,986,740    5,123,868
        Income taxes payable                               76,635      166,295
        Reserve for contract losses                       478,000      489,110
        Advance payments on contracts                   3,091,001    1,480,033
                                                       ----------   ----------
                Total Current Liabilities               9,813,376    7,559,306
Long-term Debt                                          2,890,000   11,021,000
Deferred Income Taxes                                   2,696,394    1,923,058
Excess of fair value of net assets of business
        acquired over cost, net of amortization
        of $973,666 in 1997 and $486,833 in 1996          486,833      973,667
                                                       ----------   ----------
                                                       15,886,603   21,477,031
                                                       ----------   ----------
Commitments and Contingencies
Shareholders' Equity:
        Common stock, $.10 par value; authorized
          10,000,000 shares; issued and outstanding
          4,209,365 in 1997 and 2,936,122 in 1996         420,936      293,612
        Additional paid-in capital                      8,856,516   11,448,827
        Retained earnings                              14,093,131    9,289,472
                                                       ----------   ----------
                Total Shareholders' Equity             23,370,583   21,031,911

                                                       ==========   ==========
                                                      $39,257,186  $42,508,942
                                                       ==========   ==========

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

                                       F-3
<PAGE>

                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                     53 weeks
                                                      ended              52 weeks ended
                                                     August 3,       July 28,       July 30,
                                                       1997            1996           1995
                                                    -----------    -----------     -----------
<S>                                               <C>            <C>             <C>    
Net sales                                         $ 32,195,168   $ 29,001,404    $ 24,450,267
                                                    -----------    -----------     -----------

Cost and expenses:
      Cost of products sold                         20,753,707     19,798,692      18,117,874
      Selling and administrative expenses            6,293,199      5,831,830       5,071,840
      Unusual items                                  -              -               5,447,005
                                                    -----------    -----------     -----------
                                                    27,046,906     25,630,522      28,636,719
                                                    -----------    -----------     -----------

          Operating income (loss)                    5,148,262      3,370,882      (4,186,452)
                                                    -----------    -----------     -----------

Other income (expense):
      Net gain (loss) on available-for-sale
          securities and other investments             409,399        897,919        (355,709)
      Dividend and interest income                     257,676        376,007         617,645
      Interest expense                                (531,678)      (873,452)       (961,650)
                                                    -----------    -----------     -----------
                                                       135,397        400,474        (699,714)
                                                    -----------    -----------     -----------

          Income (loss) before income taxes          5,283,659      3,771,356      (4,886,166)
Provision for income taxes                             182,400        102,400           4,000
                                                    -----------    -----------     -----------

          Net income (loss)                       $  5,101,259   $  3,668,956    $ (4,890,166)
                                                    ===========    ===========     ===========


Earnings (loss) per common and common
      equivalent share                                $ 1.44         $ 1.15         $ (1.31)
                                                       =====          =====           ======

Weighted average number of common and
      common equivalent shares outstanding           3,550,262      3,190,339       3,734,151
                                                     =========      =========       =========
</TABLE>


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

                                      F-4
<PAGE>
<TABLE>
<CAPTION>

                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                                                           
53 weeks ended August 3, 1997, and 52 weeks ended July 28, 1996 and July 30, 1995


                                                                                        Unrealized
                                                                                        Gain (Loss)
                                                           Additional                  on Available-
                                            Common Stock     Paid-in        Retained      for-sale     Treasury
                                Shares         Amount        Capital        Earnings    Securities      Stock          Total
                                ------         ------        -------        --------    ----------      -----          -----
<S>                             <C>         <C>             <C>            <C>           <C>           <C>        <C>
Balance at July 31, 1994        4,278,189   $   427,819     17,989,374     10,510,682    (201,117)     (445,620)  $ 28,281,138

Net (loss)                                                                 (4,890,166)                              (4,890,166)
Issuance of common stock           35,000         3,500         99,313                                                 102,813
Unrealized gain on
  available-for-sale
  securities                                                                              226,117                      226,117
Purchase of 1,194,701 shares
  of treasury stock                                                                                  (4,732,165)    (4,732,165)
Retirement of 1,297,201 shares
  of treasury stock            (1,297,201)     (129,720)    (5,048,065)                               5,177,785         -

                               -----------    ----------   ------------    -----------   ---------   -----------   ------------
Balance at July 30, 1995        3,015,988   $   301,599     13,040,622      5,620,516      25,000        -        $ 18,987,737

Net income                                                                  3,668,956                                3,668,956
Exercise of stock options         406,432        40,643      2,577,360                               (2,483,552)       134,451
Unrealized loss on
  available-for-sale
  securities                                                                              (25,000)                     (25,000)
Purchase of 270,339 shares
  of treasury stock                                                                                  (1,737,233)    (1,734,233)
Retirement of treasury shares    (486,298)      (48,630)    (4,169,155)                               4,217,785         -

                               -----------    ----------   ------------    -----------   ---------   -----------   ------------
Balance at July 28, 1996        2,936,122   $   293,612     11,448,827      9,289,472        -           -        $ 21,031,911

Net income                                                                  4,803,659                                4,803,659
Exercise of stock options
  and warrants                    929,060        92,906      6,653,917                               (6,429,124)       317,699
Four-for-three stock split      1,052,341       105,234       (105,234)                                                 -
Purchase of 244,519 shares
  of treasury stock                                                                                  (2,782,686)    (2,782,686)
Retirement of treasury shares    (708,158)      (70,816)    (9,140,994)                               9,211,810         -

                               -----------    ----------   ------------    -----------   ---------   -----------   ------------
Balance at August 3, 1997       4,209,365   $   420,936      8,856,516     14,093,131        -            -       $ 23,370,583
                               ===========    ==========   ============    ===========   =========   ===========   ============
</TABLE>

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

                                       F-5
<PAGE>

                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                          53 weeks
                                                                           ended              52 weeks ended
                                                                          August 3,      July 28,       July 30,
                                                                            1997           1996           1995
                                                                        ------------   ------------   ------------
<S>                                                                   <C>            <C>            <C>
Cash flows from operating activities:
     Net Income (loss)                                                $   4,803,659  $   3,668,956  $  (4,890,166)
                                                                        ------------   ------------   ------------
     Adjustments  to  reconcile  net  income  (loss)
      to net  cash  provided  by operations:
        Depreciation and amortization                                     1,538,283      1,563,354      2,116,233
        (Gain) loss on sale of available-for-sale
            securities and other investments                               (409,572)    (1,018,643)       355,709
        Decrease (increase) in deferred tax assets                         -              (393,389)       596,055
        Increase in deferred tax liabilities                                773,336        376,723        255,240
        Unrealized loss on available-for-sale securities                   -               121,550       -
        Unusual item                                                       -              -             5,447,005
        Changes in operating assets and liabilities:
            Decrease (increase) in accounts receivable                   (1,927,298)     1,430,692      1,285,694
            (Increase) in notes receivable-officers                         (17,370)    (2,083,543)      -
            Decrease (increase) in other receivables                        (27,156)        38,410        136,635
            Decrease (increase) in inventories                           (1,779,695)     1,319,366      2,208,137
            (Increase) in prepaid expenses and other                       (371,078)       (25,940)      (753,838)
            (Decrease) in accounts payable and
                accrued expenses                                           (137,128)      (513,649)    (3,879,974)
            Increase (decrease) in income taxes payable                     (89,660)       166,295       (162,543)
            (Decrease) in reserve for contract losses                       (11,110)        (6,890)        (4,000)
            Increase (decrease) in advance payments
                on contracts                                              1,610,968          3,393     (1,397,334)
            Other, net                                                     (309,500)        40,000        153,335
                                                                        ------------   ------------   ------------
                Total adjustments                                        (1,156,980)     1,017,729      6,356,354
                                                                        ------------   ------------   ------------
        Net cash provided by operations                                   3,646,679      4,686,685      1,466,188
                                                                        ------------   ------------   ------------

Cash flows from investing activities:
     Purchase of available-for-sale securities
        and other investments                                              (159,364)   (11,077,331)   (22,766,138)
     Proceeds from sale of fixed assets                                      15,468       -              -
     Proceeds from sale of available-for-sale securities
        and other investments                                             7,164,538     11,879,157     30,417,016
     Capital expenditures                                                  (862,129)      (643,330)      (182,241)
                                                                        ------------   ------------   ------------
        Net cash provided by investing activities                         6,158,513        158,496      7,468,637
                                                                        ------------   ------------   ------------

Cash flows from financing activities:
     Borrowings under bank line of credit                                 2,825,000      9,875,000      4,044,668
     Proceeds from exercise of stock options                                317,699        134,451       -
     Payments under lines of credit                                      (9,775,000)    (9,925,000)    (8,025,000)
     Payments under litigation settlement                                  -            (2,000,000)    (2,000,000)
     Payments of long-term debt                                            (300,000)      (363,709)      (512,735)
     Purchase of treasury stock                                          (2,782,686)    (1,734,233)    (2,708,732)
                                                                        ------------   ------------   ------------
        Net cash (used in) financing activities                          (9,714,987)    (4,013,491)    (9,201,799)
                                                                        ------------   ------------   ------------

        Net increase (decrease) in cash and cash equivalents                 90,205        831,690       (266,974)
Cash and cash equivalents at beginning of period                          1,104,445        272,755        539,729
                                                                        ------------   ------------   ------------

Cash and cash equivalents at end of period                            $   1,194,650  $   1,104,445  $     272,755
                                                                        ============   ============   ============
Supplemental cash flow information:
     Cashless exercise of stock options                               $   6,429,124  $   2,483,552
                                                                        ============   ============
     Liabilities assumed in connection with acquisition                                             $     915,000
                                                                                                      ============
</TABLE>

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


                                      F-6


<PAGE>
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1.     Nature of Operations

       The  Company   principally   designs,   manufactures   and  sells  flight
       instrumentation and microwave products, primarily to aerospace companies,
       the U.S. government, and several foreign governments.  The Company's main
       products  include a variety  of  transponders  which are used to  enhance
       radar signals to accurately track the flight of space launch vehicles and
       aircraft, as well as microwave devices and command and control systems.

2.     Fiscal Year

       The Company's fiscal year ends on the Sunday closest to July 31. Normally
       each  fiscal year  consists of 52 weeks,  but every five or six years the
       fiscal year will  consist of 53 weeks.  Fiscal year 1997  consisted of 53
       weeks, and fiscal years 1996 and 1995 consisted of 52 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 generally accepted accounting principles 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.     Revenue and Cost Recognition

       Under  fixed-price  contracts,  sales  and  related  costs  are  recorded
       primarily  as  deliveries  are  made.   Certain  costs  under  long-term,
       fixed-price contracts (principally either directly or indirectly with the
       U.S. Government),  which include non-recurring billable engineering,  are
       deferred  until these costs are  contractually  billable.  Revenue  under
       certain  long-term,  fixed  price  contracts,  principally  shelters,  is
       recognized  using the  percentage  of  completion  method of  accounting.
       Revenue recognized on these contracts is based on estimated completion to
       date (the total  contract  amount  multiplied by percent of  performance,
       based on direct labor  dollars).  Losses on contracts  are recorded  when
       first reasonably determined.

       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.

5.     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.  The costs
       attributed to units delivered under long-term  contracts and programs are
       based on the average costs of all units produced.


                                       F-7

<PAGE>



6.     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.  Gains and  losses
       arising from the sale or disposition of property, plant and equipment are
       recorded in income.

7.     Intangibles

       Intangibles  are comprised of customer  lists,  installed  products base,
       drawings,   patents,  licenses,  certain  government  qualifications  and
       technology  and  goodwill  in  connection  with the  acquisition  of Vega
       Precision  Laboratories,  Inc. in 1993.  Intangibles  are being amortized
       over twenty years.

       The carrying  amount of  intangibles  is evaluated on a recurring  basis.
       Current  and  future   profitability   as  well  as  current  and  future
       undiscounted cash flows of the acquired businesses are primary indicators
       of recoverability. For the three fiscal years ended August 3, 1997, there
       were no adjustments  to the carrying  amount of the cost in excess of net
       assets acquired resulting from these evaluations.

8.     Marketable Securities

       The Company  accounts for its  investments  in  marketable  securities in
       accordance  with  Statement of Financial  Accounting  Standards  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  value,  with  the
       unrealized gains and losses, net of tax, reported as a separate component
       of shareholders' equity.  Realized gains and losses and declines in value
       judged to be other-than-temporary are included in other income (expense).
       The  cost of  securities  sold is based  on the  specific  identification
       method. Interest and dividends on securities are included in other income
       (expense).

9.     Other Investments

       The  Company  is a  limited  partner  in  certain  nonmarketable  limited
       partnerships in which it owns approximately a 10% interest.  Beginning in
       1997  other  investments  are  accounted  for  under the  equity  method.
       Previously,   the  cost  method  was  utilized  as  the  amount  was  not
       significantly different from the equity method.

10.    Income Taxes

       Income  taxes  are  accounted  for by  the  asset/liability  approach  in
       accordance  with  Statement of Financial  Accounting  Standards  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.

11.    Stock-Based Compensation

       Statement of Financial  Accounting  Standards  No. 123,  "Accounting  for
       Stock-Based  Compensation," encourages, but does not require companies to
       record compensation cost for stock-based  employee  compensation plans at
       fair value. The Company has chosen to continue to account for stock-based

                                       F-8

<PAGE>



       compensation  using the intrinsic  value method  prescribed in Accounting
       Principles  Board  Opinion  No.  25,  "Accounting  for  Stock  Issued  to
       Employees," and related Interpretations.  Accordingly,  compensation cost
       for stock options is measured as the excess, if any, of the quoted market
       price of the Company's  stock at the date of the grant over the amount an
       employee must pay to acquire the stock. Because the exercise price of the
       Company's   employee  stock  options  equals  the  market  price  of  the
       underlying  stock  on the  date of  grant,  no  compensation  expense  is
       recognized.

12.    Earnings Per Common Share

       Earnings  per common  share and common  equivalent  share is based on the
       weighted average number of outstanding shares of common stock (reflective
       of a 4-for-3 stock split on September 15, 1997),  including  common stock
       equivalents (options and warrants) as determined under the treasury stock
       method as follows:  4,733,682  shares in 1997;  4,253,785 shares in 1996;
       and 4,978,868 shares in 1995.

13.    Cash and Cash Equivalents

       For purposes of the statement of cash flows, short-term investments which
       have a maturity  of ninety  days or less at the date of  acquisition  are
       considered cash equivalents.

14.    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
       $1,828,000,  $1,453,000,  and  $970,000 in fiscal 1997,  1996,  and 1995,
       respectively.

15.    New Accounting Standards

       In March 1997, the Financial  Accounting Standards Board issued Statement
       of Financial  Accounting  Standards No. 128,  "Earnings Per Share" ("SFAS
       128"),  which is  effective  for both interim and annual  periods  ending
       after  December  15,  1997.  SFAS 128  supersedes  APB No. 15 to  conform
       earnings  per share with  international  standards as well as to simplify
       the complexity of the computation  under APB No. 15. The previous primary
       earnings  per share  ("EPS")  calculation  is  replaced  with a basic EPS
       calculation.  The basic EPS differs from the primary EPS  calculation  in
       that the basic EPS does not include any potentially  dilutive securities.
       Fully  dilutive EPS is replaced  with diluted EPS and should be disclosed
       regardless of dilutive impact to basic EPS.  Earlier  application of this
       Statement  is not  permitted.  Therefore,  the  EPS  in the  Consolidated
       Statements of Operations are presented under APB No. 15.

NOTE B - ACQUISITIONS AND DISPOSALS

       In July 1995, the Company  entered into an agreement  effective as of the
       close of  business  June 30,  1995,  to  acquire  certain  assets and the
       business (consisting principally of inventories and trade receivables) of
       Stewart  Warner  Electronics  Corporation,  a Delaware  corporation.  The
       transaction,  which closed on July 28, 1995,  provided for the payment of
       $250,000  in  cash  and  the  assumption  of  approximately  $915,000  in
       liabilities  and has  been  accounted  for by the  purchase  method.  The
       acquisition  resulted  in excess of fair  value  over cost of net  assets
       acquired of $1,460,500 which is being amortized over a three-year period.

NOTE C - NOTES  RECEIVABLE-OFFICERS

       In fiscal 1996 the Company loaned $1,400,000,  $300,000,  and $300,000 to
       certain  officers,  as authorized by the Board of Directors,  pursuant to
       the terms of nonnegotiable promissory notes. The notes were initially due
       November 1996, November 1996 and March 1997, respectively.  The notes may
       be renewed by the Company from year to year.  The notes were  extended by
       the Company in fiscal 1997

                                       F-9

<PAGE>



       and are now due April 30, 1998,  January 31, 1998,  and January 31, 1998,
       respectively.  The loans are secured by 594,365 shares of common stock of
       the  Company.  Interest is payable at  maturity  at the  average  rate of
       interest  paid by the Company on borrowed  funds  during the fiscal year.
       The pledge  agreement  also provides for the Company to have the right of
       first refusal to purchase the pledged  securities,  based on a formula as
       defined, in the event of the death or disability of the officer.

NOTE D - INVENTORIES

       The major components of inventories are as follows:

                                                 August 3,         July 28,
                                                    1997             1996
           Purchased parts and raw materials     $ 4,780,336    $ 3,358,256
           Work in process                         4,899,551      4,580,538
           Finished products                         110,495         71,893
                                                ------------    -----------
                                                 $ 9,790,382    $ 8,010,687
                                                  ==========      =========

NOTE E - AVAILABLE-FOR-SALE SECURITIES

       In September 1996, the Company  liquidated all of its  available-for-sale
       securities for  approximately  $4,912,000 and used the proceeds to reduce
       its long-term bank debt. A provision for unrealized losses of $121,550 is
       included in the  statement of operations  for fiscal year 1996.  The fair
       value of available-for-sale securities at July 28, 1996 was $4,912,387.

NOTE F - OTHER INVESTMENTS

       In April 1996,  the Company  acquired a limited  partnership  interest in
       M.D. Sass  Re/Enterprise-II,  L.P., a Delaware  limited  partnership  for
       $2,000,000.  The  objective  of the  partnership  is to achieve  superior
       long-term capital appreciation  through investments  consisting primarily
       of securities of companies that are experiencing significant financial or
       business difficulties. In April 1997, the Company sold its investment and
       terminated its limited  partnership  interest for $2,080,630  realizing a
       gain of $80,630.

       In December  1995,  the Company sold its  investment  and  terminated its
       limited partnership interest in M.D. Sass Re/Enterprise Partners, L.P., a
       Delaware  limited   partnership  for  $3,823,233   realizing  a  gain  of
       $1,095,727.

       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 August 3, 1997 and July 28,
       1996 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.


                                      F-10

<PAGE>



NOTE G - PROPERTY, PLANT AND EQUIPMENT

       Property, plant and equipment are comprised of the following:

                                         August 3,       July 28,    Estimated
                                          1997            1996       Useful Life
                                          ----            ----       -----------

       Land                             $   880,270    $   880,270
       Building and building
            improvements                  5,438,663      5,362,409   10-40 years
       Machinery and equipment           17,515,954     16,788,901    5- 8 years
       Furniture and fixtures               494,056        494,056    5-10 years
       Tools                                 24,869         24,869       5 years
       Leasehold improvements               288,757        288,757    5-10 years
                                         ----------     ----------
                                         24,642,569     23,839,262
       Less accumulated depreciation     12,937,814     11,260,218
                                         ----------     ----------
                                        $11,704,755    $12,579,044
                                         ==========     ==========

NOTE H - COMMITMENTS AND CONTINGENCIES

       Leases

       The Company  leases  office,  production  and warehouse  space as well as
       computer equipment and automobiles under noncancellable operating leases.

       Rent  expense  for the 53 weeks  ended  August 3, 1997,  and the 52 weeks
       ended  July  28,  1996 and July  30,  1995  was  approximately  $229,900,
       $284,600, and $158,000, respectively.

       Minimum annual rentals under noncancellable leases are as follows:

                                                               Amount
                                                               -------
                         Year ending fiscal 1998              $204,800
                                            1999               153,900
                                            2000                97,400

       Employment Agreements

       The  Company  has  employment  agreements  with  various  executives  and
       employees  of the Company,  which,  as amended,  expire at various  dates
       through  December 31, 2002,  subject to extension  each January 1 for six
       years from that date not to extend,  in any event,  beyond  December  31,
       2006.  These   agreements   provide  for  aggregate  annual  salaries  of
       $1,185,000.  Certain  agreements provide for an annual increment equal to
       the greater of a cost of living  adjustment  based on the consumer  price
       index or 10%,  and also  provide for  incentive  compensation  related to
       pretax  income.  Incentive  compensation  in the amount of  $665,352  was
       expensed in fiscal year ended August 3, 1997.  Incentive  compensation of
       $446,750 was expensed in fiscal 1996. No incentive  compensation  was due
       for the fiscal year ended July 30, 1995.

       Certain  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.  As of August 3,
       1997,  the  amount  payable  in the  event of such  termination  would be
       approximately $2,050,000.

       One of the  employment  contracts  provides  for a  consulting  agreement
       commencing  January  1, 2002 and  terminating  December  31,  2010 at the
       annual rate of  $100,000.  Another one of the  employment  contracts,  as
       amended January 1, 1997,  provides for a consulting  period commencing at
       the end of the

                                      F-11

<PAGE>



       period of active  employment and continuing for a period of five years at
       the annual  rate of  $60,000.  One officer of the Company has a severance
       agreement providing for a lump-sum payment of $220,000 through June 1999,
       adjusted to $110,000 through June 2002.

       Litigation

       In November 1996, the Company  settled all claims in connection  with two
       class action complaints,  related to the Company's acquisition of Carlton
       Industries,  Inc. and its subsidiary,  Vega Precision Laboratories,  Inc.
       for $450,000.

       In August 1997, the Company settled all claims in connection with a class
       action  complaint  filed in 1995 for  $170,000.  The claim related to the
       Company's  settlement of the Litton Action in the Essex Superior Court of
       Massachusetts  which  alleged,  inter alia,  that there was  insufficient
       disclosure by the Company of its true potential exposure in that claim.

       In July 1996,  the  Company  was  notified  by the  American  Arbitration
       Association of the decision of the arbitrators in an action  commenced in
       March 1994 by the principal selling  shareholders of Carlton  Industries,
       Inc. and its subsidiary,  Vega Precision Laboratories,  Inc. According to
       the award, the Company was to pay to the claimants the sum of $1,052,900,
       inclusive of interest.  Correspondingly,  the  claimants  were to pay the
       Company the sum of  $277,719,  inclusive  of  interest.  The Company paid
       $775,181 to claimants,  representing the difference  between the award to
       the claimants and the award to the Company, in August, 1996. The award to
       the  claimants  was offset by  $593,162  otherwise  payable to one of the
       selling shareholders.

       The Company is also involved in 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  with a bank 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  January  31,  1999.  At August 3, 1997
       stand-by letters of credit aggregating  $3,241,392 were outstanding under
       this facility.

NOTE I - INCOME TAXES

       Income tax provision consisted of the following:

                                                         52 Weeks ended
                              53 Weeks ended          --------------------
                                 August 3,         July 28,         July 30,
                                   1997              1996             1995
                                   ----              ----             ----
              Current
                  Federal      $ (52,000)        $  90,000         $   -
                  State           89,000            12,400             -
                                ---------         --------           -----
                                  37,000           102,400             -
                                ---------          -------           -----
              Deferred
                  Federal       (142,000)             -              4,000
                  State          585,000              -                -
                                 --------          -------           -----
                                 443,000              -              4,000
                                 --------          -------           -----

                               $ 480,000         $ 102,400         $ 4,000
                                 =======           =======           =====



                                      F-12

<PAGE>



       The Company paid income taxes of approximately  $178,000 in 1997, $19,000
       in 1996, and $122,000 in 1995. The following is a  reconciliation  of the
       U. S.  statutory  income  tax rate and the  effective  tax rate on pretax
       income: 53 Weeks ended 52 Weeks ended

                                            August 3,   July 28,    July 30,
                                              1997        1996        1995
                                              ----        ----        ----
         U.S. Federal statutory rate          34.0 %      34.0 %     (34.0) %
         State taxes, net of
            federal tax benefit               12.2         0.2         -
         Alternative minimum tax               -           2.4         -
         Benefit of net operating loss
            carryforward                     (30.8)      (35.2)        -
         Non-deductible expenses                .3         1.3         -
         Increase (decrease)in valuation
            allowance                         (9.4)        -          34.0
         Other, net                            2.8         -           -
                                             -----       -----       -----
            Effective tax rate                 9.1 %       2.7 %       -   %
                                             =====       =====       =====

       The 1997 and 1996 tax  provisions  reflect the  utilization of prior year
       net operating loss carryforwards.  In 1995 a valuation allowance had been
       provided  to reduce  deferred  tax assets to their net  realizable  value
       primarily based on management's  uncertainty that past performance  would
       be indicative  of future  earnings.  In 1997 the valuation  allowance was
       reversed  through the deferred tax  provision.  A  determining  factor in
       assessing the change was the cumulative income in recent years.

       Deferred income taxes reflect the impact of temporary differences between
       the amount of assets and liabilities  recognized for financial  reporting
       purposes and such amounts recognized for tax purposes.

       As of August 3, 1997,  the Company has net operating  loss  carryforwards
       for Federal income tax purposes of approximately  $2,000,000 which expire
       in 2010.

       Components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>

                                                   August 3, 1997             July 28, 1996
                                               ----------------------      -----------------
                                               Deferred    Deferred      Deferred     Deferred
                                                  Tax         Tax          Tax          Tax
                                                Assets    Liabilities     Assets     Liabilities
                                               --------   -----------    --------    -----------
         <S>                                 <C>          <C>          <C>           <C>   
         Intangibles                         $    -       $1,681,375   $  807,537    $    -
         Alternative minimum tax                265,906        -          176,707         -
         Accrued vacation pay                   123,644        -          118,104         -
         Accrued bonus                          343,398        -          243,760         -
         Warranty costs                         220,000        -          220,000         -
         Inventory                              985,703        -          910,081         -
         Depreciation                             -        2,006,038        -         1,923,058
         Net operating loss carryforwards       725,113        -        2,781,480         -
         Litigation settlement                    -            -          495,080         -
         Contract losses                        275,635        -          215,208         -
         Other                                   71,917       78,967       97,645         -
                                              ---------    ---------    ---------    ----------
                                              3,011,316    3,766,380    6,065,602     1,923,058
         Valuation allowance                      -            -        4,454,627         -
                                              ---------    ---------    ---------     ---------
                                             $3,011,316   $3,766,380   $1,610,975    $1,923,058
                                              =========    =========    =========     =========
</TABLE>


                                      F-13

<PAGE>



NOTE J- LONG-TERM DEBT

       Long-term debt is summarized as follows:
                                                   August 3,        July 28,
                                      Rate           1997             1996
                                -------------        ----             ----
       Note payable bank (a)    6.22% -8.50%      $    -        $  6,950,000
       Mortgage note (b)        10.4%              3,225,000       3,525,000
       Long term liability (c)        -                -             846,000
                                                   ---------      ----------
                                                   3,225,000      11,321,000
       Less current portion                          335,000         300,000
                                                   ---------      ----------
                                                  $2,890,000    $ 11,021,000
                                                   =========      ==========

       (a) In January 1997, the Company renewed the revolving  credit  agreement
           with its bank  that  provides  for the  extension  of  credit  in the
           aggregate principal amount of $11,000,000 and may be used for general
           corporate  purposes,  including business  acquisitions.  The facility
           requires the payment of interest  only on a monthly basis and payment
           of the outstanding principal balance on January 31, 1999. Interest is
           set biweekly at 1% over the FOMC Target Rate  applied to  outstanding
           balances  up to 80% of the net  equity  value  of  available-for-sale
           securities,  and at the bank's Base Rate for outstanding  balances in
           excess of this limit. There were no borrowings  outstanding at August
           3, 1997. The premium rate portion of the facility would be secured by
           any available-for-sale securities.

           The agreement contains various financial covenants,  including, among
           other  matters,  the  maintenance  of working  capital,  tangible net
           worth, and restrictions on cash dividends and other borrowings.

       (b) The mortgage note provides for annual  principal  payments at varying
           amounts  through 2004 plus  semiannual  interest  payments.  Land and
           buildings in Lancaster, Pa. are pledged as collateral.

           The mortgage note agreement  contains  various  financial  covenants,
           including,  among other matters,  the maintenance of specific amounts
           of working  capital and tangible net worth.  In connection  with this
           loan,  the Company paid  approximately  $220,000 in financing  costs.
           Such  costs  are  included  in  Other  Assets  in  the   accompanying
           consolidated  balance  sheets at August 3, 1997 and July  28,1996 and
           are being amortized over the term of the loan (15 years).

       (c) Under a contract  for the  purchase of an  industrial  parcel of land
           from its  Chairman,  the  Company is  obligated  to pay  $846,000  at
           settlement on or before April 30, 1998.

       The Company paid interest of approximately  $567,000 in 1997, $854,000 in
       1996, and $1,010,000 in 1995.

       Future payments required on long-term debt are as follows:

                    Fiscal year ending during:         Amount
                                                       ------
                              1998                   $335,000
                              1999                    370,000
                              2000                    410,000
                              2001                    450,000
                              2002                    500,000
                              Thereafter            1,160,000
                                                    ---------
                                                   $3,225,000


                                      F-14

<PAGE>



NOTE K - ACCOUNTS PAYABLE AND ACCRUED EXPENSES

       Accounts payable and accrued expenses include the following:

                                            August 3,         July 28,
                                              1997              1996
                                            ---------         ---------
         Accounts payable                 $ 1,841,468       $ 1,579,230
         Accrued payroll and bonuses        1,483,915         1,160,345
         Accrued commissions                  205,692           247,687
         Accrued interest                      55,900            95,925
         Accrued litigation expenses          297,538         1,206,914
         Accrued expenses                   1,102,227           833,794
                                           ----------       -----------
                                          $ 4,986,740       $ 5,123,868
                                           ==========        ==========

NOTE L - EMPLOYEE BENEFIT PLANS

       In August 1985, the Board of Directors  approved an Employee Savings 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 15% of their salaries to the Plan. The Company,
       at its discretion  can contribute  100% of the first 2% of the employees'
       contribution and 25% of the next 4%. 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 accrued  approximately  $178,000  for the 53 weeks ended
       August 3, 1997, and contributed  approximately  $159,000, and $151,000 to
       this  plan  for the 52 weeks  ended  July 28,  1996,  and July 30,  1995,
       respectively.

NOTE M - SHAREHOLDERS' EQUITY

       The Company has two fixed  option  plans which  reserve  shares of common
       stock for  issuance to  executives,  key  employees  and  directors.  The
       Company  applies  APB  Opinion  No,  25 and  related  Interpretations  in
       accounting for these plans.  Statement of Financial  Accounting Standards
       No.123, "Accounting for Stock-Based Compensation" ("SFAS 123") was issued
       by the FASB in 1995 and , if  fully  adopted,  changes  the  methods  for
       recognition of cost on plans similar to those of the Company. The Company
       has adopted the disclosure-only  provisions of SFAS 123. Accordingly,  no
       compensation  cost has been  recognized  for the stock option plans.  Pro
       forma information regarding net income and earnings per share is required
       by Statement 123, and has been determined as if the Company had accounted
       for its  employee  stock  options  under  the fair  value  method of that
       Statement.  The fair value for these options was estimated at the date of
       grant  using a  Black-Scholes  option  pricing  model with the  following
       weighted-average assumptions: risk-free interest rate of 6.1%; volatility
       factor of the expected market price of the Company's common stock of .63;
       and a weighted-average expected life of the option of .4 years.

       The  Black-Scholes  option  valuation  model  was  developed  for  use in
       estimating  the fair  value  of  traded  options  which  have no  vesting
       restrictions and are fully  transferable.  In addition,  option valuation
       models require the input of highly subjective  assumptions  including the
       expected  stock price  volatility.  Because the Company's  employee stock
       options have characteristics significantly different from those of traded
       options,  and because  changes in the subjective  input  assumptions  can
       materially affect the fair value estimate,  in management' s opinion, the
       existing models do not  necessarily  provide a reliable single measure of
       the fair value of its employee stock options.

       Had  compensation  cost for stock  options  granted  in fiscal  1997 been
       determined  based on the fair value at the grant date consistent with the
       provisions  of SFAS No. 123, the  Company's net earnings and earnings per
       share would have been reduced to the pro forma amounts indicated below:

                                      F-15

<PAGE>



                                                         1997
                                                       ---------
                Net earnings - as reported            $4,803,659
                Net earnings - pro forma              $3,451,882
                Earnings per share - as reported           $1.01
                Earnings per share - pro forma              $.73

       No options were granted in fiscal 1996.

       The effects of  applying  the pro forma  disclosures  of SFAS 123 are not
       likely to be  representative  of the effects on reported net earnings for
       future years due to the various vesting schedules.

       In May 1997,  the Board of Directors  approved the 1997 Stock Option Plan
       which covers  1,666,666  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 is
       determined  at the time of grant by the Board of  Directors.  The options
       expire ten years from the date of grant, subject to certain restrictions.
       Options for  801,660  shares  were  granted  during the fiscal year ended
       August 3, 1997.

       In October  1995,  the Board of Directors  approved the 1996 Stock Option
       Plan which covers 666,666 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 is
       determined  at the  time of  grant  by the  Board  of  Directors.  If not
       specified, 100% of the shares can be exercised one year after the date of
       grant.  The options expire ten years from the date of grant.  Options for
       663,989 shares were granted during the fiscal year ended August 3, 1997.

       In December 1992, the Board of Directors  approved the 1992 Non-Qualified
       Stock  Option Plan which  covers  1,333,333  shares,  as amended,  of the
       Company's  common stock.  Under the terms of the Plan, the purchase price
       of the shares, subject to each option granted, is 100% of the fair market
       value at the date of grant.  The date of  exercise is  determined  at the
       time of grant by the Board of Directors;  however, if not specified,  50%
       of the shares can be  exercised  each year  beginning  one year after the
       date of grant.  The  options  expire  ten  years  from the date of grant.
       Options for 339,986 shares were granted during the fiscal year ended July
       30, 1995. These options may be exercised  cumulatively at the rate of 25%
       per year  beginning  one year  after  the date of  grant.  This  plan was
       terminated in December 1995, except for outstanding options thereunder.

       In October 1987, the Board of Directors  approved the 1988  Non-Qualified
       Stock Option Plan which covers  666,666  shares of the  Company's  common
       stock.  Under the terms of the Plan,  the  purchase  price of the shares,
       subject  to each  option  granted,  will not be less than 85% of the fair
       market value at the date of grant. The date of exercise may be determined
       at the  time  of  grant  by  the  Board  of  Directors;  however,  if not
       specified,  20% of the shares can be exercised  each year  beginning  one
       year  after the date of grant and  generally  expire  five years from the
       date of grant.  This plan was  terminated  in December  1995,  except for
       outstanding options thereunder.

A summary of stock option activity under all plans for the 53 weeks ended August
3, 1997, and the 52 weeks ended July 28, 1996, and July 30, 1995 follows:


                                      F-16

<PAGE>

<TABLE>
<CAPTION>


                                   Non-Qualified Stock Options
                               ----------------------------------
                                                          Weighted
                                                           Average      Warrant Agreements
                              Number       Price Range     Exercise      Number    Price Range
                             of shares      per share        Price     of  shares   per share
<S>                         <C>          <C>                <C>          <C>    

Outstanding July 31, 1994...   929,969   $ 4.27  - 9.01     $5.00        573,333          $5.35
   Granted .................   339,986             2.54      2.54
   Canceled.................   (13,331)    2.54  - 5.25      4.88
                            ----------    -------------      ----        -------           ----
Outstanding July 30, 1995... 1,256,624   $ 2.54  - 9.01     $4.33        573,333          $5.35
   Granted .................    -                                        293,333           4.64
   Exercised................  (541,900)    2.54  - 5.72      4.87
   Canceled.................   (31,330)    2.54  - 5.25      4.83       (533,333)          5.35
                            ----------    -------------      ----        -------    -----------
Outstanding July 28, 1996...   683,394   $ 2.54  - 9.01     $3.89        333,333  $ 4.64 - 5.35
   Granted ................. 1,465,649     6.10  -10.41      6.48
   Exercised................(1,225,384)    2.54  - 6.94      5.46        (13,333)          4.64
   Canceled.................    (7,332)    5.25  - 9.01      8.67           -
                            ----------    -------------      ----        -------    -----------
Outstanding August 3, 1997..   916,327   $ 2.54  -10.41     $5.87        320,000  $ 4.64 - 5.35
                            ==========                                   =======
</TABLE>

       Options to purchase 130,218 shares of common stock were exercisable under
       all plans at August 3, 1997 at a weighted average exercise price of $5.59
       with a  weighted  average  remaining  contractual  life of 6.8  years  as
       follows:

    Options Outstanding and Exercisable by Price Range as of August 3, 1997
<TABLE>
<CAPTION>

                                            Options Outstanding                    Options Exercisable
                                ----------------------------------------------  ---------------------------
                                               Weighted
                                                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>            <C>           <C>     
           $2.5350  -$ 5.2500     151,117           6.43           $ 2.9164       38,672        $ 4.0255
            6.0938  -  6.0938     259,997           4.67             6.0938       56,995          6.0938
            6.4688  -  6.4688     326,550           9.74             6.4688        8.889          6.4688
            6.9375  - 10.4063     178,663           4.31             7.0152       25,662          6.9375
                                  -------           ----             ------      -------          ------
           $2.5350  -$10.4063     916,327           6.79            $5.8728      130,218         $5.5948
</TABLE>
      
       In April 1993,  common stock warrants were issued to certain officers and
       directors for the right to acquire  573,333 shares of common stock of the
       Company at the fair market value of $5.35 per share at date of issue.  In
       December 1995  warrants for 533,333  shares were  canceled.  The warrants
       vest  immediately  and expire April 30, 1998.  In December  1995,  common
       stock  warrants were issued to certain  officers for the right to acquire
       293,333 shares of common stock of the Company at the fair market value of
       $4.64 per share at date of  issue.  The  warrants  vest  immediately  and
       expire  December 13, 2005.  Warrants for 13,333 shares were  exercised in
       fiscal 1997.

       In  connection  with the sale of common stock to the public in 1992,  the
       Company  issued to the  underwriter,  for its own  account,  warrants  to
       purchase 170,529 shares of common stock of the Company (as adjusted under
       the  agreement),  exercisable  for a period  of four  years at a price of
       $9.06 per share (as  adjusted  under the  agreement),  subject to further
       adjustment in certain events. The warrants expired in February 1997.


                                      F-17

<PAGE>



       On July 31, 1993, the Company issued 46,666 shares of common stock valued
       at $5.91 per share in connection  with the  acquisition of  substantially
       all of the assets of Micro-Dynamics,  Inc. These shares were subsequently
       canceled and reissued in January 1995.

NOTE N - RELATED PARTY TRANSACTIONS

       On March 6, 1996,  the Board of  directors  approved  the  purchase of an
       industrial  parcel of land from the Chairman of the Company for $940,000.
       A deposit of  $94,000  was paid on  execution  of the  contract,  and the
       balance of $846,000  will be paid at  settlement  on or before  April 30,
       1998. The Company intends to use this land for possible future expansion.

NOTE O - MAJOR CUSTOMERS

       Net sales to the U.S.  Government in 1997,  1996,  and 1995 accounted for
       approximately 34%, 33%, and 30% of net sales, respectively.  Net sales to
       the Republic of Korea and Lockheed Martin accounted for approximately 22%
       of net sales in 1997. Foreign sales amounted to approximately $9,320,000,
       $6,556,000, and $3,908,000 in fiscal 1997, 1996, and 1995, respectively.

       Included  in accounts  receivable  as of August 3, 1997 and July 28, 1996
       are amounts due from the U.S. Government of approximately  $1,454,000 and
       $933,000, respectively.

NOTE P - UNUSUAL ITEM

       The  Consolidated  Statements of Operations for the fifty-two weeks ended
       July 30, 1995  includes an unusual  charge of $5,447,005  for  settlement
       costs, legal fees, and related expenses in connection with the settlement
       of certain legal claims against the Company. Payments of $2,000,000 each,
       without interest, were made in July 1995 and July 1996 in connection with
       the settlement of one of the claims.

NOTE Q - 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.

         Notes receivable-officers:  The carrying amount reported in the balance
         sheet for notes receivable from officers approximated its fair value.

         Available-for-sale  securities:  The fair  value of  available-for-sale
         securities was based on quoted market prices.

         Long-term debt: The fair value of the mortgage note was estimated using
         discounted  cash  flow  analysis,   based  on  the  Company's   current
         incremental borrowing rate for similar types of borrowing arrangements.

       Off balance sheet financial instruments:

         Stand-by   letters  of  credit:   These  letters  of  credit  primarily
         collateralize  the  Company's  obligations  to  customers  for advanced
         payments received under contracts.  The contract amounts of the letters
         of credit approximate their fair value.


                                      F-18

<PAGE>


The carrying amounts and fair values of the Company's financial  instruments are
presented below:

                                                     August 3, 1997
                                               --------------------------
                                            Carrying Amount    Fair Value
                                            ---------------    ----------
          Cash and cash equivalents          $ 1,194,650      $ 1,194,650
          Notes receivable-officers            2,100,913        2,100,913
          Long-term debt                       2,890,000        3,408,000
          Stand-by letters of credit               -            3,241,392

NOTE R - CONCENTRATION OF CREDIT RISK

       Financial  instruments  which  potentially  subject the Company to credit
       risk consist  primarily of trade  accounts  receivable.  Credit risk with
       respect to trade  receivables  is minimized  since most of the  Company's
       business  is  direct to the U. S.  Government  or as a  subcontractor  to
       companies  with   significant   financial   resources   acting  as  prime
       contractors to the U. S. Government,  as well as to foreign  governments.
       Additionally,  shipments  to  foreign  governments  are  generally  under
       irrevocable letters of credit.

NOTE S - SUBSEQUENT EVENTS

       On August 4, 1997,  the Company  completed the  acquisition  of Metraplex
       Corporation , a Maryland  corporation  for 234,895 shares of common stock
       of the Company in exchange for all of the issued and  outstanding  common
       stock of  Metraplex.  Metraplex is a leading  manufacturer  of pulse code
       modulation  and  frequency  modulation,  telemetry  and data  acquisition
       systems for severe environment applications.  Metraplex products are used
       worldwide  for testing  space launch  vehicle  instrumentation,  aircraft
       flight testing, and amphibian, industrial and automotive vehicle testing.
       The transaction will be accounted for under the purchase method.

       On  September  4, 1997 the Board of  Directors  declared a 4-for-3  stock
       split effected as a stock dividend payable  September 29, 1997 to holders
       of record on  September  15,  1997.  The effect of the split is presented
       within shareholders' equity at August 3, 1997. The distribution increased
       the number of shares outstanding from 3,157,024 to 4,209,365.  The amount
       of $105,234 was  transferred  from the additional  paid-in capital to the
       common stock account to record this distribution. All share and per share
       data,  including  stock  options  and  warrants,  included in this annual
       report have been restated to reflect the stock split.



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