HERLEY INDUSTRIES INC /NEW - 10-K Annual Report

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

FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended July 30, 1995

OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ........to ........

Commission File No. 0-5411

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

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

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

Registrant's telephone number, including area code: (717) 397-2777
--------------
Securities registered pursuant to Section 12(b) of the Act:

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.[ ]

Based on the closing sale price of $5.5625 as of October 5, 1995 the aggregate
market value of the voting stock held by non-affiliates of the registrant was
$8,644,798.

The number of shares outstanding of registrant's common stock, $ .10 par value
was 2,802,274 as of October 5, 1995

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

HERLEY INDUSTRIES, INC.
TABLE OF CONTENTS

Page
PART I
Item 1 Business 1
Item 2 Properties 6
Item 3 Legal Proceedings 7
Item 4 Submission of Matters to a Vote of Security Holders 7

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

PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports
on Form 8K 12

SIGNATURES 13

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES F-1

PART I

Item 1. Business

Herley Industries, Inc. ("Herley" or the "Company") principally designs,
manufactures and sells flight instrumentation products, primarily to aerospace
companies, the U.S. government, and several foreign governments. One of the
Company's main products is a variety of transponders which are used to enhance
radar signals to accurately track the flight of space launch vehicles and
aircraft.

The transponders are used in conjunction with target command and control
systems, also manufactured by the Company, in the training of troops and the
testing of weapons. These command and control systems are housed in shelters on
training and testing ranges in the U. S. and in foreign countries. The Company
has an established base of approximately 100 command and control systems
installed around the world. These command and control systems are both shelter
mounted and portable radar units. Herley also manufactures microwave devices
used in its flight instrumentation products and in connection with the radar and
defense electronic systems on tactical fighter aircraft.

Since its inception in 1965, the Company has designed and manufactured microwave
devices for use on various tactical military programs. In June 1986 the Company
acquired a small engineering company 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. of Woburn, Massachusetts, a microwave
subsystem designer and manufacturer. In June of 1993, the Company acquired Vega
Precision Laboratories, Inc. ("Vega") of Vienna, Virginia, and moved the
operations to Lancaster, Pennsylvania in October, 1993. In March 1994, the
Company entered into an exclusive license agreement for the manufacture,
marketing and sale of the Multiple Aircraft GPS Integrated Command and 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.

With these recent acquisitions, the Company has reorganized into three operating
facilities; HERLEY-VEGA SYSTEMS ("HVS"), operating in Lancaster, Pennsylvania;
HERLEY-MDI ("MDI") operating in Woburn, Massachusetts, and Stewart Warner
Electronics Co. ("SWE") operating in Chicago, Illinois.

The Company manufactures flight instrumentation products, encompassing
transponder products and command and control systems; and microwave products
including microwave integrated circuits ("MIC's"), receiver-protectors, and
magnetrons. Revenues from flight instrumentation products accounted for
approximately 58%, 62% and 46%, and revenues from microwave products accounted
for approximately 42%, 38% and 54%, of net revenues from continuing operations
for the fiscal years 1995, 1994 and 1993 respectively.

Herley's business strategy is to expand its product line by acquisition and by
designing and manufacturing other flight instrumentation products for sale to
the Company's existing domestic customers. In addition, the Company due to its
broad product line, will seek to expand its foreign business. These major
products include transponders, flight termination receivers, telemetry systems
and telemetry data encoders. The Company believes that significant growth
potential for the sale of flight instrumentation products to the space launch
industry has been created by changes in government space policy, enabling
private industry to launch satellites, and new technologies providing for
broader use of satellites.

1

Products

The Company manufactures and sells transponders, microwave devices, command and
control systems, and other related products, in one industry segment, military
electronics. The Company's business is not considered to be seasonal in nature.

Transponders

The Company manufactures a variety of transponders, including range safety,
identification friend or foe (IFF), command and control, and scoring systems.

Transponders are small electronic systems consisting of a transmitter, sensitive
receiver and internal signal processing equipment. These electronic boxes are
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 signal, free of noise, upon which the tracking radar can "lock." The
transponder is generally placed upon the booster stage of a space launch
vehicle, a missile being tested, a target at which a missile is being directed,
or another unmanned or remotely piloted vehicle being operated and/or tested.
Frequently, transponders are destroyed in the process of a test or space launch.
The transponder provides "enhancement" or "augmentation" to the radar return,
which is superior to the weak noise-filled echo produced by the skin reflection
of the target. Certain transponders also provide communication with the vehicle
in which the transponder is installed.

In range safety applications, transponders enable accurate tracking of the
vehicle so that its position and direction are known throughout its flight. In
the case of several defense and commercial space launch vehicles (i.e., Delta,
Atlas, Titan and Pegasus), the Herley transponder is tracked by the ground
launch team all the way to space orbit, and in certain instances through several
orbits, as a reference location point in space to assure that the launch payload
has been properly placed in orbit. The use of the transponder is far more
effective than simple skin tracking, particularly under adverse weather
conditions after the launch.

Identification friend or foe (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. The
transponders on board these vehicles reply to the ground interrogation with a
unique signature response which both identifies the vehicle as unmanned and
provides the means to track it. The ground controller can then ensure that
commercial and private aircraft are vectored away from the flight path of the
unmanned vehicle and kept at safe separations from it.

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
which 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.

Command And Control Systems (C2S)

For over thirty years, Vega Precision Laboratories, (now part of HERLEY-VEGA
SYSTEMS ("HVS") in Lancaster, Pennsylvania) has been a leader in the radar
enhancement field. HERLEY-VEGA command and control systems have been used to
remotely fly a large variety of unmanned aerial vehicles, typically missiles

2

or aircraft used as target drones or Remote Piloted Vehicles (RPV's), and some
surface targets. Operations have been conducted by many users on the open ocean,
remote land masses, and instrumented test and training ranges. HERLEY-VEGA
command/control systems are currently in service throughout the world, making
HVS a primary supplier after three decades of experience and C2S specialization.
The HERLEY-VEGA 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 operation to fly a target or an
Unmanned Airborne Vehicle (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 C2 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.
Many foreign governments that maintain armed forces are users of HVS C2 S.

A multi-million dollar development effort by Vega Precision Laboratories has
resulted in the introduction of a new line of Target Tracking Control Systems
(TTCS), the 6104 series. This new system technology centers largely around a
multiple processor design, which provides improved operator control, system
signal conditioning, high resolution graphics displays, resident software driven
built-in-test, and enhanced system versatility.

The new HERLEY-VEGA Model 6104 TTCS is a highly flexible design which can be
field configured within minutes to fly or control any selected vehicle for which
it is equipped. The system is delivered with the necessary command panels and
graphics display software to operate with a large variety of vehicles. A basic
TTCS configuration is normally supplied with a standard HERLEY-VEGA command
panel and the software peculiar to one vehicle. Telemetry display software is
embedded for the specified vehicle, and a magnetic hard disk drive is supplied
with a mission map set prepared in accordance with a customer-supplied detailed
map of the area.

With the 1994 acquisition of the MAGIC2 systems, HVS has significantly increased
the selection of command and control ("C2") systems it offers. The 6104 TTCS
unit is a reliable line of sight C2 system with a large installed base of
equipments worldwide. HVS engineers and marketeers are now able to offer the
MAGIC2 system as a supplement to this installed base of equipment. The MAGIC2
affords over-the-horizon C2 using GPS guidance and control of multiple targets
from a single ground station. The increasing interest by the U. S. Navy as well
as foreign navies in littoral warfare scenarios can be ideally met by the use of
the MAGIC2 system.

In today's military world, surveillance of one's neighbors using UAV's, RPV's,
or drones has become a standard operational discipline. A key advantage of the
use of a UAV is that in the event of an accident or if the vehicle is shot down,
the user is not faced with a hostage problem. These inexpensive drones are
controlled in their flight by a HERLEY-VEGA shelter C2S, which is mounted in a
trailer that may be moved from place to place by helicopter or truck.
HERLEY-VEGA also supplies portable command and control systems that are mounted
on tripods that can be easily transported by an operational team. The portable
units permit ready deployment in rugged terrain and may also be used on
shipboard during open ocean exercises.

Microwave Devices

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

3

In Woburn, HERLEY-MDI designs and manufactures complex MIC's, which consist of
sophisticated assemblies that perform many functions, primarily involving
switching of microwave signals. MIC's manufactured by MDI are employed in almost
all defense electronics military systems as well as in missile programs.

A growing part of MDI's business is the production of 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. With the contraction of the defense business, only two domestic primary
producers of receiver protectors remain - HERLEY-MDI and Varian, Inc.

In Chicago, Stewart Warner Electronics Co. designs and manufactures high
frequency radio and IFF interrogators. The high frequency communications
equipment is used extensively by the U S. Navy as well as by 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.

Government Contracts

A substantial part of the Company's sales are made to U.S. government agencies
or prime contractors or subcontractors on military or aerospace programs.

Government contracts are awarded either on a competitive bid basis or on a
negotiated sole source procurement basis. Contracts awarded on a bid basis
involve several competitors bidding on the same program with the contract being
awarded based upon price and ability to perform. Negotiated sole source
procurement is utilized if the Company is deemed by the customer to have
developed proprietary equipment not available from other parties or where there
is a very stringent delivery schedule.

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

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.

Marketing and Distribution

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

Backlog

The Company's backlog of firm orders was approximately $24,975,000 on July 30,
1995 ($17,754,000 in domestic orders and $7,221,000 in foreign orders) as
compared to approximately $20,400,000 on July 31, 1994 ($15,600,000 in domestic
orders and $4,800,000 in foreign orders). Approximately $20,271,000 of the
backlog is expected to be shipped during the fiscal year ending July 28, 1996.

4

Manufacturing, Assembly and Testing

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

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

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

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

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

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

Product Development

The Company believes that its growth depends on its ability to constantly 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.
Several of the Company's officers and engineers have been involved at various
times and in varying degrees in these activities. The cost of these development
activities, including employees' time and prototype development, net of amounts
paid by customers, was approximately $970,000, $1,367,000, and $1,160,000 in
fiscal 1995, 1994, and 1993, respectively.

Competition

The flight instrumentation products which the Company manufactures are subject
to varied competition dependent on the product and market serviced. Competition
is generally based upon technology, design, price and past performance. Many of
Herley's competitors are larger and may have greater financial resources than
the Company. Competitors include Aydin Corporation, Motorola, Inc.,
Microsystems, Inc, and AMP, Inc. Competition in follow-on procurements is
generally limited after an initial award unless the original supplier has had
performance problems.

5

Employees

As of October 1, 1995, the Company employed 218 full-time persons. A total of
144 employees were engaged in manufacturing, 34 in engineering, 18 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 an incentive
stock option plan and a management stock bonus plan.

Recent Acquisition

In July 1995, the Company entered into an agreement effective as of the close of
business June 30, 1995, to acquire certain assets (consisting principally of
inventories and trade receivables) and the business (including all duties and
obligations under contracts assumed) of Stewart Warner Electronics Corporation
("SWE"), 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 consisting of trade payables, accruals, and current
estimates of warranty obligations. This transaction has been accounted for by
the purchase method. The operations of SWE were not material in fiscal 1995.

Item 2. Properties

The Company's operations are conducted at the following facilities:

Area Owned
Occupied or
Location Purpose of Facility (sq. ft) Leased
- -------- ------------------- -------- ------
Lancaster, PA (1) Production, engineering, administrative 71,200 Owned
and executive offices

Woburn, MA Production, engineering and administration 60,000 Owned
- ---------------------------
(1) The Company's executive offices occupy approximately 4,000 sq. ft. of
space at this facility with engineering and administrative offices occupying
10,000 sq. ft. each. The Company believes that its facilities are adequate for
its current and presently anticipated future needs.

Item 3. Legal Proceedings

In April 1992, Litton Systems, Inc. Electron Devices Division ("Litton")
commenced an action in the Essex Superior Court of Massachusetts against the
Company (the "Litton Action") alleging, among other claims for relief, theft of
trade secrets, unfair trade practices and related common law claims in
connection with the defendants' alleged misappropriation of Litton's beacon
magnetron drawings. In a jury trial which ended April 3, 1995, a verdict on
liability was rendered against the Company and the other defendants. Prior to a
separate, subsequent trial to determine damages, the Company settled the action
on April 12, 1995 for the sum of $4,000,000, and agreed to the entry of an
injunction precluding the use by the Company of the alleged misappropriated
drawings in connection with the manufacture of beacon magnetrons. The settlement
provides for two equal payments of $2,000,000 each without interest, the first
of which was due in July, 1995, and the second is due in July, 1996.

6

In May and June 1994, the Company was served with two class action complaints
against the Company and certain of its officers and directors in the United
States District Court for the Eastern District of Pennsylvania. The claims were
made under Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and
Rule 10b-5 thereunder. One of the claims is also based upon alleged negligence.
The claims relate to the Company's acquisition of Carlton Industries, Inc. and
its subsidiary, Vega Precision Laboratories, Inc. The claims were combined into
one matter and a consolidated Complaint. In April, 1995, the Court certified
that the claims based on the Securities Exchange Act may proceed as a Class
Action pursuant to Rule 23(b) (3), but without prejudice to the rights of the
parties thereafter to seek modification of the Class or revocation of leave to
proceed. The Court refused to certify the negligence claim as a Class Action. In
May, 1995, the parties negotiated a tentative settlement of all claims in
consideration for a payment of $450,000 subject to the negotiation and execution
of a satisfactory Settlement Agreement and Court approval after notice to Class
Members. The parties are negotiating the terms of the Settlement Agreement for
submission to the Court.

In May, 1995, the Company was served with a Class Action Complaint against the
Company and its Chief Executive Officer in the United States District Court for
the Eastern District of Pennsylvania. The claim was made under Section 10(b) and
20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5 thereunder. The
claim relates to the Company's settlement of the Litton Action in the Essex
Superior Court of Massachusetts and alleges, inter alia, that there was
insufficient disclosure by the Company of its true potential exposure in that
claim. The Company believes it has a meritorious defense and intends to
vigorously defend against the action.

In or about March, 1994, the principal selling shareholders of Carlton
Industries, Inc. ("Carlton") and its subsidiary, Vega Precision Laboratories,
Inc. ("Vega"), as claimants, commenced an arbitration proceeding before the
American Arbitration Association in New York City pursuant to the terms of the
Stock Purchase Agreement ("Agreement") by which the Company acquired the stock
of Carlton and Vega. The claimants principally are seeking to recover damages
for the Company's alleged failure to register timely the claimants' shares of
the Company's common stock in accordance with the provisions of the Agreement
and other breaches of the Agreement. The Company has denied and has contested
vigorously the legitimacy of the claimants' claims and has interposed several
counterclaims seeking indemnification under the Agreement against the principal
selling shareholders, for damages suffered by the Company in an aggregate amount
exceeding $1 million as a result of breaches of contractual representations.
Hearings have been closed and final briefs were submitted.
The matter has yet to be determined by the Arbitrators.

There is no certainty as to the outcome of the above unresolved matters.
However, in the opinion of management, the ultimate liability on these matters,
if any, will not have a material adverse effect on the consolidated financial
position or results of operations of the Company.

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

Not Applicable.

7

PART II

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

(a) The Company's Common Stock is traded in the over-the-counter National
Market System under the symbol HRLY. The following table sets forth the
high and low closing sales price as reported by NASDAQ National Market
System for the Company's Common Stock for the periods indicated. Common
Stock
High Low
Fiscal Year 1994
First Quarter........................... 8 6
Second Quarter.......................... 8 6
Third Quarter .......................... 7-1/2 4-3/4
Fourth Quarter ......................... 5-1/8 3-1/2

Fiscal Year 1995
First Quarter........................... 5-1/2 3-5/8
Second Quarter.......................... 4-1/8 2-9/16
Third Quarter .......................... 3-13/16 1-3/4
Fourth Quarter ......................... 5-5/8 3-3/16

The closing price on October 5, 1995 was $5.5625.

(b) As of October 5, 1995, there were 394 record holders of the Company's
Common Stock.
(c) There have been no cash dividends declared or paid by the Company on its
Common Stock during the past two years.

Item 6. Selected Financial Data

52 Weeks ended
---------------------------------------- Year ended
July 30, July 31, August 1, August 2, July 31,
1995 1994 1993 1992 1991
---------- ---------- ---------- ---------- ----------

Net Revenues $ 24,450,267 30,508,211 21,334,985 14,880,260 12,255,988
Earnings (loss) from continuing operations $ (4,890,166) 1,861,429 1,391,098 2,495,960 1,272,251
Earnings (loss) from
discontinued operation $ - - (2,463,642) (261,577) (259,095)
Cumulative effect of
accounting change $ - - 2,081,028 - -

Net Income (loss) $ (4,890,166) 1,861,429 1,008,484 2,234,383 1,013,156
Earnings (loss) per common
and common equivalent share:
Continuing operations $ (1.31) .44 .35 .73 .41
Discontinued operations - - (.62) (.07) (.08)
Change in accounting - - .53 - -
-------------- ----------- ----------- ----------- -----------
Net Income (loss) $ (1.31) .44 .26 .66 .33
============== =========== =========== =========== ===========

Earnings per Common Share
assuming full dilution $ .32
========

Total Assets $ 42,229,282 53,752,454 58,813,878 31,972,809 18,174,267

Total Current Liabilities $ 9,973,866 10,217,598 14,369,213 3,116,177 3,689,932
Long-Term Debt
net of current portion $ 10,525,000 14,822,834 14,054,128 4,270,000 5,194,445

8

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

Liquidity and Capital Resources

As of July 30, 1995 and July 31, 1994, working capital was approximately
$5,479,000 and $5,753,000, respectively, and the ratio of current assets to
current liabilities was 1.55 to 1 and 1.56 to 1, respectively.

As is customary in the defense industry, inventory is partially financed by
progress payments. The unliquidated balance of these advanced payments was
approximately $1,477,000 in 1995, a decrease of $1,037,000 from 1994.

Net cash provided from investing activities in 1995 results from the liquidation
of $8,105,000 of the Company's marketable securities. The Company used the
proceeds from the sales of securities to pay down $6,000,000 of its long term
bank debt, and $2,105,000 for the purchase of treasury stock.

Net cash used in investing activities in 1994 of approximately $1,432,000
primarily represents the Company's investment in capital equipment and
reinvestment of earnings on long-term investments. In 1993, additional
investments were made in marketable securities of $1,300,000, and in the
acquisition of a business of approximately $5,700,000. (See Note B)

The Company maintains a revolving credit facility with a bank, secured by
marketable securities, which was amended subsequent to year end, for an
aggregate of $9,000,000 which expires January 31, 1998. As of July 30, 1995 and
July 31, 1994, the company had borrowings outstanding of $7,000,000 and
$11,000,000, respectively. Net cash provided by financing activities in 1994 is
principally attributable to borrowings under the credit facility.

The Company paid $2,000,000 to Litton Systems, Inc. Electron Devices Division in
connection with the settlement of an action brought against the Company in
April, 1992. (See Note H, Litigation ) The Company borrowed the funds under its
credit facility to satisfy this obligation. The final installment of $2,000,000
under the settlement is due in July, 1996. The credit facility may also be
utilized to fund this payment.

The Company acquired 1,194,701 shares of its outstanding common stock for
$4,732,000 through open market purchases and the buy back of shares from former
stockholders of Carlton Industries, Inc.

At July 30, 1995, the Company owned high grade investment securities having a
market value of approximately $4,115,000, and cash and cash equivalents of
approximately $273,000.

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

Results of Operations

Fiscal 1995 Compared to Fiscal 1994

Net sales from continuing operations for the 52 weeks ended July 30, 1995 were
approximately $24,450,000 compared to $30,508,000 for fiscal 1994. The sales
decrease of $6,058,000 (20%) is attributable to a decrease of approximately
$4,699,000 in flight instrumentation products and $1,359,000 in microwave
components.

Gross profit decreased for the 52 weeks ended July 30, 1995 as compared to the
prior year from 35.7% in 1994 to 25.9% in 1995 due to the decrease of $3,983,000
in higher margin foreign sales from $7,891,000 in 1994 to $3,908,000 in 1995, as
well as a decrease in absorption of fixed costs due to the significantly lower
sales volume.

9

Selling and administrative expenses for the 52 weeks ended July 30, 1995 were
$5,072,000 compared to $7,743,000 for fiscal 1994, a decrease of $2,671,000 of
which $1,794,000 is attributable to decreased representative fees on foreign
sales, and $315,000 to a reduction in personnel and related expenses; offset by
a provision of $150,000 for customer disputed charges, and an increase in
employee medical benefits of $122,000.

Included in unusual items in 1995 are settlement costs in connection with
certain legal actions of $4,310,000, legal fees of $829,000, and related
expenses of $308,000. (See Part I, Item 3 - "Legal Proceedings")

During the fiscal year ended July 31, 1994, the Company incurred unusual charges
of $745,663 in excess of reserves in connection with warranty claims for
products shipped by Vega Precision Laboratories, Inc. prior to its acquisition
by the Company. These claims were resolved during the 1994 fiscal year.

Other income (expense) for the 52 weeks ended July 30, 1995 decreased $842,000
from the prior year due to net losses on the sales of certain long-term
investments of $356,000 as compared to gains of $524,000 in 1994, decreased
dividend and interest income of $182,000, and a decrease of $156,000 in other
income (primarily rental income in 1994); offset by a decrease in interest
expense of $375,000.

No income tax benefit has been recorded in 1995. A valuation allowance has been
provided relating to that portion of net operating loss carryforwards which
management believes may expire unutilized.

Fiscal 1994 Compared to Fiscal 1993

Net sales from continuing operations for the 52 weeks ended July 31, 1994 were
approximately $30,508,000 compared to $21,335,000 for fiscal 1993. The sales
increase of $9,173,000 (43%) resulted primarily from sales through Vega
Precision Laboratories, Inc. acquired in June, 1993.

Gross profit increased for the 52 weeks ended July 31, 1994 as compared to the
prior year from 29.1% in 1993 to 35.7% in 1994 due to the increase in sales
volume, higher margins on foreign sales which were $7,891,000 in 1994, and
reduction in overhead costs.

Selling and administrative expenses for the 52 weeks ended July 31, 1994 were
$7,743,000 compared to $4,909,000 for fiscal 1993 an increase of $2,834,000 of
which $2,118,000 is attributable to the operations of Vega (including
representative fees of approximately $1,339,000 on foreign sales) and $298,000
attributable to an increase in legal fees primarily in connection with the
Litton litigation (see Part I, Item 3 - "Legal Proceedings").

Investment income increased approximately $193,000, including net gains on sales
of marketable securities and other investments, and increased interest income.
Other income of $156,000 is primarily from sub-leases of facilities formerly
occupied by Vega. The lease and sub-leases of this facility were terminated in
December, 1993.

Interest expense increased due to the increase in average borrowings during the
year as well as an increase in the weighted average interest rate.

The loss from discontinued operations of $88,000, and the loss on disposal of
$2,376,000 in fiscal 1993 results from the decision by the Company to sell its
Marine Products Division.

During the second quarter of fiscal 1993, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 109 "Accounting for Income
Taxes" (SFAS 109) retroactive to August 3, 1992. As the result of adopting SFAS
109 the Company recognized a benefit of $2,081,000 ($.53 per common share) which
is reflected in the statements of operations as the cumulative effect of a
change in accounting.

10

Item 8. Financial Statements and Supplementary Data

The financial statements and supplementary data listed in the Index are filed as
a part of this report.

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

Not applicable

PART III

The information required by Part III is incorporated by reference to the
Company's definitive proxy statement in connection with its Annual Meeting of
Stockholders scheduled to be held in December 1995, to be filed with the
Securities and Exchange Commission within 120 days following the end of the
Company's fiscal year ended July 30, 1995.

11

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)
4.1 Convertible Note issued to certain officers and directors, including
Form of Warrant (Exhibit 4.1 of Annual Report on Form 10-K for the
fiscal year ended July 31, 1989)
10.1 Incentive Stock Option Plan (Exhibit 10(a) of Form S-1 Registration
Statement No. 2-87160)
10.2 Restricted Management Stock Bonus Plan (Exhibit 10(b) of Form S-1
Registration Statement No. 2-87160)
10.3 (a) Employment Agreement with Lee N. Blatt as modified, (Exhibit 10
of Report on Form 8-K dated June 11, 1984 and Exhibit 10 of Report
on Form 8-K dated May 19, 1988)
(b) Modification Agreement to Employment Agreement with Lee N. Blatt
dated February 1, 1990 and July 31, 1990, (Exhibit 10.3(b) of Annual
Report on Form 10-K for the fiscal year ended July 31, 1990)
(c) Modification Agreement to Employment Agreement with Lee N. Blatt
dated as of April 1, 1992, Exhibit 10.4(c) of Annual Report on Form
10-K for the fiscal year ended August 2, 1992)
(d) Modification Agreement to Employment Agreement with Lee N. Blatt
dated November 30, 1992,(Exhibit 10(a) of Report on Form 8-K dated
November 30, 1992)
10.4 (a) Employment Agreement with Myron Levy (Exhibit 10 of Report on Form
8-K dated October 6, 1988)
(b) Modification Agreement to Employment Agreement with Myron Levy dated
February 1, 1990, (Exhibit 10.4(b) of Annual Report on Form 10-K for
the fiscal year ended July 31, 1990)
(c) Modification Agreement to Employment Agreement with Myron Levy dated
as of April 1, 1992, (Exhibit 10.4(c) of Annual Report on Form 10-K
for the fiscal year ended August 2, 1992)
(d) Modification Agreement to Employment Agreement with Myron Levy dated
November 30, 1992, (Exhibit 10(c) of Report on Form 8-K dated
November 30, 1992)
10.5 (a) Employment Agreement with Gerald I. Klein dated April 1, 1990,
(Exhibit 10.5 of Annual Report on Form 10-K for the fiscal year
ended July 31, 1990)
(b) Employment Agreement with Gerald I. Klein dated January 1, 1992,
(Exhibit 10.7 of Form S-2 Registration Statement No. 33-44959)
(c) Modification Agreement to Employment Agreement with Gerald I. Klein
dated November 30, 1992, (Exhibit 10(b) of Report on Form 8-K dated
November 30, 1992)
10.6 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)
10.7 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).
10.8 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).

(b) Financial Statements

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

(c) Reports on Form 8-K

None

12

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 17 day of October, 1995.

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 17, 1995 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/ Gerald I. Klein Chief Technical Officer and
------------------------ Director
Gerald I. Klein

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

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

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

By: /S/ Richard J. Blakinger Director
-----------------------------
Richard J. Blakinger

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

13

Item 8. Financial Statements and Supplementary Data

HERLEY INDUSTRIES, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page

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

FINANCIAL STATEMENTS:

Consolidated Balance Sheets, July 30, 1995 and July 31, 1994.......... F-4

Consolidated Statements of Operations for the 52 Weeks Ended
July 30, 1995, July 31, 1994 and August 1, 1993..................... F-5

Consolidated Statements of Shareholders' Equity for the 52 Weeks
Ended July 30, 1995, July 31, 1994 and August 1, 1993............... F-6

Consolidated Statements of Cash Flows for the 52 Weeks Ended
July 30, 1995, July 31, 1994 and August 1, 1993..................... F-7

Notes to Consolidated Financial Statements............................. F-8

Schedules have been omitted as not applicable.

F-1

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
Herley Industries, Inc.

We have audited the accompanying consolidated balance sheet of Herley
Industries, Inc. and Subsidiaries as of July 30, 1995, and the related
consolidated statements of operations, shareholders' equity and cash flows for
the 52 weeks ended July 30, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit. The financial
statements as of July 31,1994 and for the 52 weeks ended July 31, 1994 and
August 1, 1993, were audited by other auditors whose report dated October 13,
1994, expressed an unqualified opinion on those statements.

We conducted our audit 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 audit provides 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 July 30, 1995, and the consolidated results of their
operations and cash flows for the 52 weeks ended July 30, 1995 in conformity
with generally accepted accounting principles.

As discussed in Note A to the consolidated financial statements, effective
August 3, 1992 Herley Industries, Inc. adopted the provisions of the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No.
109, Accounting For Income Taxes.

ARTHUR ANDERSEN LLP

Lancaster, PA
October 23, 1995

F-2

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
Herley Industries, Inc.

We have audited the accompanying consolidated balance sheet of Herley
Industries, Inc. and Subsidiaries as of July 31, 1994 and the related
consolidated statements of operations, shareholders' equity and cash flows for
the 52 weeks ended July 31, 1994 and August 1, 1993. 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 July 31, 1994 and the consolidated results of their
operations and their consolidated cash flows for the 52 weeks ended July 31,
1994 and August 1, 1993 in conformity with generally accepted accounting
principles.

As discussed in Note A to the consolidated financial statements, effective
August 3, 1992 Herley Industries, Inc. adopted the provisions of the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No.
109, Accounting For Income Taxes.

WOLINETZ, GOTTLIEB & LAFAZAN, P. C.

Rockville Centre, New York
October 13, 1994

F-3

HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

July 30, July 31,
1995 1994
--------------- ---------------

ASSETS
Current Assets:
Cash and cash equivalents $ 272,755 $ 539,729
Accounts receivable 4,679,917 4,940,304
Other receivables 163,402 300,037
Inventories 9,330,053 9,938,190
Prepaid expenses and other 1,006,503 252,666
--------------- ---------------
Total Current Assets 15,452,630 15,970,926
Property, Plant and Equipment, net 13,775,710 15,542,245
Intangibles, net of amortization of $589,550 in 1995
and $317,450 in 1994 4,852,336 5,124,436
Available-for-sale Securities 4,114,614 11,895,084
Other Investments 3,727,506 3,727,506
Note Receivable - 1,000,000
Other Assets 306,486 492,257
=============== ===============
$ 42,229,282 $ 53,752,454
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 357,078 $ 552,311
Accounts payable and accrued expenses 7,644,148 6,489,039
Reserve for contract losses 496,000 500,000
Advance payments on contracts 1,476,640 2,513,705
Income taxes payable - 162,543
--------------- ---------------
Total Current Liabilities 9,973,866 10,217,598
Long-term Debt 10,525,000 14,822,834
Deferred Income Taxes 1,282,179 430,884
Excess of fair value of net assets of
business acquired over cost 1,460,500 -
--------------- ---------------
23,241,545 25,471,316
--------------- ---------------
Commitments and Contingencies
Shareholders' Equity:
Common stock, $.10 par value; authorized
10,000,000 shares; issued 3,015,988 in 1995
and 4,278,189 in 1994 301,599 427,819
Additional paid-in capital 13,040,622 17,989,374
Retained earnings 5,620,516 10,510,682
--------------- ---------------
18,962,737 28,927,875
Less:
Unrealized (gain) loss on available-for-sale securities (25,000) 201,117
Treasury stock, at cost, 102,500 shares in 1994 - 445,620

--------------- ---------------
Total Shareholders' Equity 18,987,737 28,281,138

=============== ===============
$ 42,229,282 $ 53,752,454
=============== ===============

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

F-4

HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

52 weeks ended
----------------------------------------
July 30, July 31, August 1,
1995 1994 1993
-------------- -------------- --------------

Net sales $ 24,450,267 $ 30,508,211 $ 21,334,985
-------------- -------------- --------------

Cost and expenses:
Cost of products sold 18,117,874 19,624,788 15,129,253
Selling and administrative expenses 5,071,840 7,743,059 4,908,761
Unusual items 5,447,005 745,663 -
-------------- -------------- --------------
28,636,719 28,113,510 20,038,014
-------------- -------------- --------------

Operating income (loss) (4,186,452) 2,394,701 1,296,971
-------------- -------------- --------------

Other income (expense):
Net gain (loss) on sale of marketable
securities and other investments (355,709) 523,612 378,925
Dividend and interest income 617,645 799,478 751,463
Other income - 155,996 -
Interest expense (961,650) (1,336,358) (598,761)
-------------- -------------- --------------
(699,714) 142,728 531,627
-------------- -------------- --------------

Income (loss) from continuing operations
before income taxes and cumulative
effect of accounting change (4,886,166) 2,537,429 1,828,598
Provision for income taxes 4,000 676,000 437,500
-------------- -------------- --------------

Income (loss) from continuing operations
before cumulative effect of
accounting change (4,890,166) 1,861,429 1,391,098
-------------- -------------- --------------

Discontinued operations:
(Loss) from operations of
discontinued division net of
applicable income taxes - - (87,833)
(Loss) on disposal of discontinued
division net of applicable income
taxes - - (2,375,809)
-------------- -------------- --------------
- - (2,463,642)
-------------- -------------- --------------
Cumulative effect of change in accounting
for income taxes - - 2,081,028

============== ============== ==============
Net income (loss) $ (4,890,166) $ 1,861,429 $ 1,008,484
============== ============== ==============

Earnings (loss) per common and common equivalent share:
Continuing operations $ (1.31) $ .44 $ .35
Discontinued operations - - (.62)
Change in accounting - - .53
-------------- -------------- --------------
Net income (loss) $ (1.31) $ .44 $ .26
============== ============== ==============

Weighted average number of common and
common equivalent shares outstanding 3,734,151 4,276,422 3,942,104
============== ============== ==============

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

F-5

HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
52 weeks ended July 30, 1995, July 31, 1994 and August 1, 1993

Unrealized
Gain (Loss)
Additional on Available-
Common Stock Paid-in Retained for-sale Treasury Unearned
Shares Amount Capital Earnings Securities Stock Compensation Total
------ ------ ------- -------- ---------- ----- ------------ -----

Balance at August 2, 1992 3,852,057 $ 385,206 15,469,633 7,640,769 -- (532,375) (50,000) $22,913,233

Net income for the year 1,008,484 1,008,484
Decrease in market value
of non-current
marketable securities (60,610) (60,610)
Issuance of common stock
in connection with
businesses acquired 485,000 48,500 3,377,125 3,425,625
Vested portion of
unearned compensation 50,000 50,000
Exercise of stock options 24,000 2,400 54,720 57,120
Purchase of 20,868 shares
of treasury stock (211,836) (211,836)
Retirement of 87,868 shares
of treasury stock (87,868) (8,787) (735,424) 744,211 --

--------- ---------- ---------- ---------- -------- --------- --------- -----------
Balance at August 1, 1993 4,273,189 $ 427,319 18,166,054 8,649,253 (60,610) -- -- $27,182,016

Net income for the year 1,861,429 1,861,429
Decrease in market value
of non-current
marketable securities (140,507) (140,507)
Cancellation of common stock
in connection with
business acquired (35,000) (3,500) (272,125) (275,625)
Common stock issued
as compensation 1,000 100 6,525 6,625
Exercise of stock options 39,000 3,900 88,920 92,820
Purchase of 102,500 shares
of treasury stock (445,620) (445,620)

--------- ---------- ---------- ---------- -------- --------- --------- -----------
Balance at July 31, 1994 4,278,189 $ 427,819 17,989,374 10,510,682 (201,117) (445,620) -- $28,281,138

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

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

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

F-6

HERLEY INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

52 weeks ended
--------------------------------------
July 30, July 31, August 1,
1995 1994 1993
---------- ---------- ----------

Cash flows from operating activities:
Income (loss) from continuing operations before
cumulative effect of accounting change $ (4,890,166) $ 1,861,429 $ 1,391,098
--------- --------- ---------
Adjustments to reconcile income (loss) from continuing operations before
cumulative effect of accounting change to net cash provided by
operating activities:
Depreciation and amortization 2,116,233 2,085,245 1,377,887
(Gain) loss on sale of marketable securities 355,709 (595,334) (378,925)
Decrease (increase) in deferred tax assets * 596,055 (421,215) 130,313
Increase in deferred tax liabilities * 255,240 623,522 107,187
Common stock issued as compensation -- 6,625 50,000
Unrealized loss on securities -- 71,721 --
Unusual item 5,447,005 -- --
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 1,285,694 (645,786) 4,703,190
Decrease (increase) in other receivables 136,635 69,584 863,137
Decrease (increase) in inventories 2,208,137 1,260,010 (1,053,275)
Decrease (increase) in prepaid expenses and other (753,838) 1,198,343 (657,586)
Increase (decrease) in accounts payable and accrued expenses (3,879,974) (1,604,711) 60,380
(Decrease) in reserve for contract losses (4,000) (2,129,113) (1,181,624)
Increase (decrease) in advance payments on contracts (1,397,334) (1,034,346) (1,195,201)
Increase (decrease) in income taxes payable (162,543) 162,543 (68,594)
Other, net 153,335 (126,457) (537,209)
---------- ---------- ----------
Total adjustments 6,356,354 (1,079,369) 2,219,680
---------- ---------- ----------
Loss from discontinued operations -- -- (87,833)
Loss on disposal of discontinued operations -- -- (2,375,809)
Decrease in net assets of discontinued operations -- -- 2,875,809
---------- ---------- ----------
Net cash provided by operating activities 1,466,188 782,060 4,022,945
---------- ---------- ----------

Cash flows from investing activities:
Purchase of marketable securities and other investments (22,766,138) (32,674,407) (18,541,109)
Proceeds from sale of marketable securities and other investments 30,417,016 32,178,382 17,569,320
Acquisition of business, net of cash acquired -- -- (6,055,164)
Loan to former principal of company acquired -- -- (1,000,000)
Capital expenditures (182,241) (936,314) (1,121,797)
---------- ---------- ----------
Net cash provided by (used in) investing activities 7,468,637 (1,432,339) (9,148,750)
---------- ---------- ----------

Cash flows from financing activities:
Borrowings under bank line of credit 4,044,668 4,174,316 11,892,000
Proceeds from exercise of stock options and warrants -- 92,820 57,120
Payments under lines of credit (8,025,000) (2,500,000) --
Payments under litigation settlement (2,000,000) -- --
Payments of long-term debt (512,735) (727,223) (9,145,593)
Purchase of treasury stock (2,708,732) (445,620) (211,835)
---------- ---------- ----------
Net cash provided by (used in) financing activities (9,201,799) 594,293 2,591,692
---------- ---------- ----------

Net increase (decrease) in cash and cash equivalents (266,974) (55,986) (2,534,113)

Cash and cash equivalents at beginning of period 539,729 595,715 3,129,828
---------- ---------- ----------

Cash and cash equivalents at end of period $ 272,755 $ 539,729 $ 595,715
========== ========== ==========
Supplemental cash flow information:
Issuance of 485,000 shares of common stock in connection
with acquisitions $ 3,425,625
==========
Intangibles arising from basis differences in connection
with acquisitions $ (2,540,948) $ 2,540,948
=========== ==========
Liabilities assumed in connection with acquisitions $ 915,000 $ 20,637,796
========== ==========
Cancellation of 35,000 shares of common stock
reclassified as an accrued liability $ 275,625
==========

* Excluding effect of accounting change in 1993.
The accompanying notes are an integral part of these financial statements.

F-7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1. 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 1993 through 1995
consisted of 52 weeks.

2. Principles of Consolidation

The consolidated financial statements include the accounts of Herley
Industries, Inc. and its subsidiaries, all of which are wholly-owned. All
significant intercompany accounts and transactions have been eliminated
in consolidation.

3. Revenue and Cost Recognition

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

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

4. Inventories

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

Inventory costs relating to long-term contracts and programs are reduced
by any amounts in excess of estimated realizable value. The costs
attributed to units delivered under long-term contracts and programs are
based on the average costs of all units produced.

5. 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.

6. Intangibles

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

F-8

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 years ended July 30, 1995, there were no
adjustments to the carrying amount of the cost in excess of net assets
acquired resulting from these evaluations.

7. Marketable Securities

In May 1993 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115, "Accounting for certain
Investments in Debt and Equity Securities." The Company adopted the
provisions of the new standard for investments held as of August 1, 1994.
Adoption of this statement did not have a material effect on the
financial statements of the Company.

Management determines the appropriate classification of debt securities
at the time of purchase and reevaluates such designation as of each
balance sheet date. Debt securities are classified as held-to-maturity
when the Company has the positive intent and ability to hold the
securities to maturity. Marketable equity securities and debt securities
not classified as held-to-maturity are classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component
of shareholders' equity. Realized gains and losses and declines in value
judged to be other-than-temporary are included in other income (expense).
The cost of securities sold is based on the specific identification
method. Interest and dividends on securities are included in other income
(expense).

Realized gains or losses are determined on the specific identification
method and are reflected in income. Net unrealized losses on non-current
marketable securities are recorded directly in a separate shareholders'
equity account except those unrealized losses that are deemed to be other
than temporary, which losses are reflected in income.

8. Other Investments

The Company is a limited partner in certain nonmarketable limited
partnerships in which it owns less than a 10% interest. The Company has
no ability to influence the operating or financial policies of the
partnership. These investments are carried at cost, adjusted for any
permanent impairment in value.

9. Income Taxes

Income tax expense is based on reported earnings before income taxes.
Deferred income taxes reflect the impact of temporary differences between
the amounts of assets and liabilities recognized for financial reporting
purposes and such amounts recognized for tax purposes. In accordance with
Statement of Financial Accounting Standards (SFAS) 109, these deferred
taxes are measured by applying currently enacted tax rates.

Effective August 3, 1992, the Company implemented Statement of Financial
Accounting Standards (SFAS) 109, "Accounting for Income Taxes". SFAS 109
requires a change from the deferred to the liability method of computing
deferred income taxes. The cumulative effect of this accounting change
resulted in an increase in net income for the 52 weeks ended August 1,
1993 of $2,081,028.

10. Earnings Per Common Share

Earnings per common share and common equivalent share is based on the
weighted average number of outstanding shares of common stock including
common stock equivalents (options and warrants) as determined under the
treasury stock method as follows: 3,734,151 shares in 1995; 4,276,422
shares in 1994; and 3,942,104 shares in 1993.

F-9

11. Cash and Cash Equivalents

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

12. Product Development

The Company's primary efforts are focused on engineering design and
product development activities rather than pure research. The cost of
these development activities, including employees' time and prototype
development, net of amounts paid by customers, was approximately
$970,000, $1,367,000, and $1,160,000 in fiscal 1995, 1994, and 1993,
respectively.

13. New Accounting Standards

In March 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS
121"), which is required to be adopted by fiscal 1997. SFAS 121
establishes the accounting standards for the impairment of long-lived
assets, certain intangible assets and cost in excess of net assets
acquired to be held and used, and for long-lived assets and certain
intangible assets to be disposed of. The Company adopted this statement
during fiscal year ended July 30, 1995; it did not have a material impact
on the consolidated financial position of the Company.

14. Reclassifications

Certain fiscal 1994 and 1993 amounts have been reclassified to conform to
current year presentation.

NOTE B - ACQUISITIONS AND DISPOSALS

In July 1995, the Company entered into an agreement effective as of the
close of business June 30, 1995, to acquire certain assets and the
business (consisting principally of inventories and trade receivables) of
Stewart Warner Electronics Corporation ("SWEC"), 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. SWEC's
operations were not significant to the Company. 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. The consolidated
balance sheet includes the assets and liabilities of SWEC at July 30,
1995, and the consolidated statements of operations include the results
of SWEC's operations from July 1, 1995.

On June 18, 1993, the Company acquired all of the issued and outstanding
common stock of Carlton Industries, Inc. ("Carlton"), a Delaware
corporation and its wholly owned subsidiary Vega Precision Laboratories,
Inc. ("Vega"). The transaction provided for the payment of approximately
$4,000,000 in cash and the delivery of 450,000 shares of common stock of
the Company with a fair market value of $3,150,000. The transaction has
been accounted for by the purchase method. Accordingly, the consolidated
balance sheet includes the assets and liabilities of Carlton and Vega at
August 1, 1993, and the consolidated statements of operations include the
results of Carlton and Vega operations from June 18, 1993.

In connection with the acquisition of Carlton, the selling stockholders
have the option to sell back to the Company, at a price of $5.00 per
share, the shares of the Company's common stock originally issued to the
selling stockholders. The option is exercisable at any time during the
period commencing on January 1, 1994 through the first anniversary of the
earlier of (1) the effective date of registration of such shares with the
Securities and Exchange Commission, or (2) the rendering to a registered
broker of an opinion letter by Company counsel that the shares may be
sold in accordance with Rule 144 of the Securities Act of 1933. During
fiscal 1995, options with respect to 433,701 shares of common stock were
exercised by certain selling

F-10

stockholders. Such shares have been retired.

In September 1992, the Company entered into an agreement to acquire
substantially all of the assets of Micro-Dynamics, Inc., a Massachusetts
corporation, which is being operated as HERLEY-MDI, a division of Herley
Industries, Inc. The transaction, which closed on October 22, 1992,
provided for the payment of $1,500,000 in cash and the assumption of
approximately $3,900,000 in liabilities and has been accounted for by the
purchase method. In July, 1993 the Company paid $142,400 in cash and
issued 35,000 shares of common stock of the Company with a fair market
value of $275,625 to certain former stockholders of Micro-Dynamics, Inc.
These shares were subsequently canceled. The Company was obligated to
reissue the shares on or before September 1, 1995 and accrued a liability
of $275,625 as of July 31, 1994. The Company reissued the shares in
January, 1995. The consolidated balance sheet includes the assets and
liabilities of HERLEY-MDI at August 1, 1993, and the consolidated
statements of operations include the results of HERLEY-MDI operations
from September 1, 1992.

The following unaudited pro forma combined results of operations for the
52 weeks ended August 1, 1993 assumes that the acquisition of
substantially all of the assets of Micro-Dynamics, Inc. and all of the
issued and outstanding common stock of Carlton Industries, Inc. occurred
as of August 1, 1991. The results, which are based on various
assumptions, are not necessarily indicative of what would have occurred
had the acquisition been consummated as of August 1, 1991.

52 Weeks ended
August 1,
1993
(Unaudited)
-----------
Sales from continuing operations $33,872,280
Income from continuing operations $2,198,973
Earnings from continuing operations
per share (Primary) $.51

In February 1993, the Company sold its Marine Products Division to the
present managers of that group. As a result of the sale, the Company
recorded a charge of $2,375,809 in 1993 for the loss on disposal of the
assets (net of an income tax benefit of $100,000) and a loss from
discontinued operations net of income tax benefits of $45,000 for the
fifty-two weeks ended August 1, 1993. Net sales of the discontinued
operations were $196,896 in 1993.

NOTE C - NOTE RECEIVABLE

In connection with the acquisition of Carlton Industries, Inc., the
Company agreed to loan $1,000,000 to certain former stockholders of
Carlton. The note was due October 1, 1995 with interest payable monthly
at the prime rate as established by the Company's bank. The note was
secured by the pledge of 200,000 shares of common stock of the Company
which were held in escrow under the terms of the purchase agreement. In
December 1994, these stockholders exercised their option to sell these
shares of common stock back to the Company at a price of $5.00 per share.
The proceeds were used to satisfy this note.

F-11

NOTE D - INVENTORIES

The major components of inventories are as follows:

July 30, July 31,
1995 1994
---- ----
Purchased parts and raw materials $ 5,749,455 $ 5,412,767
Work in process 3,478,268 4,324,393
Finished products 102,330 201,030
---------- ----------
$ 9,330,053 $ 9,938,190
========== ==========

NOTE E - AVAILABLE-FOR-SALE SECURITIES

Available-for-sale securities are carried at fair value, with the
unrealized gains and losses, net of tax, reported as a separate
component of shareholders' equity. Realized gains and losses and
declines in value judged to be other-than-temporary are included in
other income (expense). The cost of securities sold is based on the
specific identification method. Interest and dividends on securities
are included in other income (expense).

The following is a summary of available-for-sale securities:

Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
July 30, 1995 --------- ------ ------- ----------
Government bonds $3,878,937 $72,968 $ 31,302 $ 3,920,603
Other 189,919 - - 189,919
--------- ------ ------- ----------
Total debt
securities 4,068,856 72,968 31,302 4,110,522
Equity securities 4,092 - - 4,092
--------- ------ ------- ----------
$4,072,948 $72,968 $ 31,302 $ 4,114,614
========= ====== ======= ==========

July 31, 1994
Government bonds $6,086,532 $20,384 $ 68,528 $ 6,038,388
Municipal bonds 4,646,008 - 247,943 4,398,065
Other 1,327,978 - - 1,327,978
--------- ------ ------- ----------
Total debt
securities 12,060,518 20,384 316,471 11,764,431
Equity securities 107,404 23,249 - 130,653
---------- ------ ------- ----------
$12,167,922 $43,633 $316,471 $11,895,084
========== ====== ======= ==========

During fiscal 1995, the Company liquidated $8,105,000 of its
available-for-sale securities and used the proceeds to pay down
$6,000,000 of its long-term bank debt, and $2,105,000 for the purchase of
treasury stock.

Included in net gains on sale of marketable securities and other
investments for the period ended July 31, 1994 are net losses of
$203,894, including the recognition of an other than temporary decline in
value of $71,721 on certain securities which was subsequently realized in
fiscal 1995.

F-12

NOTE F - OTHER INVESTMENTS

In March 1994 the Company sold its investment and terminated its
partnership interest in M.D. SASS RE/ENTERPRISE PARTNERS, L.P., a
Delaware limited partnership for $2,727,506 realizing a gain of $727,506.
In May 1994 the Company acquired a new limited partnership interest in
the partnership. 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. At July 30, 1995 and July 31, 1994 the percentage
of ownership was less than 3%. The Company's interest in the partnership
may be redeemed, based upon its proportionate share of partnership
capital, upon ninety-days notice to the managing general partner.
Redemptions are generally made as of the last day of a fiscal quarter.
The estimated fair market value, as determined by the general partner, at
July 30, 1995 and July 31, 1994 was $3,670,876 and $2,773,617
respectively.

In July 1994 the Company invested $1,000,000 in M.D. SASS MUNICIPAL
FINANCE PARTNERS-I, a Delaware limited partnership. The objectives of the
partnership are the preservation and protection of its capital and the
earning of income through the purchase of certificates or other
documentation that evidence liens for unpaid local taxes on parcels of
real property. At July 30, 1995 and July 31, 1994 the percentage of
ownership was less than 10%. The Company's interest in the partnership
may be transferred to a substitute limited partner, upon written notice
to the managing general partner, only with the unanimous consent of both
general partners at their sole discretion. The estimated fair market
value, as determined by the general partner, at July 30, 1995 and July
31, 1994 was $1,104,243 and $1,000,000 respectively.

These investments are carried at cost in the consolidated financial
statements at July 30, 1995 and July 31, 1994.

NOTE G - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are comprised of the following:

July 30, July 31, Estimated
1995 1994 Useful Life
---- ---- -----------

Land $ 880,270 $ 880,270
Building and building
improvements 5,310,925 5,264,833 10-40 years
Machinery and equipment 16,329,395 16,354,882 5- 8 years
Furniture and fixtures 492,597 492,597 5-10 years
Automotive equipment 30,243 30,243 3 years
Tools 24,869 24,869 5 years
Leasehold improvements 251,876 273,019 5-10 years
---------- ----------
23,320,175 23,320,713
Less accumulated depreciation 9,544,465 7,778,468
---------- ----------
$13,775,710 $15,542,245
========== ==========

NOTE H - COMMITMENTS AND CONTINGENCIES

Leases

The Company leases a warehouse as well as computer equipment and
automobiles under short-term operating leases.

Rent expense for the 52 weeks ended July 30, 1995, July 31, 1994 and
August 1, 1993 was approximately $158,000, $584,000, and $140,000
respectively. Rent expense in 1994 includes $308,000 for a facility

F-13

formerly occupied by Vega Precision Laboratories, Inc. This lease was
terminated in December, 1993. Minimum annual rentals under noncancellable
leases are as follows:
Amount
-------
Year ending fiscal 1996 $114,000
1997 28,900
1998 8,625

Employment Agreements

The Company has employment agreements with various executives and
employees of the Company which expire at various dates through December
31, 2002. These agreements provide for aggregate annual salaries of
$1,185,000. Certain agreements provide for an annual increment equal to
the greater of a cost of living adjustment based on the consumer price
index or 10%, and also provide for incentive compensation related to
pretax income. No incentive compensation is due for the fiscal year ended
July 30, 1995. Incentive compensation for the years ended July 31, 1994
and August 1, 1993 was waived by these executives.

Certain agreements also provide that, in the event there is a change in
control of the Company, as defined, the executives have the option to
terminate the agreements and receive a lump-sum payment. As of July 30,
1995, the amount payable in the event of such termination would be
approximately $1,100,000.

One of the employment contracts, as amended November 30, 1992, provides
for a consulting agreement commencing January 1, 1998 and terminating
December 31, 2010 at the annual rate of $100,000

Litigation

In April 1992, Litton Systems, Inc. Electron Devices Division ("Litton")
commenced an action in the Essex Superior Court of Massachusetts against
the Company (the "Litton Action") alleging, among other claims for relief,
theft of trade secrets, unfair trade practices and related common law
claims in connection with the defendants' alleged misappropriation of
Litton's beacon magnetron drawings. After trial, the jury rendered a
verdict on liability against the Company and the other defendants. Prior
to a separate, subsequent trial to determine damages, the Company settled
the action for the sum of $4,000,000, and agreed to the entry of an
injunction precluding the use by the Company of the alleged
misappropriated drawings in connection with the manufacture of beacon
magnetrons. The settlement provides for two equal payments of $2,000,000
each without interest, due in July, 1995 and 1996.

In May and June 1994, the Company was served with two class action
complaints against the Company and certain of its officers and directors
in the United States District Court for the Eastern District of
Pennsylvania. The claims were made under Section 10(b) and 20(a) of the
Securities Exchange Act of 1934 and Rule 10b-5 thereunder. One of the
claims is also based upon alleged negligence. The claims relate to the
Company's acquisition of Carlton Industries, Inc. and its subsidiary, Vega
Precision Laboratories, Inc. The claims were consolidated into one matter
and a consolidated Complaint. In April, 1995, the Court certified that the
claims based on the Securities Exchange Act may proceed as a Class Action
pursuant to Rule 23(b) (3), but without prejudice to the rights of the
parties thereafter to seek modification of the Class or revocation of
leave to proceed. The Court refused to certify the negligence claim as a
Class Action. In May, 1995, the parties negotiated a tentative settlement
of all claims in consideration for a payment of $450,000 subject to the
negotiation and execution of a satisfactory Settlement Agreement and Court
approval after notice to Class Members. The parties are negotiating the
terms of the Settlement Agreement for submission to the Court.

In May, 1995, the Company was served with a Class Action Complaint against
the Company and its Chief Executive Officer in the United States District
Court for the Eastern District of Pennsylvania. The claim was

F-14

made under Section 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10(b)-5 thereunder. The claim relates to the Company's settlement
of the Litton Action in the Essex Superior Court of Massachusetts and
alleges, inter alia, that there was insufficient disclosure by the Company
of its true potential exposure in that claim. The Company believes it has
a meritorious defense and intends to vigorously defend against the action.

In or about March, 1994, the principal selling shareholders of Carlton
Industries, Inc. ("Carlton") and its subsidiary, Vega Precision
Laboratories, Inc. ("Vega"), as claimants, commenced an arbitration
proceeding before the American Arbitration Association in New York City
pursuant to the terms of the Stock Purchase Agreement ("Agreement") by
which the Company acquired the stock of Carlton and Vega. The claimants
principally are seeking to recover damages for the Company's alleged
failure to register timely the claimants' shares of the Company's common
stock in accordance with the provisions of the Agreement and other
breaches of the Agreement. The Company has denied and has contested
vigorously the legitimacy of the claimants' claims and has interposed
several counterclaims seeking indemnification under the Agreement against
the principal selling shareholders, for damages suffered by the Company in
an aggregate amount exceeding $1 million as a result of breaches of
contractual representations. Hearings have been closed and final briefs
were submitted. The matter has yet to be determined by the Arbitrators.

There is no certainty as to the outcome of these matters. However, in the
opinion of management, the ultimate liability on these matters, if any,
will not have a material adverse effect on the consolidated financial
position or results of operations of the Company.

Stand-by Letters of Credit

The Company maintains a letter of credit facility with a bank, which was
amended subsequent to year end, that provides for the issuance of stand-by
letters of credit in the aggregate of $4,200,000. The facility requires
the payment of a fee of 1.25% per annum of the amounts outstanding under
the facility. The facility expires January 31, 1997. At July 30, 1995
stand-by letters of credit aggregating $2,546,267 were outstanding under
this facility.

NOTE I - INCOME TAXES

Effective August 3, 1992 the Company elected adoption of SFAS 109,
"Accounting for Income Taxes". SFAS 109 requires a change from the
deferred to the liability method of computing deferred income taxes.

The cumulative effect of this accounting change resulted in an increase in
net income for the 52 weeks ended August 1, 1993 of $2,081,028.

Components of income (loss) before income taxes are as follows:

52 Weeks ended
----------------------------
July 30, July 31, August 1,
1995 1994 1993

Continuing operations $ (4,886,166) $ 2,537,429 $ 1,828,598

Discontinued operations - - (2,608,642)
---------- ---------- ----------

$ (4,886,166) $ 2,537,429 (780,044)
========== ========== ==========

F-15

Income tax provision consisted of the following:

52 Weeks ended
------------------------
July 30, July 31, August 1,
1995 1994 1993
---- ---- ----
Current
Federal $ - $ - $ -
State - 236,000 55,000
Deferred, Federal
and State 4,000 440,000 237,500
------ -------- -------
$ 4,000 $ 676,000 $ 292,500
====== ======== =======

The Company paid income taxes of approximately $122,000 in 1995, $77,000 in
1994, and $197,000 in 1993. The following is a reconciliation of the U. S.
statutory income tax rate and the apparent tax rate on income from continuing
operations:

52 weeks ended
------------------------
July 30, July 31, August 1,
1995 1994 1993
---- ---- ----
U.S. Federal statutory rate 34.0% 34.0% 34.0%
State taxes, net of
federal tax benefit - 6.2% 2.0%
Benefit of net operating loss
carryforward - (10.8)% -
Non-taxable interest income - (9.2)% -
Tax benefit derived from
discontinued operations - - (7.9)%
Increase in valuation allowance (34.0)% - -
Other, net - 6.4% (4.2)%
----- ----- -----
Apparent tax rate - % 26.6% 23.9%
===== ===== =====

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

As of July 30, 1995, the Company has net operating loss carryforwards for
Federal income tax purposes of approximately $7,000,000 which expire as
follows:

2002 $ 547,000
2003 620,000
2004 597,000
2005 579,000
2008 1,731,000
2010 2,926,000
---------
$7,000,000
=========
F-16

Temporary differences and carryforwards which give rise to deferred tax
assets and liabilities are as follows:

July 30, 1995 July 31, 1994
----------------- -----------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Intangibles $ - $ 73,687 $ - $ 40,578
Alternative minimum tax 86,707 - 86,977 -
Accrued vacation pay 126,231 - 122,801 -
Inventory 503,360 - 67,500 -
Depreciation - 1,455,982 - 1,250,517
Net operating loss
carryforwards 2,411,221 - 1,385,277 -
Litigation settlement 880,000 - - -
Contract losses 218,240 - - -
Other 171,600 16,666 - -
--------- --------- --------- ---------
4,397,359 1,546,335 1,662,555 1,291,095
Valuation allowance 3,179,773 - 679,541 -
--------- --------- --------- ---------
$ 1,217,586 $1,546,335 $ 983,014 $1,291,095
========= ========= ========= =========

No income tax benefit has been recorded in 1995. A valuation allowance has been
provided relating to that portion of net operating loss carryforwards which
management believes may expire unutilized.

NOTE J- LONG-TERM DEBT

Long-term debt is summarized as follows:
July 30, July 31,
Rate 1995 1994
---- ---- ----

Note payable bank (a) 6.75% -8.75% $ 7,000,000 $11,000,000

Mortgage note (b) 10.4% 3,800,000 4,045,000

Series A and B notes (c) 12.0% - 18.0% 41,161 191,377

Capital lease obligations
secured by certain equipment
final payment due in 1996 5.4% - 20.64% 40,917 138,768
---------- ----------
10,882,078 15,375,145

Less current portion 357,078 552,311
---------- ----------
$10,525,000 $14,822,834
========== ==========

(a) The Company has a revolving credit facility with a bank, secured by its
portfolio of marketable securities, which was amended subsequent to year
end, that provides for the extension of credit in the aggregate principal
amount of $9,000,000. The facility requires the payment of interest only on
a monthly basis and payment of the outstanding principal balance on January
31, 1998. Interest is set daily at 1% over the bank's earliest daily rate
quoted for Federal Funds (5.75% at July 30, 1995) applied to outstanding
balances up to 80% of the net equity value of certain investments, and at
.5% over the bank's National Commercial Rate (8.75% at July 30, 1995) for
outstanding balances in excess of this limit. At July 31, 1994, interest
was at the bank's National Commercial Rate of 7.25%. In addition, the
agreement provides for a fee of 1/8 of 1% of the unused availability under
the facility payable quarterly.

F-17

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

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

The mortgage note agreement contains various financial covenants,
including, among other matters, the maintenance of specific amounts
of working capital and tangible net worth. In connection with this
loan, the Company paid approximately $220,000 in financing costs.
Such costs are included in Other Assets in the accompanying
consolidated balance sheets at July 30, 1995 and July 31,1994 and are
being amortized over the term of the loan (15 years).

(c) During the fiscal year ended July 31, 1994, the Company redeemed
$200,000 principal amount of Series A Notes representing all Series A
notes outstanding. In fiscal 1995 and 1994, the Company redeemed
$85,000 and $30,000 principal amount of Series B notes, respectively.
The balance of Series B Notes outstanding includes interest accrued
at 18% simple interest totaling $22,161 at July 30, 1995 and $87,377
at July 31, 1994. The balance of the Series B Notes is due to a
former principal, and related party, of Vega Precision Laboratories,
Inc. Payment of these notes is pending the resolution of the
arbitration discussed in Note H.

The Company paid interest of approximately $1,010,000 in 1995, $1,296,000
in 1994, and $530,000 in 1993.

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

Fiscal year ending during: Amount
------
1996 $ 357,078
1997 300,000
1998 7,335,000
1999 370,000
2000 410,000
Thereafter 2,110,000
----------
$10,882,078
==========

NOTE K - ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses include the following:

July 30, July 31,
1995 1994
---- ----
Accounts payable $ 1,302,789 $ 2,841,616
Accrued payroll 553,276 637,024
Accrued commissions 390,097 2,206,360
Accrued interest 98,141 138,674
Accrued litigation expenses 2,688,165 -
Accrued expenses 2,611,680 665,365
--------- ---------
$ 7,644,148 $ 6,489,039
========= =========

NOTE L - EMPLOYEE BENEFIT PLANS

In August 1985, the Board of Directors approved an Employee Savings Plan
which qualified as a thrift plan under Section 401(k) of the Internal
Revenue Code. This Plan, as amended and restated, allows employees to
contribute between 2% and 15% of their salaries to the Plan. The Company,
at its discretion can contribute

F-18

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 $151,000 for the fiscal year ended
July 30, 1995, and contributed approximately $199,000, and $98,000 to this
plan for the fifty-two weeks ended July 31, 1994, and August 1, 1993.

NOTE M - SHAREHOLDERS' EQUITY

In October 1987, the Board of Directors approved the 1988 Non-Qualified
Stock Option Plan which covers 500,000 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. At
July 31, 1995, July 31, 1994 and August 1, 1993, options to purchase
29,775, 19,850, and 50,975 shares of common stock, respectively, were
exercisable.

In December 1992, the Board of Directors approved the 1992 Non-Qualified
Stock Option Plan which covers 1,000,000 shares, as amended, of the
Company's common stock. Under the terms of the Plan, the purchase price of
the shares, subject to each option granted, is 100% of the fair market
value at the date of grant. The date of exercise is determined at the time
of grant by the Board of Directors; however, if not specified, 50% of the
shares can be exercised each year beginning one year after the date of
grant. The options expire ten years from the date of grant. Options for
255,000, 254,000 and 428,800 shares were issued during the fiscal years
ended July 30, 1995, July 31, 1994 and August 1, 1993, respectively. These
options may be exercised cumulatively at the rate of 25% per year
beginning one year after the date of grant. Options for 534,800 and
211,400 shares were exercisable at July 30, 1995 and July 31, 1994
respectively. No options under the Plan were exercisable at August 1,
1993.

A summary of stock option activity for the 52 weeks ended July 30, 1995,
July 31, 1994, and August 1, 1993 follows:

Non-Qualified Stock Options Warrant Agreements
--------------------------- ------------------
Number Price Range Number Price Range
of shares per share of shares per share
--------- ------------- --------- ---------
Outstanding August 2, 1992.... 210,900 $2.38 - 12.01
Granted.................... 428,800 6.50 - 7.63 430,000 $7.13
Exercised.................. (24,000) 2.38
Canceled................... (100,000) 7.44
------- ------------- ------- ----
Outstanding August 1, 1993.... 515,700 $2.38 - 12.01 430,000 $7.13
Granted ................... 254,000 6.00 - 6.88
Exercised.................. (39,000) 2.38
Canceled................... (33,000) 5.69 - 12.01
------- ------------- ------- ----
Outstanding July 31, 1994..... 697,500 $5.69 - 12.01 430,000 $7.13
Granted ................... 255,000 3.38
Canceled................... (10,000) 3.38 - 7.00
------- ------------- ------- ----
Outstanding July 30, 1995..... 942,500 $3.38 - 12.01 430,000 $7.13
======= =======

In April 1993, common stock warrants were issued to certain officers and
directors for the right to acquire 430,000 shares of common stock of the
Company at the fair market value of $7.125 per share at date of issue.
The warrants expire April 30, 1998.

F-19

In connection with the sale of common stock to the public in 1992, the
Company issued to the underwriter, for its own account, warrants to
purchase 100,000 shares of common stock of the Company, exercisable for a
period of four years at a price of $15.45 per share (120% of the public
offering price), subject to adjustment in certain events. The warrants
expire in February 1996.

On June 18, 1993 the Company issued 450,000 shares of common stock valued
at $7.00 per share in connection with the acquisition of Vega Precision
Laboratories, Inc. During fiscal 1995 certain selling stockholders
exercised their options to sell back to the Company 433,701 shares of
common stock. (See Note B).

On July 31, 1993, the Company issued 35,000 shares of common stock valued
at $7.875 per share in connection with the acquisition of substantially
all of the assets of Micro-Dynamics, Inc. These shares were subsequently
canceled. The Company reissued the shares in January, 1995. (See Note B).

NOTE N - MAJOR CUSTOMERS

Net sales to the U.S. Government in 1995, 1994, and 1993 accounted for
approximately 30%, 25%, and 36% of net sales, respectively. In 1994 sales
to a major customer accounted for 16% of net sales, and in 1993 sales to
a major customer accounted for 14% of net sales. Foreign sales amounted
to approximately $3,908,000, $7,891,000, and $1,623,000 in fiscal 1995,
1994, and 1993, respectively.

Included in accounts receivable as of July 30, 1995 and July 31, 1994 are
amounts due from the U.S. Government of approximately $718,000 and
$774,000, respectively.

NOTE O - UNUSUAL ITEM

The Consolidated Statements of Operations for the fifty-two weeks ended
July 30, 1995 includes an unusual charge of $5,447,005 for settlement
costs, legal fees, and related expenses in connection with the settlement
for certain legal claims against the Company. (See Note H, Litigation).

During the fiscal year ended July 31, 1994, the Company incurred unusual
charges of $745,663 in excess of reserves in connection with warranty
claims for products shipped by Vega prior to its acquisition by the
Company. These claims were resolved during the fiscal year and the
Company does not anticipate any further costs as a result of these
claims.

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