UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K
(Mark One)
    [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934
                    For the fiscal year ended August 2, 1998

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

                           Commission File No. 0-5411

                             Herley Industries, Inc.
             (Exact name of registrant as specified in its charter)

    Delaware                                                     23-2413500
    --------------------------------                       -------------------
    State or other jurisdiction                               (I.R.S. Employer
    of incorporation or organization                       Identification No.)

    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. [X] Yes  [ ] No

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

Based on the closing  sale price of $8.8125 as of October 6, 1998 the  aggregate
market value of the voting stock held by  non-affiliates  of the  registrant was
$36,892,994.

The number of shares  outstanding of registrant's  common stock, $ .10 par value
as of October 6, 1998 was 5,313,040.

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 7A    Quantitative and Qualitative Disclosures About Market Risk    15
   Item 8     Financial Statements and Supplementary Data                   15
   Item 9     Changes in and Disagreements with Accountants on
                 Accounting and Financial Disclosure                        15
PART III
   Item 10    Directors and Executive Officers of the Registrant            15
   Item 11    Executive Compensation                                        15
   Item 12    Security Ownership of Certain Beneficial
                 Owners and Management                                      15
   Item 13    Certain Relationships and Related Transactions                15

PART IV
   Item 14    Exhibits, Financial Statement Schedules and Reports
              on Form 8K                                                    16

SIGNATURES                                                                  17

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., a Delaware corporation,  ("Herley" or the "Company") is
engaged   in  the   design,   development,   manufacture   and  sale  of  flight
instrumentation  components and systems, and microwave products 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 scoring systems. Flight instrumentation products
are used to: (i) accurately track the flight of space launch vehicles,  targets,
and unmanned airborne vehicles ("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.

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

The Company has grown internally and through five strategic  acquisitions.  As a
result, the Company has evolved from a components  manufacturer to a systems and
service provider and has leveraged its technical capabilities and expertise into
domestic commercial and foreign defense markets.

Since its inception in 1965, the Company has designed and manufactured microwave
devices for use in 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, a manufacturer of flight instrumentation  products. 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


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1997, 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.

Products

         Command and Control Systems (C2)

For over thirty years,  Vega (a division of the Company) 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 users on
the open ocean, remote land masses, and instrumented test and training ranges.

The Company's  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 command and control systems ground station.  The
UAV may also be used as a decoy,  since  the  operator  can  direct  the  flight
operations that will make the small drone appear to be a larger combat aircraft.

With  the 1994  licensing  of the  MAGIC2  system,  the  Company  increased  the
selection of command and control  systems.  The 6104 TTCS  (Target  Tracking and
Control  System)  unit is a  line-of-sight  command and  control  system 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 system affords over-the-horizon command
and control  using GPS  guidance  and control of multiple  targets from a single
ground station.  The ability to control multiple targets at increased  distances
represents a significant product improvement. The increasing demand for enhanced
performance  by the U.S.  Navy as well as  foreign  navies in  littoral  warfare
scenarios can be satisfied 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 designed to
operate with a large variety of vehicles. A basic TTCS configuration is normally
supplied with a standard Company 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.  The TTCS is used in  support  of
missile,  aircraft and other weapons  systems  development  and testing.  Herley
continues to provide this system to customers to support their requirement.

The MAGIC2  system  provides  control of multiple  targets from a single  ground
control system, and utilizes GPS to provide accurate position  information.  The
MAGIC2 system meets a growing  requirement to test against multiple threats with
the automated defense  capabilities of ships like the AEGIS cruiser and the E-2C
aircraft.

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 command and control system,  which may be mounted in a trailer that
may be moved  from  place to place by  helicopter  or truck.  The  Company  also
manufactures  portable  command and control  systems that are mounted on tripods

                                        2

<PAGE>
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.

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  alliances.
Teaming  arrangements with Tracor  Corporation and Northrop Grumman  Corporation
have resulted in recent awards to the Company for command and control systems 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
requires  flight safety and  performance  data  transmission  to maximize flight
safety during the test operation.  Surveillance and intelligence  gathering UAVs
also  require a data  transmission  downlink  and a command and control  systems
uplink to accomplish their mission. 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.  Metraplex is now a leading  manufacturer of PCM and FM
telemetry  and data  acquisition  systems for severe  environment  applications,
whose   products  are  used   worldwide   for  testing   space  launch   vehicle
instrumentation,   aircraft  flight  testing,  and  amphibian,   industrial  and
automotive vehicle testing.  The product portfolio ranges in size and complexity
from miniature encoders to completely programmable data acquisition systems.

The Company's  acquisition  of Metraplex  allows the Company to offer a complete
airborne  data link  system.  With the digital  capability  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  offers a full line of  narrow  or wide  band  airborne
telemetry  systems to meet a wide variety of industrial 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,  particularly  under adverse
weather conditions after the launch.

In range safety  applications,  transponders  enable accurate  tracking of space
launch  and  unmanned  aerial  vehicles,  missiles,  and  target  drones so that
position and direction are known  throughout its flight.  In the case of several
defense and commercial  space launch vehicles  (i.e.,  Delta,  Atlas,  Titan and
Pegasus),  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.

                                        3

<PAGE>
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 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, a UAV, a
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.

         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  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.

In Woburn,  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 manufactures  magnetrons,  which are the
power source utilized in the production of the Company's transponders.

The  Company  produces  receiver  protector  devices.  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  has only one  significant
competitor in this market.

The  Company  also  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,  in part, 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
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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 require and budgets  permit.
The  cost  of  these  development  activities,  including  employees'  time  and
prototype  development,  net of amounts paid by  customers,  were  approximately
$1,562,000,   $1,828,000,  and  $1,453,000  in  fiscal  1998,  1997,  and  1996,
respectively.

The new products and systems that the Company plans to design,  manufacture  and
sell are data link systems,  which include  telemetry data  encoders.  Data link
systems and data  encoders are  currently  being sold by others to the Company's
existing  customers.  With its  acquisition  of Metraplex  in August  1997,  the
Company  now offers  data link  systems to its  customers,  either  directly  or
through  teaming  arrangements.  Upon  receipt  of an order,  the  Company  will
customize  the design of a system for its customer for delivery  typically  nine
months after receipt of such order.

         Data Link Systems

Data  link  systems  contain  transmitters,   amplifiers,  receivers  and  other
components,  and provide the means of  communication  between the control tower,
the ground  station and the test or launch  vehicle.  Data link  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
telemetry data encoder.

Through the  application  of  technology  acquired from  Metraplex,  the Company
manufactures 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)  produced by the Company in a known sequence and rate so as
to create a data stream that may be  transmitted  to the ground by the telemetry
system.

         Commercial Lighting

Over the past three years, the Company has been seeking commercial  applications
for the magnetron  tubes  produced by the Company's MDI division.  In 1995,  the
Company signed  agreements  with a large lighting  company to develop  miniature
cost-effective  magnetron  tubes,  using  electrode-less  high  density  ("EHD")
techniques,  for medical and industrial lighting applications.  Based on initial
engineering  results,  prototype  tubes were designed,  manufactured  and tested
satisfactorily  to the  specifications  required.  The  Company  and this  other
company are currently  planning limited production of magnetron tubes to be used
in an EHD industrial lighting application.

Government Contracts

A substantial part of the Company's sales are made to U.S. government  agencies,
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.

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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.

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 on the work completed.

Recent Developments

As of August 21, 1998,  the Company  entered into an agreement to acquire all of
the issued and outstanding  common stock of General  Microwave Corp., a New York
corporation, for $18.00 per share and a three-year warrant to purchase one share
of the Company's  common stock at an aggregate  purchase price of  approximately
$23,000,000.  The warrant is exercisable at $14.40 per share through January 11,
1999, and thereafter at $15.60 per share,  until  expiration.  General Microwave
designs,  manufactures  and markets  microwave  components and  subsystems,  and
related electronic test and measurement equipment.  The company is headquartered
in Amityville,  New York, and operates two other  facilities,  one in Billerica,
Massachusetts,  and one in Israel. The transaction is subject to the approval of
the  stockholders of General  Microwave Corp. The transaction  will be accounted
for under the purchase method.

Marketing and Distribution

The Company's  marketing approach is to determine  customer  requirements in the
developmental  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  (including options) 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  $38,724,000 on August 2,
1998  ($25,727,000  in domestic  orders and  $12,997,000  in foreign  orders) as
compared to approximately $36,911,000 on August 3, 1997 ($26,135,000 in domestic
orders  and  $10,776,000  in  foreign  orders).   Management   anticipates  that
approximately  $32,093,000 of the backlog will be shipped during the fiscal year
ending August 1, 1999. 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 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 testing procedures based upon customer
requests. All of such testing is performed by the Company at its facilities.

All  electronic  parts are  procured in  controlled  lots that are  subjected to
physical  inspection and screening at Herley  facilities before use in products.
Physical  inspection  may  require 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  continuously  monitor,  analyze and measure 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

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<PAGE>
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,  with the exception of
one component part which, if unavailable, can be manufactured by the Company.

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.

Competition

The flight  instrumentation and microwave products that 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 or programs,  the Company believes it
is sole source,  which means that all work is directed to a single manufacturer.
In other cases, there may be other suppliers that 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,   L-3  Communications
Corporation, Microsystems, Inc., AMP, Inc. and Remec, Inc.

Employees

As of October 4, 1998, the Company  employed 306 full-time  persons.  A total of
228 employees were engaged in manufacturing, 38 in engineering, 19 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  nondisclosure  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.


                                        7

<PAGE>
Item 2.  Properties

The Company's properties are as follows:
<TABLE>
<CAPTION>
                                                                Area    Owned
                                                              Occupied    or
Location           Purpose of Property                        (Sq. ft.) Leased
-----------------  ------------------------------------------ --------- ------
<S>                <C>                                         <C>       <C>
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   11,000   Leased

Lancaster, PA      Land held for expansion                     26 Acres  Owned
--------------
<FN>
     (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.
</FN>
</TABLE>

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 Nasdaq  National  Market under
     the  symbol  HRLY.  The  following  table sets forth the high and low sales
     price as reported by the Nasdaq  National  Market for the Company's  Common
     Stock for the  periods  indicated  and gives  effect to the  four-for-three
     stock split of the Common Stock on September 30, 1997.
<TABLE>
<CAPTION>
                                                        Common Stock
                                                       ---------------
                                                       High       Low
                                                       ----       ---
     <S>                                               <C>       <C>

     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
     Fiscal Year 1998
         First Quarter..............................   15.00     10.13
         Second Quarter.............................   14.75     10.50
         Third Quarter..............................   14.69     10.88
         Fourth Quarter.............................   14.25      8.63
     Fiscal Year 1999
         First Quarter (through October 20, 1998)...   10.38      7.63
</TABLE>
     The closing price on October 20, 1998 was $8.375.

(b)  As of October 1, 1998, 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 fiscal years.

      Item 6.  Selected Financial Data
<TABLE>
<CAPTION>
                                         52 Weeks     53 Weeks              52 Weeks ended
                                           Ended        Ended     -----------------------------------
                                         August 2,    August 3,    July 28,     July 30,     July 31,
                                          1998 (2)      1997         1996       1995 (3)       1994
                                        ----------   ----------   ----------   ----------   ----------
<S>                                   <C>            <C>          <C>          <C>          <C>   
Net sales                             $ 40,797,991   32,195,168   29,001,404   24,450,267   30,508,211
                                        ==========   ==========   ==========   ==========   ==========
Net income (loss)                     $  5,496,608    4,803,659    3,668,956   (4,890,166)   1,861,429
                                         =========    =========    =========    =========    =========
Earnings (loss) per common share (1)
     Basic                              $ 1.11           1.18          .97         (.98)         .33
                                          ====           ====          ===          ===          ===
     Assuming Dilution                  $ 1.02           1.01          .86         (.98)         .33 
                                          ====           ====          ===          ===          ===

Total Assets                          $ 57,552,529   39,257,186   42,508,942   42,229,282   53,752,454
Total Current Liabilities             $  9,843,041    9,813,376    7,559,306    9,973,866   10,217,598
Long-Term Debt net of current portion $  4,110,885    2,890,000   11,021,000   10,525,000   14,822,834
------------------
<FN>
(1)  As adjusted to give effect to a 4-for-3 stock split effective September 30,
     1997.

(2)  On August 4, 1997, the Company acquired Metraplex  Corporation.  See Note B
     of the financial statements.

(3)  Fiscal 1995 includes  settlement costs, legal fees, and related expenses in
     the amount of approximately $5,447,000 in connection with the settlement of
     certain legal claims.
</FN>
</TABLE>
                                        9
<PAGE>
Item 7.  Management's Discussion and Analysis of Financial Condition and
                  Results of Operations

Overview

The  Company  is  engaged  in  the  design,   manufacture  and  sale  of  flight
instrumentation components and systems, and microwave products, 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 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 $38,724,000 at August 2, 1998,  $25,727,000 is
attributable  to domestic  orders and  $12,997,000  is  attributable  to foreign
orders.  Management  anticipates that  approximately  $32,093,000 of its backlog
will be shipped  during the  fiscal  year  ending  August 1, 1999.  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 of
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.
Revenue recognized on these contracts is based on estimated  completion to date,
which is the total contract amount  multiplied by percent of performance,  based
on total costs incurred in relation to total estimated cost at completion. As of
August 2, 1998,  costs  incurred and income  recognized in excess of billings on
uncompleted contracts was $1,665,008.  There were no long-term contracts of this
nature as of August 3, 1997.  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
$1,562,000,$1,828,000,  and  $1,453,000  in fiscal  years  1998,  1997 and 1996,
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 1998 and 1997 was 34.8% and 9.1%,
respectively.  The low effective rate in 1997 reflects 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

                                       10

<PAGE>
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.

Results of Operations

The  following  table sets forth for the  periods  indicated  certain  financial
information  derived  from  the  Company's  consolidated  statements  of  income
expressed as a percentage of net sales. There can be no assurance that trends in
sales growth or operating results will continue in the future.
<TABLE>
<CAPTION>
                                              52 weeks    53 weeks    52 weeks
                                               ended       ended       ended
                                             August 2,   August 3,    July 28,
                                                1998        1997        1996
                                                ----        ----        ----
<S>                                            <C>         <C>         <C>
Net sales                                      100.0%      100.0%      100.0%
                                               
Cost of products sold                           59.2%       64.5%       68.3%
                                               -----       -----       -----
Gross profit                                    40.8%       35.5%       31.7%
                                                
Selling and administrative expenses             20.4%       19.5%       20.1%
                                               -----       -----       -----
Operating income                                20.3%       16.0%       11.6%
                                               -----       -----       -----
Other income, net:
      Net gain on available-for-sale
        securities and other investments         0.3%        1.3%        3.1%
      Dividend and interest income               1.1%        0.8%        1.3%
      Interest expense                          (1.1)%      (1.7)%      (3.0)%
                                               -----       -----       -----
                                                 0.3%        0.4%        1.4%
                                               -----       -----       -----
Income before income taxes                      20.7%       16.4%       13.0%
Provision for income taxes                       7.2%        1.5%        0.4%
                                               -----       -----       -----
Net income                                      13.5%       14.9%       12.7%
                                               =====       =====       =====
</TABLE>

    Fiscal 1998 Compared to Fiscal 1997

Net sales for the 52 weeks ended August 2, 1998 were  approximately  $40,798,000
compared to  $32,195,000  for fiscal  1997.  The sales  increase  of  $8,603,000
(26.7%) is primarily attributable to the acquisition of Metraplex Corporation as
of August 4, 1997 which  contributed  $4,015,000  in revenues in fiscal 1998, an
increase of approximately $3,542,000 in flight instrumentation  products, and an
increase of approximately $1,046,000 in microwave components.

Gross profit of 40.8% for the 52 weeks ended  August 2, 1998  exceeded the prior
year of 35.5% due to an increase of $2,545,000  in higher  margin  foreign sales
from  $9,398,000  in 1997 to  $11,943,000  in  1998,  and  improved  margins  in
microwave components, as well as an increase in absorption of fixed costs due to
the higher sales volume.

                                       11

<PAGE>
Selling and  administrative  expenses for the 52 weeks ended August 2, 1998 were
$8,339,000  compared to $6,293,000  for fiscal 1997, an increase of  $2,046,000.
The  addition  of  Metraplex   Corporation   added  $1,195,000  in  selling  and
administrative  expenses in fiscal 1998. In addition,  $304,000 of the change is
attributable to increased  representative fees on foreign sales, $415,000 is due
to  increased  personnel  and  related  expenses,  including  additional  travel
expenses,  and  $350,000  relates to increased  consulting  fees  primarily  for
software  changes  addressing  the year  2000  computer  software  issues.  Such
increases  were offset by cost  savings of $243,000  related to the  transfer of
substantially  all of the  production  from the  Stewart  Warner  facilities  in
Chicago to the Company's facilities in Lancaster,  Pennsylvania. As a percentage
of net sales,  selling and administrative  expenses increased from 19.5% in 1997
to 20.4% in 1998.

Other income, net, for the 52 weeks ended August 2, 1998 was consistent with the
prior year.

The effective tax rate in 1998 was 34.8% as compared to 9.1% in fiscal 1997. The
1997 tax provision  reflects 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

     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 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, net, 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.

Subsequent Event

As of August 21, 1998,  the Company  entered into an agreement to acquire all of
the issued and outstanding  common stock of General  Microwave Corp., a New York
corporation  , for $18.00 per share and a  three-year  warrant to  purchase  one
share of the Company's common stock at an aggregate purchase price of

                                       12

<PAGE>
approximately  $23,000,000.  The  warrant  is  exercisable  at $14.40  per share
through January 11, 1999, and thereafter at $15.60 per share,  until expiration.
General Microwave  designs,  manufactures and markets  microwave  components and
subsystems,  and related electronic test and measurement equipment.  The company
is headquartered in Amityville, New York, and operates two other facilities, one
in Billerica,  Massachusetts,  and one in Israel.  The transaction is subject to
the approval of the  stockholders of General  Microwave Corp. at a meeting to be
held in December 1998. The transaction  will be accounted for under the purchase
method.  As of October 20,  1998,  the Company has  acquired  362,400  shares of
General Microwave in the open market for approximately $6,217,000.

Liquidity and Capital Resources

As of August 2, 1998 and  August 3,  1997,  working  capital  was  approximately
$26,593,000 and  $10,662,000,  respectively,  and the ratio of current assets to
current  liabilities  was 3.70 to 1 and 2.09 to 1,  respectively.  At  August 2,
1998, the Company had cash and cash  equivalents of  approximately  $10,689,000,
primarily from the proceeds  received from the public stock  offering  discussed
below.

On  August  4,  1997,  the  Company   completed  the  acquisition  of  Metraplex
Corporation , a Maryland  corporation for 313,139 (as adjusted) shares of common
stock of the Company,  with a fair market value of  $3,170,471,  in exchange for
all of the issued and outstanding common stock of Metraplex.

As is customary  in the defense  industry,  inventory  is partially  financed by
advance  payments.  The  unliquidated  balance  of these  advance  payments  was
approximately  $1,825,000 in 1998,  and  $3,091,000 in 1997. The decrease in the
current  fiscal year is directly  attributable  to  shipments  under the related
contracts.

Net  cash  provided  by  (used  in)  operations  and  investing  activities  was
approximately $3,647,000, and $6,159,000,respectively in 1997, and approximately
$4,571,000 and ($1,051,000) , respectively in 1998.

 Net cash  provided  by  financing  activities  in fiscal  1998  consists of net
proceeds of  $7,452,000  from the sale of 700,000  shares of common  stock,  and
1,265,000 Common Stock Purchase  Warrants to the public.  Net borrowings under a
bank line of credit  provided  $1,500,000 in financing.  The Company  received a
partial distribution of $592,824 from its M.D. Sass Municipal Finance Partners-I
limited  partnership  investment.  Cash was  used in  financing  activities  for
payments of long-term  debt of $2,257,000  and the purchase of treasury stock of
$1,084,000 Cash provided by investing activities in 1997 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  $21,000,000,  which  expires  January 31,  2000.  As of August 2, 1998,  the
Company had borrowings outstanding of $1,500,000. No borrowings were outstanding
on this line at August 3, 1997.

In January 1998, the Company  purchased 89,888 shares of its outstanding  common
stock for  $1,084,326  from  certain  officers of the Company  based on the fair
market  value of the stock on the date  acquired.  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  42,016 and 463,639 shares of common stock in 1998 and
1997,  respectively,  valued  at  $538,376  and  $6,429,124,   respectively,  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,  as well
as the proceeds received from the public stock offering.
                                       13

<PAGE>
Year 2000 Readiness

The  "Year  2000"  problem  relates  to  computer  systems  that  have  time and
date-sensitive  programs that were designed to read years  beginning  with "19",
but may not properly  recognize the year 2000. If a computer  system or software
application  used by the Company or a third party dealing with the Company fails
because of the inability of the system or  application to properly read the year
2000 the results could have a material adverse effect on the Company.

A substantial  part of the Company's  revenues are derived from firm fixed price
contracts with U.S. government agencies,  prime contractors or subcontractors on
military or aerospace programs, and many foreign governments.  If the Company is
unable to perform under these contracts due to a Year 2000 problem, the customer
could  terminate  the contract  for  default.  While lost revenue s from such an
event are a concern for the  Company,  the greater  risks are the  consequential
damages for which the Company  could be liable for failure to perform  under the
contracts.  Such damages could have a material  adverse  impact on the Company's
results of operations and financial position.

The most likely  reason for a customer to terminate a contract for default would
be due to the Company's  inability to manufacture  and deliver product under the
contract.  Breakdowns  in any  number  of the  Company's  computer  systems  and
applications  could prevent the Company from being able to manufacture  and ship
its products.  Examples are failures in the Company's manufacturing  application
software,  computer chips embedded in engineering test equipment, lack of supply
of materials from its suppliers, or lack of power, heat, or water from utilities
servicing its facilities. The Company's products do not contain computer devices
that  require  remediation  to meet  Year  2000  requirements.  A review  of the
Company's  status with respect to remediating its computer systems for Year 2000
compliance is presented below.

For its information technology, the Company currently utilizes a Hewlett Packard
HP3000-based  computing  environment.  The HP3000 hardware is in compliance with
Year  2000  requirements.  The  Company's  financial,  manufacturing,  and other
software  applications  related to the HP3000  have been  updated to comply with
Year 2000 requirements at a cost of approximately $350,000. Certain modules have
been fully tested,  with the remaining modules to be tested by the end of fiscal
1999. In addition,  the Company  utilizes a wide area network ("WAN") to connect
its operating  facilities to the HP3000. The WAN has been updated to comply with
Year 2000  requirements.  A local area network ("LAN") is used to supplement the
HP3000 environment and has also been upgraded and is fully Year 2000 compliant.

The Company is also reviewing its utility systems (heat, light,  phones,  liquid
nitrogen, etc.) for the impact of Year 2000, as well as determining the state of
readiness of its material suppliers. The Company will develop a questionnaire to
be sent to its significant  suppliers,  and to its test equipment  manufacturers
concerning  embedded  technology,  regarding  their  compliance  and  attempt to
identify any problem  areas with  respect to them.  This process will be ongoing
and the  Company's  efforts with respect to specific  problems  identified,  and
future costs  associated  with them,  will depend in part upon its assessment of
the risk that any such problems may cause a disruption in manufacturing or other
problem which the Company  believes would have a material  adverse impact on its
operations.  However,  the Company  cannot control the conduct of its suppliers.
Therefore,  there can be no guarantee that Year 2000 problems originating with a
supplier will not occur. The Company has not yet developed  contingency plans in
the event of a Year 2000 failure caused by a supplier or third party,  but would
intend  to do  so if a  specific  problem  is  identified  through  the  process
described  above.  The Company has developed  multiple sources for a substantial
portion of its raw material requirements and, therefore,  does not believe there
would be a significant disruption in supply.

The information set forth above identifies the key steps taken by the Company to
address the Year 2000  problem.  There can be no absolute  assurance  that third
parties will convert their systems in a timely manner. The Company believes that
its actions will minimize these risks and that any additional  cost of Year 2000
compliance for its  information  and production  systems will not be material to
its consolidated results of operations and financial position.


                                       14

<PAGE>
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to market risk  associated with changes in interest rates
and stock  prices.  The Company has not entered  into any  derivative  financial
instruments  to manage the above risks and the Company has not entered  into any
market risk  sensitive  instruments  for trading  purposes.  The Company's  debt
consists of a working capital line of credit with a bank having an interest rate
that  floats  with the FMOC  Target  Rate  (7.15% as of August 2,  1998),  and a
mortgage on its facilities in Lancaster, Pa. at a fixed rate of 10.4% The credit
line is reviewed on an annual basis.  After the proposed  acquisition of General
Microwave Corp. the Company will be subject to potentially  adverse movements in
foreign  currency  rate  changes.  The  Company  does not  anticipate  any other
material changes in its primary market risk exposures in fiscal 1999.

As of August 2, 1998,  the Company  holds an investment in the common stock of a
public company that is exposed to price risk with a cost basis and a fair market
value basis of $143,330.

The table below provides  information about the Company's debt that is sensitive
to  changes  in  interest  rates.  The table  presents  principal  cash flows by
maturity date.

Future principal  payments  required under the mortgage and line of credit,  and
corresponding fair values are as follows:
<TABLE>
<CAPTION>
         Fiscal year ending during:     Mortgage    Line of Credit
         -------------------------      ---------   --------------
                         <S>           <C>             <C>
                         1999          $  370,000      $
                         2000             410,000       1,500,000
                         2001             450,000
                         2002             500,000
                         2003             550,000
                         2004             610,000                
                                        ---------       ---------
                                       $2,890,000      $1,500,000
                                        =========       =========
             Fair value                $2,908,000      $1,500,000
                                        =========       =========
</TABLE>
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  January  1999,  to be  filed  with  the
Securities  and Exchange  Commission  within 120 days  following  the end of the
Company's fiscal year ended August 2, 1998.

                                       15

<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 (Exhibit 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 October 1, 1998.

    10.4  Employment  Agreement between Herley  Industries,  Inc. and Myron Levy
          dated as of October 1, 1998.

    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).

    10.11 Agreement and Plan of Merger dated as of August 21, 1998 among General
          Microwave Corp.,  Eleven General  Microwave Corp.,  Shareholders,  GMC
          Acquisition  Corporation  and  Registrant  (Exhibit 1 of Schedule  13D
          dated August 28, 1998).

    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

                                       16

<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 26th day of October, 1998.

                                          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  26,  1998 by the  following  persons in the
capacities indicated:


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

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           Secretary and Director
    --------------------------
         David H. Lieberman

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

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

By:    /S/ Alvin M. Silver               Director
    -----------------------
         Alvin M. Silver

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


                                       17

<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 2, 1998
       and  August 3, 1997.                                                F-3

    Consolidated  Statements of Income for the 52 Weeks Ended
       August 2, 1998, 53 Weeks Ended August 3, 1997
       and 52 Weeks Ended July 28, 1996.                                   F-4

    Consolidated  Statements  of  Shareholders'  Equity
       for the 52 Weeks Ended August 2, 1998, 53 Weeks Ended
       August 3, 1997 and 52 Weeks Ended July 28, 1996.                    F-5

    Consolidated Statements of Cash Flows for the 52 Weeks Ended
       August 2, 1998, 53 Weeks Ended August 3, 1997
       and 52 Weeks Ended July 28, 1996.                                   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 2, 1998, and August 3, 1997, and
the related  consolidated  statements of income,  shareholders'  equity and cash
flows for the 52 weeks ended August 2, 1998,  the 53 weeks ended August 3, 1997,
and the 52 weeks  ended  July  28,  1996.  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 2,  1998,  and  August  3,  1997,  and the
consolidated  results of their  operations and cash flows for the 52 weeks ended
August 2, 1998,  the 53 weeks ended August 3, 1997,  and the 52 weeks ended July
28, 1996 in conformity with generally accepted accounting principles.


                                                 /s/ ARTHUR ANDERSEN LLP  
                                                     ARTHUR ANDERSEN LLP



Lancaster, PA
 September 17, 1998


                                       F-2

<PAGE>
                                HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                                       CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
                                                                             August 2,        August 3,
                                                                              1998              1997
                                                                         ---------------    --------------
<S>                                                                    <C>                <C>

                      ASSETS
Current Assets:
        Cash and cash equivalents                                      $     10,689,193   $     1,194,650
        Accounts receivable                                                   6,193,947         5,176,523
        Notes receivable-officers                                              -                2,100,913
        Costs incurred and income recognized in excess
           of billings on uncompleted contracts                               1,665,008           -
        Other receivables                                                       248,298           152,148
        Prepaid income taxes                                                    377,448           -
        Inventories                                                          15,068,618         9,790,382
        Deferred taxes and other                                              2,194,004         2,061,066
                                                                         ---------------    --------------
                             Total Current Assets                            36,436,516        20,475,682
Property, Plant and Equipment, net                                           12,549,343        11,704,755
Intangibles, net of amortization of $1,524,393 in 1998
        and $1,133,750 in 1997                                                6,080,218         4,308,136
Available-for-sale Securities                                                   143,330           -
Other Investments                                                               849,324         1,313,502
Other Assets                                                                  1,493,798         1,455,111
                                                                         ===============    ==============
                                                                       $     57,552,529   $    39,257,186
                                                                         ===============    ==============
        LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
        Current portion of long-term debt                              $        404,984   $       335,000
        Note payable to related party                                          -                  846,000
        Accounts payable and accrued expenses                                 6,468,183         4,986,740
        Income taxes payable                                                   -                   76,635
        Reserve for contract losses                                           1,145,128           478,000
        Advance payments on contracts                                         1,824,746         3,091,001
                                                                         ---------------    --------------
                             Total Current Liabilities                        9,843,041         9,813,376
Long-term Debt                                                                4,110,885         2,890,000
Deferred Income Taxes                                                         3,158,353         2,696,394
Excess of fair value of net assets of business
        acquired over cost, net of accumulated
        amortization of $973,667 in 1997                                       -                  486,833
                                                                         ---------------    --------------
                                                                             17,112,279        15,886,603
                                                                         ---------------    --------------
Commitments and Contingencies
Shareholders' Equity:
        Common stock, $.10 par value; authorized
          20,000,000 shares; issued and outstanding
          5,266,159 in 1998 and 4,209,365 in 1997                               526,616           420,936
        Additional paid-in capital                                           20,323,895         8,856,516
        Retained earnings                                                    19,589,739        14,093,131
                                                                         ---------------    --------------
                             Total Shareholders' Equity                      40,440,250        23,370,583

                                                                         ===============    ==============
                                                                       $     57,552,529   $    39,257,186
                                                                         ===============    ==============
<FN>
        The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
                                       F-3
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
                                                                      52 weeks              53 weeks               52 weeks
                                                                        ended                 ended                 ended
                                                                      August 2,             August 3,              July 28,
                                                                        1998                  1997                   1996
                                                                  ------------------    ------------------     -----------------
<S>                                                             <C>                   <C>                    <C>               
Net sales                                                       $        40,797,991   $        32,195,168    $       29,001,404
                                                                  ------------------    ------------------     -----------------

Cost and expenses:
      Cost of products sold                                              24,169,034            20,753,707            19,798,692
      Selling and administrative expenses                                 8,338,789             6,293,199             5,831,830
                                                                  ------------------    ------------------     -----------------
                                                                         32,507,823            27,046,906            25,630,522
                                                                  ------------------    ------------------     -----------------

           Operating income                                               8,290,168             5,148,262             3,370,882
                                                                  ------------------    ------------------     -----------------

Other income, net:
      Net gain on available-for-sale
           securities and other investments                                 133,147               409,399               897,919
      Dividend and interest income                                          453,402               257,676               376,007
      Interest expense                                                     (446,109)             (531,678)             (873,452)
                                                                  ------------------    ------------------     -----------------
                                                                            140,440               135,397               400,474
                                                                  ------------------    ------------------     -----------------

           Income before income taxes                                     8,430,608             5,283,659             3,771,356
Provision for income taxes                                                2,934,000               480,000               102,400
                                                                  ------------------    ------------------     -----------------

           Net income                                           $         5,496,608   $         4,803,659    $        3,668,956
                                                                  ==================    ==================     =================

Earnings per common share - Basic                               $       1.11          $       1.18           $       .97
                                                                  ==================    ==================     =================

      Weighted average shares outstanding                             4,969,248             4,063,505             3,786,176
                                                                  ==================    ==================     =================

Earnings per common share - Diluted                             $       1.02          $       1.01           $       .86
                                                                  ==================    ==================     =================

      Weighted average shares outstanding -
            Assuming Dilution                                         5,407,283             4,733,682             4,253,785
                                                                  ==================    ==================     =================
<FN>
      The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>


                                       F-4
<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
52 weeks ended August 2, 1998, 53 weeks ended August 3, 1997 and 52 weeks ended
                                  July 28, 1996
<TABLE>
<CAPTION>
                                                                                         Unrealized Gain
                                                               Additional              (Loss) 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 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                                                                                       (1,734,233)    (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

Net income                                                                    5,496,608                                   5,496,608
Net proceeds from public offering
  of 700,000 shares of common stock
  and 1,265,000 warrants              700,000       70,000      7,381,579                                                 7,451,579
Issuance of common stock in
  connection with business acquired   313,139       31,314      3,139,157                                                 3,170,471
Exercise of stock options
  and warrants                        175,559       17,556        885,289                                   (538,376)       364,469
Tax benefit upon exercise of stock
  options                                                       1,670,866                                                 1,670,866
Purchase of 89,888 shares
  of treasury stock                                                                                       (1,084,326)    (1,084,326)
Retirement of treasury shares        (131,904)     (13,190)    (1,609,512)                                 1,622,702         -

                                  ------------   ----------   ------------   -----------   -----------   ------------   ------------
Balance at August 2, 1998           5,266,159  $   526,616     20,323,895    19,589,739        -              -       $  40,440,250
                                  ============   ==========   ============   ===========   ===========   ============   ============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
                                       F-5

<PAGE>
                    HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                           52 weeks          53 weeks          52 weeks
                                                                             ended             ended             ended
                                                                             August 2,         August 3,       July 28,
                                                                             1998              1997              1996
                                                                         --------------    --------------    --------------
<S>                                                                    <C>               <C>               <C>
Cash flows from operating activities:
     Net Income                                                        $     5,496,608   $     4,803,659   $     3,668,956
                                                                         --------------    --------------    --------------
     Adjustments to reconcile net income
        to net cash provided by operations:
         Depreciation and amortization                                       1,869,459         1,538,283         1,563,354
         (Gain) on sale of available-for-sale
            securities and other investments                                   -                (409,572)       (1,018,643)
         Equity in income of limited partnership                              (128,646)          -                 -
         Decrease (increase) in deferred tax assets                          1,207,090           -                (393,389)
         Increase in deferred tax liabilities                                  173,245           773,336           376,723
         Unrealized loss on available-for-sale securities                      -                 -                 121,550
         Changes in operating assets and liabilities:
            (Increase) decrease in accounts receivable                        (767,997)       (1,927,298)        1,430,692
            Decrease (increase) in notes receivable-officers                 2,100,913           (17,370)       (2,083,543)
            (Increase) in costs incurred and income recognized
               in excess of billings on uncompleted contracts               (1,665,008)          -                 -
            (Increase) decrease in other receivables                           (23,132)          (27,156)           38,410
            (Increase) in prepaid income taxes                                (377,448)          -                 -
            (Increase) decrease in inventories                              (3,757,660)       (1,779,695)        1,319,366
            (Increase) in prepaid expenses and other                           (55,200)         (371,078)          (25,940)
            Increase (decrease) in accounts payable and
                accrued expenses                                               773,399          (137,128)         (513,649)
            Increase (decrease) in income taxes payable                        468,847           (89,660)          166,295
            Increase (decrease) in reserve for contract losses                 667,128           (11,110)           (6,890)
            (Decrease) increase in advance payments
                on contracts                                                (1,363,870)        1,610,968             3,393
            Other, net                                                         (46,509)         (309,500)           40,000
                                                                         --------------    --------------    --------------
                Total adjustments                                             (925,389)       (1,156,980)        1,017,729
                                                                         --------------    --------------    --------------
         Net cash provided by operations                                     4,571,219         3,646,679         4,686,685
                                                                         --------------    --------------    --------------

<PAGE>
Cash flows from investing activities:
     Purchase of available-for-sale securities
         and other investments                                                 -                (159,364)      (11,077,331)
     Proceeds from sale of fixed assets                                          1,100            15,468           -
     Partial distribution from limited partnership                             592,824           -                 -
     Proceeds from sale of available-for-sale securities
         and other investments                                                 -               7,164,538        11,879,157
     Capital expenditures                                                   (1,645,204)         (862,129)         (643,330)
                                                                         --------------    --------------    --------------
         Net cash (used in) provided by investing activities                (1,051,280)        6,158,513           158,496
                                                                         --------------    --------------    --------------
Cash flows from financing activities:
     Net proceeds from public offering of common stock                       7,451,579           -                 -
     Borrowings under bank line of credit                                    4,050,000         2,825,000         9,875,000
     Proceeds from exercise of stock options                                   364,469           317,699           134,451
     Payments under lines of credit                                         (2,550,000)       (9,775,000)       (9,925,000)
     Payments under litigation settlement                                      -                 -              (2,000,000)
     Payments of long-term debt                                             (2,257,118)         (300,000)         (363,709)
     Purchase of treasury stock                                             (1,084,326)       (2,782,686)       (1,734,233)
                                                                         --------------    --------------    --------------
         Net cash provided by (used in) financing activities                 5,974,604        (9,714,987)       (4,013,491)
                                                                         --------------    --------------    --------------
         Net increase in cash and cash equivalents                           9,494,543            90,205           831,690
Cash and cash equivalents at beginning of period                             1,194,650         1,104,445           272,755
                                                                         --------------    --------------    --------------
Cash and cash equivalents at end of period                             $    10,689,193   $     1,194,650   $     1,104,445
                                                                         ==============    ==============    ==============
Supplemental cash flow information:
     Cashless exercise of stock options                                $       538,376   $     6,429,124   $     2,483,552
                                                                         ==============    ==============    ==============
     Stock issued for business acquired                                $     3,170,471           -                 -
                                                                         ==============    ==============    ==============
     Tax benefit related to stock options                              $     1,670,866           -                 -
                                                                         ==============    ==============    ==============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
                                       F-6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1.     Nature of Operations

       The  Company,  a  Delaware   corporation,   is  engaged  in  the  design,
       development,  manufacture and sale of flight  instrumentation  components
       and systems,  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  years  1998  and 1996
       consisted of 52 weeks, and fiscal year 1997 consisted of 53 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  inter-company 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.     Cash and Cash Equivalents

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

5.     Concentration of Credit Risk

       Financial  instruments  which  potentially  subject the Company to credit
       risk consist primarily of trade accounts receivable.  Accounts receivable
       are  principally  from  the  U.S.   Government,   major  U.S.  Government
       contractors,  several foreign governments,  and domestic customers in the
       aerospace  and  defense  industries.  Credit  is  extended  based  on  an
       evaluation of the customer's financial condition and generally collateral
       is not required.  In many cases irrevocable letters of credit accompanied
       by advanced  payments are received from foreign  customers,  and progress
       payments are  received  from  domestic  customers.  The Company  performs
       periodic credit  evaluations of its customers and maintains  reserves for
       potential credit losses.

6.     Inventories

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


                                       F-7

<PAGE>
       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.

7.     Property, Plant and Equipment

       Property,  plant  and  equipment  are  stated at cost.  Depreciation  and
       amortization are provided  principally by the  straight-line  method over
       the  estimated  useful  lives of the  related  assets.  Gains and  losses
       arising from the sale or disposition of property, plant and equipment are
       recorded in income.

8.     Intangibles

       Intangibles  are comprised of customer  lists,  installed  products base,
       drawings,   patents,  licenses,  certain  government  qualifications  and
       technology and goodwill in connection with the  acquisitions of Metraplex
       Corporation  in 1997,  and 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 2, 1998, there
       were no adjustments  to the carrying  amount of the cost in excess of net
       assets acquired resulting from these evaluations.

9.     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 , net. The
       cost of securities sold is based on the specific  identification  method.
       Interest and dividends on securities are included in other income, net.

10.    Other Investments

       The Company is a limited partner in a nonmarketable  limited  partnership
       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.

11.    Revenue and Cost Recognition

       Under  fixed-price  contracts,  revenue  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 command and control
       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 total costs incurred in relation to total estimated
       cost at completion).  Prospective losses on long-term contracts are based


                                       F-8

<PAGE>
     upon the anticipated excess of inventoriable  manufacturing  costs over the
     selling price of the remaining  units to be delivered and are recorded when
     first  reasonably  determined.   Actual  losses  could  differ  from  those
     estimated due to changes in the ultimate  manufacturing  costs and contract
     terms.

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


12.  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.

13.  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
     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.

14.  Earnings Per Common Share

     In 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
     Financial  Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"),
     which replaced 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. In  accordance  with SFAS 128, all earnings per share  amounts for all
     periods  presented have been restated  (reflective of a 4-for-3 stock split
     on September 30, 1997).

15.  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
     $1,562,000,  $1,828,000,  and  $1,453,000 in fiscal 1998,  1997,  and 1996,
     respectively.

16.  New Accounting Standards

     In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
     "Segment Information",  which is effective for fiscal years beginning after
     December  15,  1997.  SFAS No.  131  amends  the  requirements  for  public
     enterprises  to report  financial  and  descriptive  information  about its
     reportable operating segments.  Operating segments,  as defined in SFAS No.
     131,  are  components  of  an  enterprise  for  which  separate   financial
     information is required to be reported on the basis that is used internally

                                       F-9
<PAGE>
     for evaluating the segment performance. The Company believes it operates in
     one business segment,  and as this standard relates entirely to disclosure,
     the  adoption  of this  standard  will not have a  material  impact  on the
     Company's financial statements.

NOTE B - ACQUISITIONS

       On August 4, 1997,  the Company  completed the  acquisition  of Metraplex
       Corporation , a Maryland  corporation for 313,139 (as adjusted) shares of
       common stock of the Company,  with a fair market value of $3,170,471,  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.  The transaction has been accounted for by the
       purchase method. Accordingly, the consolidated balance sheet includes the
       assets  and   liabilities  of  Metraplex  at  August  2,  1998,  and  the
       consolidated  statements  of income  include  the  results  of  Metraplex
       operations  from August 4, 1997.  The  acquisition  resulted in excess of
       cost over fair value of net assets acquired of $2,162,725  which is being
       amortized over twenty years.

       On the basis of a pro forma consolidation of the results of operations as
       if the  acquisition  had taken  place at the  beginning  of fiscal  1997,
       unaudited  consolidated net sales, net income,  basic earnings per share,
       and diluted  earnings  per share for the year ended  August 3, 1997 would
       have  been  approximately  $36,589,333,   $4,686,236,  $1.07,  and  $.93,
       respectively.   The  pro  forma  information   includes  adjustments  for
       additional  depreciation  based on the fair market  value of the property
       and equipment acquired,  and the amortization of intangibles arising from
       the transaction.  The pro forma financial  information is not necessarily
       indicative  of the results of  operations as they would have been had the
       transaction been effected at the beginning of fiscal 1997.

       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 were
       extended  by the  Company  in fiscal  1997 and were due  April 30,  1998,
       January 31, 1998, and January 31, 1998, respectively. The loans were paid
       in full with accrued interest as of December 19, 1997.

NOTE D - INVENTORIES

       The major components of inventories are as follows:
<TABLE>
<CAPTION>
                                                   August 2,          August 3,
                                                      1998               1997
                                                   -----------       ----------
       <S>                                        <C>               <C>        
       Purchased parts and raw materials          $  7,377,882      $ 4,780,336
       Work in process                               7,303,533        4,899,551
       Finished products                               387,203          110,495
                                                    ----------       ----------
                                                  $ 15,068,618      $ 9,790,382
                                                    ==========       ==========
</TABLE>
                                      F-10

<PAGE>
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 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 2, 1998 and August 3,
       1997 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.

       In July 1998 the Company received a partial distribution of $592,824 from
       the Partnership.  As of August 2, 1998 the Company's limited  partnership
       interest had an estimated fair value of $849,324.

NOTE G - PROPERTY, PLANT AND EQUIPMENT

       Property, plant and equipment are comprised of the following:
<TABLE>
<CAPTION>
                                         August 2,     August 3,      Estimated
                                            1998          1997       Useful Life
                                         ----------    ----------    -----------
       <S>                             <C>           <C>             <C>
       Land                            $    880,270  $    880,270
       Building and building
            improvements                  5,486,900     5,438,663    10-40 years
       Machinery and equipment           20,104,794    17,515,954     5- 8 years
       Furniture and fixtures               624,576       494,056     5-10 years
       Tools                                 34,495        24,869      5   years
       Leasehold improvements               292,894       288,757     5-10 years
                                         ----------    ----------
                                         27,423,929    24,642,569
       Less accumulated depreciation     14,874,586    12,937,814
                                         ----------    ----------
                                       $ 12,549,343  $ 11,704,755
                                         ==========    ==========
</TABLE>
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 52 weeks ended August 2, 1998, 53 weeks ended August
       3, 1997 and 52 weeks  ended  July 28,  1996 was  approximately  $546,000,
       $229,900, and $284,600, respectively.

                                      F-11

<PAGE>
       Minimum annual rentals under noncancellable leases are as follows:
<TABLE>
<CAPTION>
                           Year ending fiscal       Amount
                           ------------------       ------
                                 <S>               <C>     
                                 1999              $394,000
                                 2000               318,000
                                 2001               188,000
                                 2002               165,000
</TABLE>
       Employment Agreements

       The  Company  has  employment  agreements  with  various  executives  and
       employees  of the Company,  which,  as amended,  expire at various  dates
       through  October 31, 2002,  subject to extension each January 1 for three
       years from that date.  These  agreements  provide  for  aggregate  annual
       salaries for fiscal 1999 of $800,000.  Certain  agreements provide for an
       annual cost of living  adjustment  based on the consumer price index, and
       also provide for  incentive  compensation  based on pretax  income of the
       Company  in  excess  of 10% of the  Company's  stockholders'  equity  for
       specific  periods,  as  adjusted  for stock  issuances  and  repurchases.
       Incentive compensation in the amount of $727,659,  $665,352, and $446,750
       was expensed in fiscal years 1998, 1997, and 1996, respectively.

       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 of approximately
       three times their annual salary. As of August 2, 1998, the amount payable
       in the event of such termination would be approximately $2,400,000.

       One of the  employment  contracts  provides  for a  consulting  agreement
       commencing  at the end of the  employment  period which will be effective
       October 1, 1998, and terminating  December 31, 2010 at the annual rate of
       $100,000.  Another one of the employment contracts, as amended October 1,
       1998,  provides  for a  consulting  period  commencing  at the end of the
       period of active  employment and continuing for a period of five years at
       the annual rate of $100,000.  Two officers of the Company have  severance
       agreements  providing for a lump-sum  payment of $430,000  through fiscal
       1999,  adjusted to $320,000 in fiscal 2000, $215,000 through fiscal 2002,
       and $105,000 in fiscal 2003.

       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.

                                      F-12

<PAGE>
       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,  2000.  At August 2, 1998
       stand-by letters of credit aggregating  $1,505,285 were outstanding under
       this facility.

NOTE I - INCOME TAXES

       Income tax provision consisted of the following:
<TABLE>
<CAPTION>
                             52 Weeks ended   53 Weeks ended   52 Weeks ended
                                August 2,        August 3,        July 28,
                                  1998             1997             1996
                             --------------   --------------   --------------
              <S>             <C>              <C>                <C> 
              Current
                  Federal     $ 1,468,665      $ (52,000)         $  90,000
                  State            85,000         89,000             12,400
                                ---------        -------            -------
                                1,553,665         37,000            102,400
                                ---------        -------            -------
              Deferred
                  Federal       1,307,970       (142,000)              -
                  State            72,365        585,000               -      
                                ---------        -------            -------
                                1,380,335        443,000               -      
                                ---------        -------            -------
                              $ 2,934,000      $ 480,000          $ 102,400
                                =========        =======            =======
</TABLE>
     The Company paid income taxes of approximately $1,486,000 in 1998, $178,000
     in 1997, and $19,000  in  1996. The following  is a  reconciliation  of the
     U.S. statutory income tax rate and the effective tax rate on pretax income:
<TABLE>
<CAPTION>
                                              52 Weeks   53 Weeks   52 Weeks
                                               ended      ended      ended
                                              August 2,  August 3,  July 28,
                                                1998       1997       1996
                                                ----       ----       ----
       <S>                                      <C>        <C>        <C>   
       U.S. Federal statutory rate              34.0 %     34.0 %     34.0 %
       State taxes, net of
          federal tax benefit                    1.5       12.2        0.2
       Alternative minimum tax                   -          -          2.4
       Benefit of foreign sales corporation     (1.8)       -          -
       Benefit of net operating loss
          carryforward                           -        (30.8)     (35.2)
       Non-deductible expenses                    .8         .3        1.3
       Decrease in valuation allowance           -         (9.4)       -
       Other, net                                 .3        2.8        -
                                                ----       ----       ----    
          Effective tax rate                    34.8 %      9.1 %      2.7 %
                                                ====       ====       ====
</TABLE>
       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.

                                      F-13

<PAGE>
       Components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
                                                      August 2, 1998                    August 3, 1997
                                             ------------------------------       ---------------------------    
                                               Deferred          Deferred         Deferred         Deferred
                                                  Tax               Tax              Tax              Tax
                                                Assets          Liabilities        Assets         Liabilities
                                             ----------        ------------       --------        -----------
         <S>                                <C>               <C>                <C>             <C>        
         Intangibles                        $      -          $ 1,775,858        $   -           $ 1,681,375
         Alternative minimum tax                952,426             -              265,906             -
         Accrued vacation pay                   133,962             -              123,644             -
         Accrued bonus                          438,976             -              343,398             -
         Warranty costs                          88,000             -              220,000             -
         Inventory                              971,825             -              985,703             -
         Depreciation                             -             2,334,917         -                2,006,038
         Net operating loss carryforwards         -                 -              725,113             -
         Contract losses                        503,856             -              275,635             -
         Other                                   60,689           202,364           71,917            78,967
                                              ---------         ---------        ---------         ---------
                                            $ 3,149,734       $ 4,313,139      $ 3,011,316       $ 3,766,380
                                              =========         =========        =========         =========
</TABLE>
         The Company has available a $952,426  alternative minimum tax credit to
         carry forward for an indefinite period of time.

NOTE J- LONG-TERM DEBT

       Long-term debt is summarized as follows:
<TABLE>
<CAPTION>
                                                   August 2,      August 3,
                                         Rate        1998           1997
                                         ----      ---------      ----------
       <S>                              <C>      <C>            <C>     
       Note payable bank (a)             7.15%   $ 1,500,000    $      -
       Mortgage note (b)                10.4 %     2,890,000       3,225,000
       Capital lease obligations (c)      -          125,869           -    
                                                   ---------       ---------    
                                                   4,515,869       3,225,000
       Less current portion                          404,984         335,000
                                                   ---------       ---------
                                                 $ 4,110,885     $ 2,890,000
                                                   =========       =========
</TABLE>
       (a) In July 1998, the Company renewed the revolving credit agreement with
           a bank that  provides for the  extension  of credit in the  aggregate
           principal amount of $21,000,000 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, 2000.
           Interest is set biweekly at 1.65% over the FOMC Target Rate.

           The agreement contains various financial covenants,  including, among
           other  matters,  the  maintenance  of working  capital,  tangible net
           worth, and restrictions on 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. having a net book value of $1,904,000 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 2, 1998 and August 3, 1997 and
           are being amortized over the term of the loan (15 years).

       (c) Certain  noncancellable  leases are  classified as capital leases and
           the leased  assets are  included  as part of  "Property,  Plant,  and
           Equipment" at $143,006, net of depreciation of $23,834.

                                      F-14

<PAGE>
       The Company paid interest of approximately  $441,000 in 1998, $567,000 in
       1997, and $854,000 in 1996.

       Future payments required on long-term debt are as follows:
<TABLE>
<CAPTION>
                    Fiscal year ending during:                         Amount
                    -------------------------                       ----------
                              <S>                                  <C>
                              1999                                 $   404,984
                              2000                                   1,950,220
                              2001                                     497,583
                              2002                                     503,082
                              2003                                     550,000
                              2004                                     610,000
                                                                     ---------
                                                                   $ 4,515,869
                                                                     =========
</TABLE>
NOTE K - 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 was paid at  settlement in April,  1998.  The Company
       intends  to use this  land,  which is  included  in other  assets  in the
       consolidated balance sheet, for possible future expansion.

NOTE L - ACCOUNTS PAYABLE AND ACCRUED EXPENSES

       Accounts payable and accrued expenses include the following:
<TABLE>
<CAPTION>
                                                   August 2,        August 3,
                                                     1998             1997
         <S>                                     <C>               <C>        
         Accounts payable                        $ 3,064,596       $ 1,841,468
         Accrued payroll and bonuses               1,865,426         1,483,915
         Accrued commissions                         615,022           205,692
         Accrued interest                             56,491            55,900
         Accrued litigation expenses                  37,487           297,538
         Accrued expenses                            829,161         1,102,227
                                                   ---------         ---------
                                                 $ 6,468,183       $ 4,986,740
                                                   =========         =========
</TABLE>
NOTE M - 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  $197,000  for the 52 weeks ended
       August 2, 1998, and contributed  approximately  $181,000, and $159,000 to
       this plan for the 53 weeks  ended  August 3, 1997 and the 52 weeks  ended
       July 28, 1996, respectively.

                                      F-15

<PAGE>
NOTE N - COMPUTATION OF PER SHARE EARNINGS

       The following table shows the calculation of basic earnings per share and
       earnings per share assuming dilution:
<TABLE>
<CAPTION>
                                                              52 Weeks ended   53 Weeks ended   52 Weeks ended
                                                              August 2, 1998   August 3, 1997    July 28,1996
                                                              --------------   --------------   --------------
<S>                                                            <C>              <C>               <C>
Numerator:
      Net Income                                               $ 5,496,608      $ 4,803,659       $ 3,668,956
                                                                 =========        =========         =========
Denominator:
      Basic weighted-average shares                              4,969,248        4,063,505         3,786,176
         Effect of dilutive securities:
            Employee stock options and warrants                    438,035          670,177           467,609 
                                                                 ---------        ---------         ---------
Diluted weighted-average shares                                  5,407,283        4,733,682         4,253,785
                                                                 =========        =========         =========
Earnings per common share - Basic                                    $1.11            $1.18             $ .97
                                                                      ====             ====              ====
Earnings per common share - Diluted                                  $1.02            $1.01             $ .86
                                                                      ====             ====              ====
</TABLE>
NOTE O - SHAREHOLDERS' EQUITY

      At the annual  meeting of  stockholders  held on February  18,  1998,  the
      stockholders  of the Company  approved a proposal to amend the Certificate
      of  Incorporation  to increase the authorized  shares of Common Stock from
      10,000,000 to 20,000,000 shares.

      In December  1997, the Company  completed the sale of 1,100,000  shares of
      common  stock to the  public,  of which  700,000  shares  were sold by the
      Company and 400,000 shares were sold by certain selling  stockholders.  In
      addition , the Company also sold 1,265,000 Common Stock Purchase Warrants.
      The  Company  received  net  proceeds  of  $7,451,579  after  underwriting
      discounts and commissions and other expenses of the offering. Each Warrant
      entitles  the holder to purchase  one share of common  stock at $14.40 per
      share (subject to adjustment  under certain  conditions)  through  January
      1999 and thereafter at $15.60 per share until they expire in January 2000.
      The Company has also issued to the  underwriters,  for their own accounts,
      warrants  to  purchase  110,000  shares  of  common  stock of the  Company
      (subject to adjustment  under certain  circumstances),  exercisable  for a
      period  of  twenty-five  months at a price of  $14.40  per  share  through
      January 1999, and at a price of $15.60 per share through their  expiration
      in January 2000.

      On September 4, 1997 the Board of Directors declared a 4-for-3 stock split
      effected  as a stock  dividend  payable  September  30, 1997 to holders of
      record on September 15, 1997. The amount of $105,234 was transferred  from
      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 the  financial  statements  have been  restated to
      reflect the stock split.

      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 4.9%;  volatility  factor of the
      expected market
                                      F-16

<PAGE>
      price  of the  Company's  common  stock  of  .59;  and a  weighted-average
      expected life of the option, after the vesting period, 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 1998 and 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
      using the statutory income tax rate of 34%:
<TABLE>
<CAPTION>
                                                    1998               1997
                                                    ----               ----    
           <S>                                    <C>                <C>       
           Net earnings  -  as reported           $5,496,608         $4,803,659
           Net earnings  -  pro forma             $4,925,488         $3,911,486
           Earnings per share  -  as reported
                Basic                                  $1.11              $1.18
                Diluted                                 1.02               1.01
           Earnings per share  - pro forma
                Basic                                   $.99               $.96
                Diluted                                  .91                .83
</TABLE>
       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 88,333 and  801,660  shares  were  granted  during the fiscal
       years ended August 2, 1998, and August 3, 1997, respectively.

       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,

                                      F-17
<PAGE>
       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 52 weeks ended
       August 2, 1998, the 53 weeks ended August 3, 1997, and the 52 weeks ended
       July 28, 1996 follows:
<TABLE>
<CAPTION>
                                              Non-Qualified Stock Options
                                        ----------------------------------------
                                                                        Weighted      Warrant Agreements
                                                                         Average      ------------------  
                                          Number         Price Range    Exercise    Number       Price Range
                                        of shares         per share       Price    of shares      per share  
                                        ---------       -------------     -----    ---------     -----------
<S>                                     <C>            <C>               <C>       <C>          <C>
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
   Granted ..........................      88,333       10.31  -13.88     12.04
   Exercised.........................    (135,594)       2.54  - 6.94      5.08     (40,000)            5.35
   Canceled..........................      (8,222)       2.54  - 6.47      5.31        -
                                        ---------       -------------     -----     -------      -----------
Outstanding August 2, 1998...........     860,844      $ 2.54  -13.88    $ 6.65     280,000           $ 4.64
                                        =========                                   =======              
</TABLE>
       Options to purchase 582,389 shares of common stock were exercisable under
       all plans at August 2, 1998 at a weighted average exercise price of $5.87
       with a  weighted  average  remaining  contractual  life of 8.2  years  as
       follows:


       Options Outstanding and Exercisable by Price Range as of August 2, 1998
<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>
       $ 2.5350  -$ 6.0938        301,117             7.43        $ 5.0302      301,117       $ 5.0302
         6.4688  -  6.4688        300,062             8.75          6.4688      113,140         6.4688
         6.9375  - 12.8750        224,665             8.44          7.9716      168,132         6.9540
        13.0000  - 13.8750         35,000             9.36         13.5673         -              -
                                  -------             ----         -------      -------         ------ 
        $2.5350  -$13.8750        860,844             8.23        $ 6.6464      582,389       $ 5.8651
                                  =======                                       =======
</TABLE>
                                      F-18
<PAGE>
       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,  and  the
       remaining  40,000  warrants  were  exercised in fiscal 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.

NOTE P - MAJOR CUSTOMERS

       Net sales to the U.S.  Government in 1998,  1997,  and 1996 accounted for
       approximately 26%, 34%, and 33% of net sales, respectively. Foreign sales
       amounted to  approximately  $11,943,000,  $9,398,000,  and  $6,556,000 in
       fiscal 1998, 1997, and 1996, respectively.

       Included in accounts  receivable  as of August 2, 1998 and August 3, 1997
       are amounts due from the U.S.  Government of  approximately  $933,000 and
       $1,454,000, respectively.

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.

The carrying amounts and fair values of the Company's financial  instruments are
presented below:
<TABLE>
<CAPTION>
                                                     August 2, 1998
                                             ------------------------------
                                             Carrying Amount     Fair Value
                                             ---------------     ----------
            <S>                               <C>              <C>         
            Cash and cash equivalents         $ 10,689,193     $ 10,689,193
            Long-term debt                       4,110,885        4,499,000
            Stand-by letters of credit               -            1,505,285
</TABLE>
NOTE R - SUBSEQUENT EVENTS

       As of August 21, 1998,  the Company  entered into an agreement to acquire
       all of the  issued and  outstanding  common  stock of  General  Microwave
       Corp.,  a New York  corporation  , for $18.00 per share and a  three-year
       warrant  to  purchase  one  share  of the  Company's  common  stock at an
       aggregate purchase
                                      F-19
<PAGE>
       price of approximately $23,000,000.  The warrant is exercisable at $14.40
       per share through  January 11, 1999,  and thereafter at $15.60 per share,
       until  expiration.  General Microwave  designs,  manufactures and markets
       microwave  components and  subsystems,  and related  electronic  test and
       measurement  equipment.  The company is headquartered in Amityville,  New
       York, and operates two other facilities, one in Billerica, Massachusetts,
       and one in Israel.  The  transaction  is subject to the  approval  of the
       stockholders  of  General  Microwave  Corp.  at a  meeting  to be held in
       December 1998. The  transaction  will be accounted for under the purchase
       method.  As of October 20, 1998, the Company has acquired  362,400 shares
       (27%)  of  General   Microwave  in  the  open  market  for  approximately
       $6,217,000.


                                      F-20