<PAGE>
 
                              ISOMET CORPORATION


                              1997 ANNUAL REPORT
<PAGE>
 
Isomet, founded in 1956, is headquartered in Springfield, Virginia with an
operating subsidiary in the United Kingdom.  The Company designs and
manufactures acousto-optic laser control components and electronics for
information handling and other applications.  It also produces high resolution
digital color scanners, film recorders, laser plotters and related equipment for
color image reproduction markets.



                              FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
 
 
                                   1997        1996     % of Change
                                ----------  ----------  -----------
<S>                             <C>         <C>         <C>
 
Revenue                         $8,653,000  $5,804,000     +49
                                                          
Net Income                      $1,331,000  $  682,000     +95
                                                          
Number of Shares of Common                                
    Stock and Common Stock                                
    Equivalents Outstanding      1,971,000   1,949,000      +1
                                                          
Diluted Net Income Per Share    $      .68  $      .35     +94
                                                          
Inventory at 12/31              $3,381,000  $3,730,000      (9)
                                                          
Working Capital                 $5,263,000  $4,095,000     +29
                                                          
Current Ratio                        4.3:1       3.4:1       -
                                                          
Number of Employees                     50          49      +2
                                                          
Revenue Per Employee            $  173,100  $  118,400     +46
                                                          
New Orders                      $7,568,000  $4,807,000     +57
                                                          
Unfilled Orders at 12/31        $3,451,000  $4,549,000     (24)
</TABLE>
<PAGE>
 
TO SHAREHOLDERS AND EMPLOYEES

     We are pleased to report very strong financial results for fiscal year
1997.  Revenue increased 49% to $8.7 million from $5.8 million in 1996.
Resultant net income for 1997 was $1.3 million or $.68 per share (vs.) $682,000
or $.35 per share.  The 1997 results were net of $663,000 in tax charges;
whereas, the 1996 net earnings included tax benefits of $68,000.

     The substantial revenue increase in 1997 was due to increases in both the
component and system product lines.  Component sales increased by approximately
$1.1 million, primarily for laser based inspection system applications.  System
sales increased by approximately $1.7 million as a result of expanded sales of
laser plotters to Polaroid Corporation.

     New orders received in 1997 totaled $7.6 million compared to $4.8 million
the previous year.  Component orders in 1997 were particularly strong and made
up $6.6 million of the total.  At year-end 1997 unfilled orders totaled $3.5
million, compared to $4.5 million the previous year.

     During the period December 1997 - February 1998, new orders for laser
plotters were received totaling approximately $1.7 million, with deliveries
scheduled through June 1998.  These orders were accepted as add-ons to the
previous agreement.  Any material follow-on orders for this product will be
announced to shareholders when they occur.

     In 1997 we paid $240,000 against the outstanding NationsBank loans, leaving
a balance of $864,000 on December 31, 1997.  These loans mature April 1, 1998,
however, the bank has advised the Company that it will extend the loan
agreements for at least a two year period with a reduction in the interest rate
and with the same principal reduction rate.

     In spite of the strong revenue last year, we are concerned about the mix of
our revenue with only a few customers constituting a significant portion of our
business as has been the case for a number of years.  We plan to expend
considerable effort this year in finding new products and business opportunities
that will broaden our base of revenue.

     I would like to express my appreciation to all of Isomet's employees in
Springfield, Virginia and at Isomet UK in Wales for their efforts in making 1997
the outstanding year that it was for the Company.  We will be working to build
on this success and to continue a creative and rewarding environment for our
employees and value for our shareholders.

                                Henry Zenzie
                                President
<PAGE>
 
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                      ------------------------------------
                                        
REVENUE

     Consolidated net revenue in 1997 totaled $8,653,000, an increase of
$2,849,000 from $5,804,000 in 1996.  The following table reflects the sales and
total revenue comparisons for both years by product line and operating entity:
<TABLE>
<CAPTION>
 
                                                  1997
Components            1997        1996     Increase/(Decrease)
-----------------  ----------  ----------  -------------------
<S>                <C>         <C>         <C>
 
Isomet U.S. (1)    $3,616,000   $2,522,000     $1,094,000
Isomet U.K.         1,484,000    1,456,000         28,000
                   ----------   ----------     ----------
Total:             $5,100,000   $3,978,000     $1,122,000
                                             
Systems                                      
-----------------                            
                                             
Isomet U.S. (1)    $3,380,000   $1,721,000     $1,659,000
Isomet U.K.           153,000       99,000         54,000
                   ----------   ----------     ----------
Total:             $3,533,000   $1,820,000     $1,713,000
                   ----------   ----------     ----------
                                             
Total Sales        $8,633,000   $5,798,000     $2,835,000
                                             
Other Income           20,000        6,000         14,000
                   ----------   ----------     ----------
                                             
Total Revenue:     $8,653,000   $5,804,000     $2,849,000
</TABLE>

(1) - Includes sales to foreign countries other than in Europe.

     As shown above, the sales increase in 1997 of $2,835,000 is composed of
$1,122,000 from component products and $1,713,000 from systems.  Shipments of
laser plotters to Polaroid Corporation, under a contract received in November
1995, caused the systems increase that we experienced in 1997.

COSTS AND EXPENSES

     On a consolidated basis, the Company had net earnings in 1997 of $1,331,000
or $.68 per share (diluted).  This compares to a net income in 1996 of $682,000
or $.35 per share (diluted).  The 1996 net results include income tax benefits
of $68,000.  The application of net operating loss carry forwards in 1996
eliminated any tax liability against the 1996 earnings.  (See Note 7 to the
Consolidated Financial Statements for a detailed analysis of income taxes.)

     1.  The cost of sales percentage in 1997 decreased to 61.1% from 64.3% in
1996.  Resultant gross profit increased by approximately $1,294,000 in 1997.
The decline in the cost of sales percentage is due, primarily, to more efficient
manufacturing operations in 1997 as a result of the increased activity, which
resulted from higher sales.
<PAGE>
 
     2.  Selling and G & A expenses in 1997 increased by $2,000 from 1996.  As a
percentage of revenue, these expenses decreased to 14.7% from 21.8% in 1997.

     3.  Interest expense declined in 1997 to $119,000 from $152,000 in 1996, as
the Company continued to reduce its borrowing level.

     4.  Expensed product development and improvement costs were $0 in 1997
compared to $38,000 in 1996.  During 1997 and 1996, most of the Company's
engineering effort was applied to systems contracts and accounted for in cost of
sales.

     5.  For the two years ended December 31, 1997, the Company's revenue and
cost of sales were not significantly impacted by the effects of inflation.  In
addition, the Company's sales and costs have not been materially affected by
changing prices due to inflation.  Lower unit sales prices, however, have been
experienced in the color scanner product line due to competitive pressures.

FOREIGN EXCHANGE RISKS

     In 1997, $2,807,000 of the $8,633,000 Company total sales were to customers
in foreign countries, primarily Japan and Europe.  From the United States, all
sales to foreign customers are invoiced in U.S. dollars.  The Company's
operating subsidiary in the United Kingdom imports products from the Parent
Company and re-sells to customers in various European countries; the majority of
these sales are in U.S. dollars.  As a result, the Company's foreign currency
risks are limited to the pound sterling - U.S. dollar relationship, which has
been relatively stable over time.  Consequently, the Company has not had and
does not expect to have a material exposure to foreign exchange risks.
<PAGE>
 
LIQUIDITY AND CAPITAL RESOURCES

     Unrestricted cash and cash equivalent balances on December 31, 1997 of
$1,534,000 is a $1,333,000 increase from the previous year.  The major elements
constituting this rise are as follows:
<TABLE>
<CAPTION>
 
 
<S>        <C>                                 <C>          <C>
     1.    Operating Activities
           ----------------------------------
 
           Decrease in Inventories             $  348,000
           Decrease in Deferred Revenue          (446,000)
           Net Income                           1,331,000
           Depreciation and Amorization            93,000
           Increase in Income Taxes Payable       681,000
           Decrease in Accounts Payable          (362,000)
           Other                                  (67,000)  $1,578,000
                                               ----------
 
     2.    Investing Activities
           ----------------------------------
 
           Purchase of Property and Equipment     (58,000)     (58,000)
 
     3.    Financing Activities
           ----------------------------------
 
           Repayment of Debt                     (242,000)
           Other                                   56,000     (186,000)
                                               ----------
 
     4.    Exchange Rate Effect                    (1,000)      (1,000)
           ----------------------------------  ----------   ----------
 
           Total:                                           $1,333,000
 
</TABLE>

     Major increases at year-end 1997 as compared to 1996 in operating
activities, as shown above, are primarily the result of increased production and
shipment activity in 1997 against a significant contract for laser plotters.
This contract was received in the fourth quarter of 1995.

     The Company has no material commitments for capital expenditures as of
December 31, 1997 and accordingly, no funds from sources other than internally
generated funds are considered necessary.
<PAGE>
 
     A summary of working capital and order backlog over the Company's 1997
fiscal year by quarterly period is as follows:
<TABLE>
<CAPTION>
 
<S>                    <C>         <C>         <C>         <C>
                         3/31/97     6/30/97     9/30/97    12/31/97
                       ----------  ----------  ----------  ----------
 
Current Assets         $5,801,000  $5,971,000  $6,006,000  $6,859,000
Current Liabilities     1,492,000   2,168,000   2,015,000   1,596,000
                       ----------  ----------  ----------  ----------
Working Capital        $4,309,000  $3,803,000  $3,991,000  $5,263,000
 
Order Backlog          $4,323,000  $3,294,000  $4,260,000  $3,451,000
                       ----------  ----------  ----------  ----------
 
</TABLE>

     The reduction in working capital for the period April 1 - September 30,
1997 reflects, in part, the reclassification of bank debt to short-term since
the loan agreement matures April 1, 1997.  Subsequent to December 31, 1997 the
bank has advised the Company that it intends to extend the agreement.  As a
result, at December 31, 1997, current liabilities include only the current
portion of the debt.

     The decline in backlog at December 31, 1997 is the result of increased
shipments in the fourth quarter of approximately $800,000 in excess of new
orders booked.


BANK ARRANGEMENTS

     Pursuant to the NationsBank loan agreement extension of April 1, 1997, the
Company paid $240,000 of principal in 1997.  In addition, the Company was in
compliance with all other terms, conditions and operating ratios called for
under the agreement.  The NationsBank loans are due on April 1, 1998, however,
the bank has advised the Company that it intends to extend the agreement for a
two year period with a reduction in the interest rate.  Although all specific
terms and conditions have not been determined, it has been verbally agreed that
the $240,000 annual repayment of principal will continue under the extension
agreement.


WORKING CAPITAL

     In 1998, additional working capital, if required, is expected to be
generated from operations.
 
<PAGE>
 
REVENUE
     Total Revenue for 1997 and 1996 was distributed as follows:
<TABLE>
<CAPTION>
 
                                1997       %       1996       %    
                             ----------  -----  ----------  -----  
<S>                          <C>         <C>    <C>         <C>
Commercial Sales                        
     Foreign                 $2,807,000   32.5  $2,514,000   43.3
     Domestic                 5,816,000   67.2   3,241,000   55.9
Government Sales Direct          10,000     .1      43,000     .7
Interest and Other Income        20,000     .2       6,000     .1
                             ----------  -----  ----------  -----
     Total Revenue:          $8,653,000  100.0  $5,804,000  100.0
</TABLE>

COST AND EXPENSES
     An analysis of costs and expenses as a percentage of revenue is shown
below:
<TABLE>
<CAPTION>
 
                                            1997    1996
                                           ------  ------
<S>                                        <C>     <C>
 
Revenue                                    100.0%  100.0%
Cost and Expenses
     Cost of Sales                          60.9    64.3
     Selling, General and Admin             14.7    21.8
     Product Development                       -      .7
     Interest                                1.4     2.6
     Non-Recurring Charges                     -       -
                                           -----   -----
     Total Cost and Expenses:               77.0    89.4
Income (Loss) Before Tax, Minority
     Interest and Other                     23.0    10.6
Income Tax, Minority Interest and Other     (7.7)    1.1
                                           -----   -----
     Net Income (Loss)                      15.3%   11.7%
</TABLE>

SELECTED FINANCIAL DATA
For the Years Ended December 31,
<TABLE>
<CAPTION>
 
                          1997       1996       1995        1994        1993
                       ---------- ---------- ----------- ---------- ------------
<S>                    <C>        <C>        <C>         <C>        <C>
                                                                   
Revenue                $8,653,000 $5,804,000 $4,800,000  $5,746,000 $ 5,801,000
Net Income (Loss)      $1,331,000 $  682,000 $  (44,000) $   23,000 $(1,645,000)
Weighted Avg #                                                     
  Shares Outstanding  1,971,000    1,949,000  1,906,000   1,906,000   1,906,000
Income (Loss) Per                                                  
   Share (Diluted)           $.68       $.35      $(.02)       $.01       $(.86)
Working Capital        $5,263,000 $4,095,000 $3,595,000  $3,824,000 $ 3,953,000
Total Assets           $7,189,000 $6,201,000 $4,991,000  $5,289,000 $ 6,576,000
Long Term                                                          
   Liabilities         $  637,000 $  876,000 $1,122,000  $1,405,000 $ 1,659,000
Stockholders'                                                      
   Equity              $4,955,000 $3,588,000 $2,901,000  $2,905,000 $ 2,863,000
</TABLE>
<PAGE>
 
                             CORPORATE INFORMATION



Corporate Headquarters:  5263 Port Royal Road, Springfield, VA 22151
                         Tel: (703) 321-8301    E-Mail: isomet@isomet.com
                         Fax: (703) 321-8546    Web Site: http://www.isomet.com

Officers:                Henry Zenzie, President
                         Leon Bademian, Executive Vice President, Operations
                         Robert G. Bonner, Vice President, Components Mfg
                         Frank V. Hamby, Vice President, Systems Mfg
                         Delmar R. Rader, Vice President, Product Engineering
                         Jerry W. Rayburn, Executive Vice President, Finance,
                          Treasurer and Secretary

Transfer Agent:          Chemical Mellon Shareholder Services
                         Four Station Square, Pittsburgh, PA  15219-1173

General Counsel:         Ginsburg, Feldman and Bress, Chartered
                         1250 Connecticut Avenue NW, Suite 800
                         Washington, DC  20036

Directors:               Leon Bademian, Exec Vice President, Operations, Isomet
                         Lee R. Marks, Member, Ginsburg, Feldman and Bress,
                          Chartered, Washington, DC
                         Thomas P. Meloy, Benedum Professor, West VA University
                         Jerry W. Rayburn, Exec Vice President, Finance, Isomet
                         Henry Zenzie, President, Isomet, Private Investor,
                          Henry Zenzie and Co., Princeton, NJ

Auditors:                Aronson, Fetridge & Weigle,
                         6116 Executive Blvd., Rockville, MD  20852

Market Information:      The Company's common stock trades on the Nasdaq
                         Smallcap Market (SM) tier of the Nasdaq Stock Market
                         (SM) under the symbol IOMT.
 
                         Price Range             High                Low
                         -----------             -----              ------
                                                                  
                           1995                  3 1/4                 7/8
                           1996                  3                   1 1/4
                           1997                  7                   1 1/2
<PAGE>
 
10K Report:              A copy of Isomet's annual report on Form 10-KSB for the
                         fiscal year ended December 31, 1997, including
                         financial statements and schedules, as filed with the
                         Securities Exchange Commission, will be provided
                         without charge to those stockholders who request one.

Write:                   Executive Vice President, Finance
                         Isomet Corporation, 5263 Port Royal Road
                         Springfield, VA  22151

Operating Subsidiary:    Isomet UK, Ltd., 18 John Baker Close, Llantarnam Ind
                          Park,
                         Cwmbran Gwent NP44 3AX, UNITED KINGDOM
                         Tel: (44) 16338-72721
                         Fax: (44) 16338-74678

                         REPRESENTATIVES AND DISTRIBUTORS

Components:              Isramex, 16 Hazaz Street, Tel-Aviv 69407 ISRAEL
                         Tel: (972) 3-6474440      Fax: (972) 3-6473773
 
                         Indeco, Inc., 11-14 Kasuga, 1-Chome Bunkyo-Ku,
                         Tokyo 112 JAPAN
                         Tel: (03) 3818-4011       Fax: (03) 3818-4015
                        
                         Optilas B.V., P.O. Box 222, 2400 AE Alphen A/D,
                         Rijn Huygensweg HOLLAND
                         Tel: (31) 1-72 44 6060    Fax: (31) 1-72 44 3414
                        
                         Optilas GmbH, Boschstrasse 12, D82178 Pucheim BHF,
                         GERMANY
                         Tel: (49) 8989 01350      Fax: (49) 89800 2561
                        
                         Optilas Iberica S.A., C/Maria Tubau, 5 28050 Madrid 
                          SPAIN
                         Tel: (34) 1 358 8611      Fax:  (34) 1 358 9271
                        
                         Optilas, Ltd., Mill Square, Featherstone Road,
                         Wolverton Mill South, Milton Keynes MK12 5ZY
                         Buckinghamshire, ENGLAND
                         Tel: (44) 1908-326326     Fax:  (44) 1908-221110
                        
                         Optilas S.A., 4 Alle Du Cantal, ZI LaPetite Montagne,
                         Sud 91018 Evry Cedex FRANCE
                         Tel: (33) 1 607 95900     Fax:  (33) 1 608 69633

                         Opitlas, Chaussee de Charleroi 95, B-6060
                         Charleroi BELGIUM
                         Tel: (32) 71-488448       Fax:  (32) 71-488444
 
<PAGE>
 
                         Optilas, Billedvej 2, DK-2100 Copenhagen DENMARK
                         Tel: (45) 354 30133       Fax: (45) 354 38334
                        
                         Crisel Instruments, Clivo di Cinna, 196-001 36 
                          Roma ITALY
                         Tel: (39) 635 402933      Fax:  (39) 635 402879

Systems:                 Graphic Arts Trading (GmbH), Uhlenhorst 81, 21435
                         Stelle, GERMANY
                         Tel: (49) 41-74-5041      Fax:  (49) 41-74-4885
 
                         MIG, SRL, Via Toselli 25/B, 20091 Bresso ITALY
                         Tel:  392-610-4809        Fax:  392-614-1015