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United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

for the fiscal year ended June 30, 2004

for the transition period from                      to                     .

Commission File Number: 0-16195

II-VI INCORPORATED

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: 724-352-4455

Securities registered pursuant to Section 12(b) of the Act: None.

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

Common Stock, no par value.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  x    No  ¨

Aggregate market value of outstanding Common Stock, no par value, held by non-affiliates of the Registrant at December 31, 2003, was approximately $368,778,000 based on the closing sale price reported on the Nasdaq National Market. For purposes of this calculation only, directors and executive officers of the Registrant and their spouses are deemed to be affiliates of the Registrant.

Number of outstanding shares of Common Stock, no par value, at August 31, 2004, was 14,490,137.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement, which will be issued in connection with the 2004 Annual Meeting of Shareholders, are incorporated by reference into Part III of this annual report on Form 10-K.

Forward-Looking Statements

This annual report on Form 10-K (including certain information incorporated herein by reference) contains forward looking statements as defined by Section 21E of the Securities Exchange Act of 1934, as amended, including the statements regarding projected growth rates, markets, product development, financial position, capital expenditures and foreign currency hedging. Forward-looking statements are also identified by words such as “expects,” “anticipates,” “intends,” “plans,” “projects” or similar expressions.

Actual results could materially differ from such statements due to the following factors: materially adverse changes in economic or industry conditions generally (including capital markets) or in the markets served by the Company, the development and use of new technology and the actions of competitors. Other important factors and uncertainties include, but are not limited to the Risk Factors set forth in Item 7.

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PART I

Introduction

II-VI Incorporated (“II-VI” or the “Company”) was incorporated in Pennsylvania in 1971. Our executive offices are located at 375 Saxonburg Boulevard, Saxonburg, Pennsylvania 16056. Our telephone number is 724-352-4455. Reference to the “Company” or “II-VI” in this Form 10-K, unless the context requires otherwise, refers to II-VI Incorporated and its wholly- and majority-owned subsidiaries: eV PRODUCTS operates as a division of II-VI Incorporated and Wide Band Gap Materials operates as a development group of II-VI Incorporated. The Company’s name is pronounced “Two-Six Incorporated.” The majority of our revenues are attributable to the sale of optical components for lasers used in the materials processing industry.

Our Internet address is www.ii-vi.com. On this web site we post the following filings as soon as reasonably practical after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and any amendments to those reports or statements filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In addition, we post our proxy statement as Schedule 14A related to our annual shareholders’ meeting as well as reports filed by our directors, officers and ten percent beneficial owner pursuant to Section 16 of the Securities Exchange Act of 1934. All such filings are located on the Investor Relations page of our web site and are available free of charge.

Information Regarding Market Segments and Foreign Operations

Financial data regarding our revenues, results of operations, industry segments and international sales for the three years ended June 30, 2004 is set forth in the consolidated statements of earnings and in Note L to the Company’s consolidated financial statements included in this Form 10-K.

General Description of Business

We develop, manufacture and market high technology materials and derivative products for precision use in industrial, medical, military, security and aerospace applications. We use advanced material growth technologies coupled with proprietary high precision fabrication, micro-assembly, and thin-film coating production processes. The resulting optical and optoelectronic devices are supplied to manufacturers and users of a wide variety of laser, sensor and military components and systems. A key strategy is to develop and manufacture complex materials from the periodic table of elements. We focus on providing critical components to the heart of our customers’ assembly lines for products such as high power laser material processing systems, military fire control and missile guidance devices and advanced medical and security scanning systems. We develop, manufacture and market high power carbon dioxide (CO₂) and Yttrium Aluminum Garnet (YAG) laser optical elements, military infrared optical components, x-ray and gamma ray sensors for both the medical and nuclear radiation industries and single crystal silicon carbide (SiC) substrates.

Our United States production operations are located in Pennsylvania, Florida, California and New Jersey and our non-United States production operations are based in Singapore and China. In addition to sales offices at each of our manufacturing sites we have sales and marketing subsidiaries in Germany, Japan, Switzerland, Belgium and the United Kingdom. Approximately 41% of our revenues are from product sales to customers outside of the United States.

Our primary products are optical and optoelectronic components used in the laser, military and nuclear radiation sensor industries.

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We are at the forefront of advanced material growth research, development and high volume production. During fiscal 2004 our expanded material growth development included a new product line, ultra-violet (UV) filters, used in early warning missile detection.

Our Markets

Our business is comprised of five primary markets:

Infrared Market. In recent years, increases in laser component consumption have been driven by continued worldwide proliferation of laser processing applications. We believe the industrial laser market is estimated to be approximately $140 million. Manufacturers are seeking solutions to increasingly complex demands for quality, precision, speed, throughput, flexibility, automation and cost control. High power CO₂ lasers provide these benefits in a wide variety of cutting, welding, drilling, ablation, balancing, cladding, heat treating, and marking applications. For example, automobile manufacturers use lasers to facilitate rapid prototyping, production simplification, efficient sequencing, and computer control on high throughput production lines. Manufacturers of recreation vehicles, motorcycles, lawn mowers and garden tractors cut, trim and weld metal parts with lasers to achieve flexibility, high consistency, reduced post processing and lower costs. Furniture manufacturers utilize lasers to provide easily reconfigurable, low-distortion, low-cost prototyping and production capabilities that facilitate the manufacturing of customer specified designs. On high-speed processing lines, laser marking provides automated date coding for food packaging and computer driven container identification for pharmaceuticals.

Near-Infrared Market. Over recent years, the laser market has required increased power levels and reduced operating costs. High power YAG laser systems are enabling this technology to address new applications. YAG lasers are

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used in high power applications such as cutting, welding, marking and date coding. We believe the addressable markets serviced by our Near-Infrared segment are approximately $185 million.

We provide optical elements and components for both CO₂ and YAG laser systems. In addition to use by original equipment manufacturers (OEMs), a replacement part aftermarket exists in support of an estimated current worldwide installed base of over 100,000 CO₂ and YAG lasers.

Military Infrared Optics Market. Several key optical components such as windows, domes and related subassemblies are core products offered to the military market for infrared applications in night vision, targeting, navigation and Homeland Security systems. Infrared windows and window assemblies are employed on fixed and rotary-wing aircraft, ground vehicles and Unmanned Air Vehicles (UAV’s) to provide advanced targeting and navigation capabilities. Infrared domes are often used on missiles with infrared guidance systems ranging from small, man portable designs to larger designs mounted on helicopters, fixed-wing aircraft and ground vehicles. High-precision domes are an integral component of the missile’s targeting system providing efficient tactical capability while serving as a protective cover to its internal components. Our infrared optical products are sold primarily to the U.S. government prime contractors and directly to various U.S. government agencies.

The current demand for infrared optical components is being driven by the replacement and repair of hardware used in combat in Iraq and the desire to upgrade the current capabilities of weapons, aircraft and ground vehicles. We believe current market estimates for military infrared optics to address these demands is approximately $450 million. Germanium windows used in night vision and targeting systems on vehicles such as the Abrams M-1 Tank and Bradley Fighting Vehicle have been returned for refurbishment and/or replacement. The desire to provide the military with increased capabilities has driven upgrades to navigation and targeting systems for aircraft such as the Apache Attack Helicopter and the F-16 fighter jet. Similarly, the increased use of remotely piloted and autonomous surveillance and reconnaissance vehicles is demanding increased use of multi-spectral sensor systems. Finally, the Department of Homeland Security is considering the use of infrared countermeasures on commercial aircraft and we are actively supporting aspects of this program. These upgrades require more advanced optical components in order to meet today’s more demanding performance requirements.

Compound Semiconductor Group Market. The Company’s Compound Semiconductor Group (formerly named “Other”) includes the combined operations of the Company’s eV PRODUCTS division (solid-state radiation sensor market), the Company’s Wide Bandgap Materials (WBG) group (Silicon Carbide semiconductor materials market), the Company’s Advanced Materials Development Center (AMDC) group and remaining corporate activities. We believe the addressable markets serviced by the Compound Semiconductor Group is estimated to be approximately $400 million.

Solid-State Radiation Sensor Market. Solid-state radiation sensors and components are sold primarily to companies engaged in the manufacture of medical diagnostic, medical imaging or industrial gauging/inspection and security and monitoring equipment. In an increasing number of applications, the use of gamma- or x-ray radiation enables more rapid and accurate measurement of medical conditions, industrial quality and early detection and identification of nuclear materials and threatening items, including explosive materials. Solid-state sensors based on CdZnTe are making inroads against older, more established technologies, such as cryogenically cooled germanium detectors or sodium iodide scintillators coupled to photomultiplier tubes. CdZnTe sensors have already been substituted for these older technologies in applications where increased accuracy, easier operation, portability and lower cost are required. CdZnTe is beginning to enable new medical, industrial and security/monitoring applications not feasible with the older technologies and is already being used routinely in bone densitometry systems that scan for osteoporosis, cancer probes and process control systems.

We believe the annual worldwide market for all solid-state radiation sensors is currently over $250 million and growing up to 10% per year. Digital radiography (the recording of digital x-ray images) represents the largest market segment followed in order by nuclear medicine (the detection or imaging of radioactive isotopes employed in medical procedures), industrial gauging, radiation monitoring, security scanning, including baggage inspection and nuclear safeguards/non-proliferation. Presently, we believe that the addressable CdZnTe market has grown to represent $50 million of the worldwide solid-state radiation sensor market, and that CdZnTe addressable market will grow at 10% to 20% per year.

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During the next several years, we believe the performance of CdZnTe, and other solid-state sensors will be improved through investment in additional research and development, ultimately creating the potential for digital imaging to become a cost-effective replacement of x-ray film in a variety of traditional radiography applications.

We believe that the market for CdZnTe sensors and imagers will grow because of several factors, including:

Equipment manufacturers increasingly desire to procure fully tested, packaged components rather than devices that must be qualified and assembled. We believe that this trend will require leading suppliers to provide products containing ever-increasing levels of signal processing enabling easy-to-use applications at the same or lower cost of traditional radiation sensors and, as a result, the market will place high value on suppliers having strong applications engineering capabilities and a focus on customer relationships.

Silicon Carbide Semiconductor Materials Market. Silicon Carbide is a wide band gap semiconductor material that offers high-temperature, high-power and high-frequency capabilities as a substrate for applications that are rapidly emerging at the high-performance end of the optoelectronic, telecommunication, power distribution and transportation markets. SiC has certain inherent physical and electronic advantages over competing semiconductor materials such as silicon and gallium arsenide. For example the high thermal conductivity of silicon carbide enables SiC- and Gallium Nitride- (GaN) based devices to operate at high power levels and still dissipate the excess heat generated. Other intrinsic properties allow SiC-based devices to operate at high temperatures above 400 degrees Centigrade (750 degrees Fahrenheit). Typically, either SiC or GaN layers are deposited on a SiC substrate and the desired optoelectronic or electronic devices are fabricated in the resulting material structure. SiC- and GaN-based structures are being developed and deployed for the manufacture of a wide variety of microwave and power switching devices while GaN-based structures are already standard for the manufacture of blue and green light emitting diodes (LEDs) and blue laser diodes.

We believe that wide band gap semiconductor devices incorporating SiC materials technology will penetrate a wide range of applications in the optoelectronic, telecommunication, power distribution, transportation and defense markets during the next decade. For instance, blue and green LEDs built on SiC substrates offer the promise of higher output power than devices currently built on less expensive but less thermally conducting sapphire substrates. The realization of this promise will establish SiC- and GaN-based substrates as an important building block in high brightness computer driven signs or displays, in high brightness automotive lighting and in the replacement of incandescent and eventually fluorescent lighting by high power, high efficiency solid-state lamps. High power, high frequency SiC based microwave devices promise to rival gallium arsenide devices in telecommunication base station transmitters and silicon devices in both commercial and military air traffic radar applications. SiC high power, high-speed switching devices promise to improve the performance and reliability of utility transmission and distribution systems and for motor controls in a wide variety of applications including aircraft, automotive, industrial, communications and energy exploration applications.

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Our Strategy

Our strategy is to build businesses with world-class, high technology materials capabilities at their core. The following current business activities follow this model: Infrared optics based on Zinc Selenide (ZnSe) and Zinc Sulfide (ZnS), near infrared optics based on YAG and YLF, solid-state radiation sensors based on CdZnTe, and optoelectronic and electronic substrates based on SiC. In each case we subsequently manufacture precision parts and components from these materials using established but evolving expertise in low damage surfacing and micro fabrication, thin-film coating and exacting metrology. A substantial portion of our business is based on long-term contracts with market leaders, which enables substantial forward planning and production efficiencies. In addition, industry leading product quality and delivery performance allows us to achieve comparatively high operating margins in major segments of our business. We intend to capitalize on the execution of this proven model and continually gain market share for infrared and near-infrared optics, military infrared optics, solid-state radiation sensors and optoelectronic/electronic materials and substrates.

Our specific strategies are as follows:

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Our Products

Our products include optical, optoelectronic and electronic materials, devices and components for use in laser, sensor, military, security scanning and advanced electronic and optoelectronic applications. These products are sold to laser system manufacturers and end-users, military laser system and defense suppliers, manufacturers of nuclear radiation sensor systems and component suppliers to the optoelectronic and electronic industries.

Infrared Optics. We supply a broad line of precision infrared optical components such as lenses, waveplates, and mirrors to the CO₂ laser market. CO₂ lasers are used in a wide variety of industrial processes including cutting, welding, drilling, marking and heat treating of materials such as steel alloys, non-ferrous metals, plastics, wood, paper, fiberboard, ceramics and composites. CO₂ lasers are also used in cosmetic and invasive medical surgery. Our precision optical components are used to regulate the amount of laser energy, enhance the properties of the laser beam, and focus and direct laser beams to a target work surface. The optical components include both reflective and transmissive optics and are made from materials such as ZnSe, copper, silicon and germanium. Transmissive optics used with CO₂ lasers are predominately made from ZnSe. We believe we are the largest manufacturer in the world of ZnSe providing us with a significant cost advantage. We believe our ZnSe production capability, high precision fabrication operations and proprietary thin-film coating technology has earned us a reputation as the quality leader in this world market.

Additionally, we supply replacement optics to end users of CO₂ lasers. Over time optics may become contaminated and must be replaced to maintain peak laser operations. This aftermarket portion of our business continues to grow as laser applications proliferate worldwide and the installed base of serviceable laser systems increases each year. We service the aftermarkets via a combination of selling to OEM’s who in turn service their customers with our products, and selling directly to end system users through our direct sales and marketing employees.

Near-Infrared Optics. We offer a family of standard and custom laser gain materials and optics for industrial, medical, military, scientific and research YAG lasers. Our YAG laser gain materials are produced to stringent industry specifications and precisely fabricated into rods or slabs. Key materials and precision optical components for YAG and other solid-state laser systems are part of our near-infrared optics product offering. The increasing power levels and reduced operating costs of evolving YAG laser systems are enabling this technology to address new applications. YAG lasers are used in high power applications such as cutting, welding, marking and date coding. Additionally, YAG laser energy can be delivered through optical fibers that provide high flexibility beam delivery systems.

We manufacture waveplates, polarizers, lenses, prisms and mirrors for visible and near-infrared applications which are used to control or alter visible or near-infrared energy and its polarization. In addition, we manufacture coated windows used as debris shields in the industrial and medical laser aftermarkets.

A new product line serviced by our near-infrared optics segment is ultra-violet (UV) filters used in early warning missile detection. This product line was acquired from Coherent Inc. during fiscal 2004. The end use of the products we make is in systems used to detect shoulder-launched missiles to help improve the survivability of low-flying aircraft if attacked. Production occurs at our VLOC facilities in Florida with material growth support from our Advanced Materials Development Center in Pennsylvania.

Military Infrared Optics. We offer optics and optical subassemblies for military infrared systems including thermal imaging, night vision, targeting and navigation systems. Our product offering is comprised of missile domes,

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electro-optical windows and subassemblies, imaging lenses and other components. Our precision optical products utilize infrared optical materials such as sapphire, ZnSe, ZnS, germanium, silicon, and ALON. In addition, our products also include visible materials and fused silica as well. The vertical integration of our manufacturing processes gives us a unique capability to design, fabricate, coat and assemble complex optical products that may include electromagnetic interference and low observable requirements. Our products are currently utilized on the Abrams M-1 Tank, Apache Attack Helicopter, F-14 and F-16 military aircraft, UAV’s and other platforms, as well as future production programs such as the Joint Strike Fighter.

Compound Semiconductor Group

Solid-State Radiation Sensors. We design, manufacture and market CdZnTe room temperature, solid-state radiation sensors combined with custom-designed low noise electronics and imbedded control systems. New and expanding applications in industry, medicine, agriculture, security and research are fueling increased demand for our products. Our solid-state CdZnTe nuclear radiation sensors are attractive because of their reduced size, improved ruggedness, and lower voltage requirements as compared to traditional detectors based on scintillator/photomultiplier or cooled germanium technologies.

CdZnTe-based imaging arrays can be used in both nuclear medicine (internally emitted gamma-rays) and radiography (x-rays from an external source). In security applications, the unique properties of CdZnTe can provide additional information during a normal baggage scan that allow the system to not only show the image of a suspicious object, but more importantly, tell the operator the material or chemical composition of the item. In nuclear medicine, CdZnTe makes feasible a new generation of gamma cameras, offering much improved position sensitivity and the ability to produce images using lower doses of injected radioactivity. In radiography, higher density CdZnTe can provide much improved sensitivity to the higher x-ray energies used in some of the newer diagnostic techniques. Direct-read digital radiography cameras are being developed which, if successful, will allow the physician to view the relevant part of the body in real time, reducing the time required for diagnosis.

Silicon Carbide Substrates. We recently expanded our 6H-SiC poly-type product offerings to include two-and three-inch diameters, both semi-insulating and conducting. First commercial sales of four-inch substrates were made in June 2004.

Research, Development and Engineering

Our research and development effort calls for the pursuit of a program of internally and externally funded research and development totaling between 5 and 10 percent of product sales. From time to time the ratio of contract to internally funded activity varies significantly due to the unevenness and uncertainty associated with government research programs. We are committed to accepting only funded research that ties closely to our long-term strategic objectives.

We devote significant resources to research, development and engineering programs directed at the continuous improvement of existing products and processes and to the timely development of new technologies, materials and products. We believe that our research, development and engineering activities are essential to our ability to establish and maintain a leadership position in each of the markets that we serve. As of June 30, 2004, we employed 151 people in research, development and engineering functions, 113 of which are engineers or scientists. In addition, manufacturing personnel support or participate in research and development on an ongoing basis. Interaction between the development and manufacturing functions enhances the direction of projects, reduces costs and accelerates technology transfers.

During the past fiscal year, we have made focused research and development investments in:

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The development of our products and processes is largely based on proprietary technical know-how and expertise. We rely on a combination of contract provisions, trade secret laws and patents to protect our proprietary rights. When faced with potential infringement, we have in the past vigorously protected our rights.

Internal and external research, development and engineering expenditures were $12.1 million, $13.1 million and $11.3 million for the fiscal years ended June 30, 2004, 2003 and 2002, respectively. For these same periods, the external customer and government funded portions of these expenditures (i.e. contract research and development revenue) were $8.7 million, $11.0 million and $7.6 million, respectively.

Marketing and Sales

We market our products through a direct sales force in North America, Japan, Singapore, China, Germany, Belgium, Switzerland and the UK, and through representatives and distributors elsewhere in the world. Our market strategy is focused on understanding customer requirements and building market awareness and acceptance of our products. New products are constantly being produced and sold to our established customers in the laser component market places.

Each of our product lines is responsible for their own worldwide marketing and sales functions, as follows:

Our sales force develops effective communications with our OEM and end-user customers worldwide. Divisions actively market their products through targeted mailings, telemarketing, select advertising and attendance at trade shows. Our sales force includes a highly trained team of application engineers to assist customers in designing, testing and qualifying our parts as key components of our customers’ systems. As of June 30, 2004, we employed 86 individuals in sales, marketing and support.

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Manufacturing Technology and Processes

A majority of the products we produce depend on our ability to manufacture difficult materials. The table below shows these key materials and the processes used to produce them.

The ability to produce these difficult materials and to control the quality and yields is an expertise of the Company. Processing of these materials into finished products is difficult to accomplish; yet the quality and reproducibility of these products are critical to the performance of our customer’s instruments and systems. In the markets we serve there are a limited number of suppliers of many of the components we manufacture.

Our network of worldwide manufacturing sites allows products to be produced in regions that provide cost-effective advantages. We employ numerous advanced manufacturing technologies and systems in all product-manufacturing facilities. These include automated, Computer Numeric Control optical fabrication, high throughput thin-film coaters, micro precision metrology and custom-engineered automated furnace controls for the crystal growth processes. Producing products for use across the electromagnetic spectrum requires the capabilities to repeatedly produce products with high yields to tolerances in the nanometer range. We embody a technology and quality mindset that gives our customers the confidence to utilize our products in a just in time basis straight into the heart of their production lines.

Sources of Supply

The major raw materials we use are Zinc, Selenium, Hydrogen Selenide, Hydrogen Sulfide, Cadmium, Tellurium, Yttrium Oxide, Aluminum Oxide and Iridium. We produce the majority of our Zinc Selenide, Hydrogen Selenide and Zinc Sulfide requirements. We also purchase Gallium Arsenide, Copper, Silicon, Germanium, Molybdenum, Quartz, optical glass and small quantities of other materials from outside vendors for use as base materials for laser optics. We purchase Thorium Fluoride and other materials for use in optical fabrication and coating processes. Excluding our own production, there are more than two external suppliers for all of the above materials except for Zinc Selenide, Zinc Sulfide, Hydrogen Selenide and Thorium Fluoride, for each of which there is one proven source of supply outside of the Company’s capabilities. For most materials, we have entered into annual purchase arrangements whereby suppliers provide discounts for annual volume purchases in excess of specified amounts.

The continued high quality of these materials is critical to the stability of our manufacturing yields. We conduct testing of materials at the onset of the production process. Additional research may be needed to better define future starting material specifications. We have not experienced significant production delays due to shortages of materials. However, we do occasionally experience problems associated with vendor supplied materials not meeting contract specifications for quality or purity. A significant failure of our suppliers to deliver sufficient quantities of necessary high-quality materials on a timely basis could have a materially adverse effect on the results of our operations.

During the fiscal year ended June 30, 2002, the Company acquired a minority ownership interest in a supplier of high-purity Cadmium, Zinc and Tellurium to provide material to our eV PRODUCTS division.

Customers

Our infrared optics customer base for our laser component products consists of over 5,000 customers worldwide.

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The three main groups of customers for these products are as follows:

For our near infrared optics products, our customers are original equipment manufacturers and system integrators of high power lasers used in industrial, scientific, military and medical markets.

For our military infrared optics products, our customers are manufacturers of equipment and devices for aerospace, defense and commercial markets. Our customers include U.S. government prime contractors and various U.S. government agencies.

For our solid-state radiation sensor products, our customers are manufacturers of equipment and devices for industrial process control, security monitoring, nuclear medicine, x-ray imaging, environmental monitoring, nuclear safeguards and nonproliferation, and health physics. We are currently dependent on a limited number of key customers for this product line.

For our silicon carbide products, our customers are manufacturers and developers of equipment and devices for high power RF electronics for Department of Defense applications, opto-electronic applications for green, blue and white LED’s and high power and high voltage switching applications.

Competition

We believe that we are a significant producer of products and services in our addressed markets. In the area of commercial infrared laser optics and materials, we believe we are an industry leader. We are a significant supplier of YAG rods and YAG laser optics to the worldwide markets of scientific, research, military, medical and industrial laser manufacturers. We are a leading supplier of infrared optics used in complex military assemblies for targeting, navigation and thermal imaging systems to every major military prime contractor. We are a leading supplier of CdZnTe substrates and devices for x-ray and gamma-ray sensors and components. We believe we are an alternative to the leading supplier of single crystal SiC substrates for use in the solid-state lighting, wireless infrastructure, RF electronics and power switching industries.

We compete on the basis of product technical specifications, quality, delivery time, technical support and pricing. Management believes that we compete favorably with respect to these factors and that our vertical integration, manufacturing facilities and equipment, experienced technical and manufacturing employees, and worldwide marketing and distribution provide competitive advantages.

We have a number of present and potential competitors which have greater financial, selling, marketing or technical resources. A competitor of our production of ZnSe is a division of Rohm and Haas Company. Competitors producing infrared and CO₂ laser optics include Sumitomo in Japan and Ophir Optronics in Israel as well as several companies producing limited quantities of infrared and CO₂ laser optics. Competing producers of YAG materials and optics include a division of Northrop Grumman Corporation and a division of Saint-Gobain. Competing producers of infrared optics for military applications are in-house fabrication and thin film coating capabilities of major military prime contractors, such as Raytheon Corporation. Competing producers of CdZnTe and CdZnTe sensors include Acrorad in Japan and Imarad in Israel.

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In addition to competitors who manufacture products similar to those we produce, there are other technologies or materials that can compete with our products.

Bookings and Backlog

We define our bookings as customer orders received that are expected to be converted to revenues over the next twelve months. For long-term customer orders, the Company takes the view of not including in bookings the portion of the customer order that is beyond twelve months due to the inherent uncertainty of an order that far in the future. For the year ended June 30, 2004, our bookings were $162.8 million compared to bookings of $136.3 million for the year ended June 30, 2003. This 19% increase in bookings was primarily attributable to stronger market demands across all our business segments led by the Infrared Optics segment.

We define our backlog as bookings that have not been converted to revenues by the end of the reporting period. Bookings are adjusted if changes in customer demands or production schedules move a delivery out past twelve months. As of June 30, 2004, our backlog was $69.0 million compared to $57.5 million at June 30, 2003. The 20% increase in backlog is primarily reflective of strong bookings across all our business segments.

Employees

As of June 30, 2004, we employed 1,242 persons worldwide. Of these employees, 151 were engaged in research, development and engineering, 819 in direct production and the balance in sales and marketing, administration, finance and support services. Our production staff includes highly skilled optical craftsmen. In July 2004 approximately 4% of our direct production employees voted to be covered under a collective bargaining agreement. The employees work in our Pennsylvania facility for one department in our infrared optics business. We have a long-standing policy of encouraging active employee participation in areas of operations management. We believe our relations with our employees to be good. We reward our employees with incentive compensation based on achievement of performance goals.

Trade Secrets, Patents and Trademarks

We rely on our trade secrets and proprietary know-how to develop and maintain our competitive position. We have begun to pursue process patents in certain areas of our businesses. We have confidentiality and noncompetition agreements with our executive officers and certain other personnel. We require all United States employees sign a confidentiality and noncompetition agreement upon commencement of employment.

The processes and specialized equipment utilized in crystal growth, infrared materials fabrication and infrared optical coatings as developed by us are complex and difficult to duplicate. However, there can be no assurance that others will not develop or patent similar technology or that all aspects of our proprietary technology will be protected. Others have obtained patents covering a variety of infrared optical configurations and processes, and others could obtain patents covering technology similar to our technology. We may be required to obtain licenses under such patents, and there can be no assurance that we would be able to obtain such licenses, if required, on commercially reasonable terms, or that claims regarding rights to technology will not be asserted which may adversely affect our results of operations. In addition, our research and development contracts with agencies of the U.S. Government present a risk that project-specific technology could be disclosed to competitors as contract reporting requirements are fulfilled.

We currently hold six registered trademarks: the II-VI INCORPORATED^(™) name; INFRAREADY OPTICS^(™) for replacement optics for industrial CO₂ lasers; EPIREADY^(™) for low surface damage substrates for Mercury Cadmium Telluride epitaxy; eV PRODUCTS^(™) for products manufactured by our eV PRODUCTS division; LASER POWER CORPORATION^(™) name; and MP-5^(™) for low absorption coating technology. The trademarks are registered with the U.S. Patent and Trademark Office but not with any states. We are not aware of any interference or opposition to these trademarks in any jurisdiction.

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Information regarding our principal properties at June 30, 2004 is set forth below:

During the quarter ended September 30, 2003, the Company was awarded a jury verdict in the amount of $0.8 million in a trade secret lawsuit which it had initiated. In addition, the Company was initially entitled to punitive damages and reimbursement of its attorneys’ fees and costs at the discretion of the court. On April 27, 2004, the court denied the award relating to punitive damages and reimbursement of its attorneys’ fees and costs. This award is subject to post-trial motions and appeals. As such, the Company has not made any adjustments to its financial position or results of operations for this contingent gain. Expenses relating to this legal proceeding have been reflected in the Company’s results of operations as incurred through June 30, 2004.

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Form 10-K.

EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of the Company and their respective ages and positions are as follows:

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Carl J. Johnson, a co-founder of the Company in 1971, serves as Chairman, Chief Executive Officer, and Director of the Company. He served as President of the Company from 1971 until 1985 and has been a Director since 1971 and Chairman since 1985. From 1966 to 1971, Dr. Johnson was Director of Research & Development for Essex International, Inc., an automotive electrical and power distribution products manufacturer. From 1964 to 1966, Dr. Johnson worked at Bell Telephone Laboratories as a member of the technical staff. Dr. Johnson completed his Ph.D. in Electrical Engineering at the University of Illinois. He holds B.S. and M.S. degrees in Electrical Engineering from Purdue University and Massachusetts Institute of Technology (MIT), respectively.

Francis J. Kramer has been employed by the Company since 1983 and has been its President and Chief Operating Officer since 1985. Mr. Kramer has served as a Director of the Company since 1989. Mr. Kramer joined the Company as Vice President and General Manager of Manufacturing and was named Executive Vice President and General Manager of Manufacturing in 1984. Prior to his employment by the Company, Mr. Kramer was the Director of Operations for the Utility Communications Systems Group of Rockwell International Corp. Mr. Kramer graduated from the University of Pittsburgh with a B.S. degree in Industrial Engineering and from Purdue University with an M.S. degree in Industrial Administration.

Herman E. Reedy has been employed by the Company since 1977 and has been Executive Vice President – Infrared Optics since February 2003. Previously, Mr. Reedy held positions at the Company as Vice President and General Manager of Quality and Engineering, Manager of Quality and Manager of Components. Prior to his employment by the Company, Mr. Reedy was employed by Essex International, Inc., serving last as Manager, MOS Wafer Process Engineering. Prior to 1973, he was employed by Carnegie Mellon University and previously held positions with SemiElements, Inc. and Westinghouse Electric Corporation. Mr. Reedy is a graduate of the University of Pittsburgh with a B.S. degree in Electrical Engineering.

James Martinelli has been employed by the Company since 1986 and has been Vice President – Government and Military Businesses since February 2003. Previously, Mr. Martinelli served as General Manager of Laser Power Corporation since 2000 and Chief Financial Officer of II-VI Incorporated since 1994. Mr. Martinelli joined the Company as Accounting Manager, was named Corporate Controller in 1990 and named Chief Financial Officer and Treasurer in 1994. Prior to his employment by the Company, Mr. Martinelli was Accounting Manager at Tippins Incorporated and Pennsylvania Engineering Corporation from 1980 to 1985. Mr. Martinelli graduated from Indiana University of Pennsylvania with a B.S. degree in Accounting.

Craig A. Creaturo has been employed by the Company since 1998 and has been Chief Accounting Officer since February 2003. Mr. Creaturo has served as Treasurer since 2000. Previously, Mr. Creaturo served as Director of Finance, Accounting and Information Systems since 2000 and initially joined the Company as Corporate Controller. Prior to his employment by the Company, Mr. Creaturo was employed by the Pittsburgh, Pennsylvania office of Arthur Andersen LLP from 1992 to 1998 and served in the audit and attestation division with a final position as Audit Manager. Mr. Creaturo graduated from Grove City College with a B.S. degree in Accounting. Mr. Creaturo is a Certified Public Accountant in the Commonwealth of Pennsylvania and is a member of the American Institute of Certified Public Accountants and the Pennsylvania Institute of Certified Public Accountants.

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PART II

The Company’s Common Stock is traded on the Nasdaq National Market under the symbol “IIVI.” The following table sets forth the range of high and low closing sale prices per share of the Company’s Common Stock for the fiscal periods indicated, as reported by Nasdaq.

On August 31, 2004, the last reported sale price for the Common Stock was $38.06 per share. As of such date, there were approximately 835 holders of record of the Common Stock. The Company historically has not paid cash dividends and does not anticipate paying cash dividends in the foreseeable future.

FIVE-YEAR FINANCIAL SUMMARY

Share and per share data for 2000 were adjusted to reflect the two-for-one stock split in fiscal 2001.

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FORWARD-LOOKING STATEMENTS

Certain statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are forward-looking statements. Forward-looking statements are also identified by words such as “expects,” “anticipates,” “believes,” “intends,” “plans, “projects,” or similar expressions. Actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including risk factors described in the Risk Factors set forth in this Item 7.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America and the Company’s discussion and analysis of its financial condition and results of operations requires the Company’s management to make judgments, assumptions, and estimates that affect the amounts reported in its consolidated financial statements and accompanying notes. Note A of the Notes to Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates.

Management believes the Company’s critical accounting policies are those related to revenue recognition, allowance for doubtful accounts, warranty reserves, inventory valuation, valuation of long-lived assets including acquired intangibles and goodwill, accrual of bonus and profit sharing estimates, accrual of income tax liability estimates and accounting for stock-based compensation. Management believes these policies to be critical because they are both important to the portrayal of the Company’s financial condition and results of operations, and they require management to make judgments and estimates about matters that are inherently uncertain.

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is established or determinable and collectibility is probable.

Revenue for all business segments, other than for contract research and development, is recognized from the sale of products at the point of passage of title, which is at the time of shipment.

The Company performs research and development under contract agreements with customers based on cost plus fixed fee, cost reimbursable or fixed fee terms. These contracts generally require the Company to produce and provide developmental materials and/or products to those customers. Revenues from cost plus fixed fee and cost reimbursable contracts are recognized as costs are incurred.

We follow the guidelines of Statement of Position 81-1 “Accounting for Performance of Construction–Type and Certain Production-Type Contracts” for our fixed fee contracts. Revenue and profits on each fixed fee contract are accounted for using the percentage-of-completion method of accounting, whereby revenue and profits are recognized throughout the performance period of the contract. Percentage-of-completion is determined by relating the actual cost of work performed to date to the estimated total cost for each contract. The estimated total cost for each contract is periodically reevaluated and revised, when necessary, throughout the life of the contract. Losses on contracts are recorded in full when identified.

We establish an allowance for doubtful accounts and a warranty reserve based on historical experience and believe the collection of revenues, net of these reserves, is reasonably assured. The allowance for doubtful accounts is an estimate for potential non-collection of accounts receivable based on historical experience. The Company has not experienced a non-collection of accounts receivable materially affecting its financial position or results of operations as of and for the fiscal years ended June 30, 2004, 2003 and 2002. If the financial condition of the Company’s customers were to deteriorate causing an impairment of their ability to make payments, additional provisions for bad debts may be required in future periods.

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The Company records a warranty reserve as a charge against earnings based on a percentage of revenues utilizing actual returns over the last twelve months. If actual returns are not consistent with the historical data used to calculate these estimates, additional warranty reserves could be required.

The Company records a slow moving inventory reserve as a charge against earnings for all products on hand that have not been sold to customers in the past twelve months or cannot be further manufactured for sale to alternative customers. An additional reserve is recorded for product on hand that is in excess of product sold to customers over the past twelve months. If actual market conditions are less favorable than projected, additional inventory reserves may be required.

The Company tests goodwill on at least an annual basis for impairment. Other intangible assets are amortized over their estimated useful lives. The determination of related estimated useful lives of other intangible assets and whether goodwill is impaired involves judgments based upon long-term projections of future performance. A discounted cash flow model is used to determine the fair value of the reporting units for purposes of testing goodwill for impairment. Based on the results of the most recently completed analysis, the Company’s goodwill was not impaired as of June 30, 2004. No event has occurred as of or for the period ended June 30, 2004 that would give management an indication that an impairment charge was necessary that would adversely affect the Company’s financial position or results of operations.

The Company records bonus and profit sharing estimates as a charge against earnings based on a formula percentage of the Company’s operating income. These estimates are adjusted to actual based on final results of operations achieved during the fiscal year. Partial bonus amounts are paid quarterly based on interim Company performance, and the remainder is paid after fiscal year end and final determination of the applicable percentage. Other bonuses and profit sharing are paid annually.

The Company records an estimated income tax liability to recognize the amount of income taxes payable or refundable for the current year and deferred income tax liabilities and assets for the future tax consequences of events that have been recognized in the Company’s financial statements or income tax returns. Judgment is required in estimating the future income tax consequences of events that have been recognized in the Company’s financial statements or the income tax returns.

The Company uses the intrinsic value approach specified in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” for stock options granted to officers and key employees, and therefore does not record compensation costs based upon the fair value of options at the date of grant. See Notes A and K to the Company’s consolidated financial statements.

From time to time, estimated accruals are recorded as a charge against earnings based on known circumstances where it is probable that a liability has been incurred or is expected to be incurred and the amount can reasonably be estimated.

INTRODUCTION

We generate revenues, earnings and cash flows from developing, manufacturing and marketing high technology materials and derivative products for precision use in industrial, medical, military, security and aerospace applications. We also generate revenue, earnings and cash flows from external customer and government funded research and development contracts relating to the development and manufacture of new technologies, materials and products.

Our customer base includes original equipment manufactures, laser end users, system integrators of high-power lasers, manufacturers of equipment and devices for industrial, security and monitoring, x-ray imaging, U.S. government prime contractors and various U.S. government agencies. Approximately 41% of our revenues during the fiscal year ended June 30, 2004 were from product sales to customers outside the United States.

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Fiscal 2004 Compared to Fiscal 2003

Overview (millions except per share data)

RESULTS OF OPERATIONS

NET EARNINGS Net earnings increased 49% in fiscal 2004 to $17.3 million ($1.18 per share-diluted) from $11.6 million ($0.81 per share-diluted) in fiscal 2003. Net earnings increase was primarily attributed to the overall strong demand for all of the Company’s products as evidenced by an 18% increase in revenues from the prior year. Earnings increases also resulted from operating improvements in all segments from the prior year due to production efficiencies, yield improvements and cost control programs. Approximately one-half of the earnings improvement was attributable to stronger revenues and gross margins from the Infrared Optics segment and approximately one-third of the earnings improvement was attributable to operational performance improvements of our eV PRODUCTS division.

BOOKINGS Bookings increased 19% to $162.8 million in fiscal 2004 compared to $136.3 million in fiscal 2003. Order backlog increased 20% to $69.0 million at June 30, 2004 from $57.5 million at June 30, 2003 as a result of bookings outpacing shipments in fiscal 2004. Manufacturing orders comprised approximately 94% of the backlog at June 30, 2004. Manufacturing bookings increased by approximately $25.7 million while contract research and development bookings increased by approximately $0.7 million. The 19% growth in bookings attests to the strong worldwide demand for all of the Company’s products. All operating segments experienced double-digit percentage increases in bookings during fiscal 2004. Bookings are defined as customer orders received that are expected to be converted to revenues over the next twelve months. For long-term customer orders, the Company does not include in bookings the portion of the customer order that is beyond twelve months due to the inherent uncertainty of an order that far in the future.

REVENUES Revenues increased 18% to $150.8 million in fiscal 2004 compared to $128.2 million in fiscal 2003. The revenue growth reflects the general strength of our product offering and, more specifically, strong demand in our infrared optics business. The increase in revenues for fiscal 2004 compared to fiscal 2003 was primarily due to stronger shipments of commercial infrared optics to both Original Equipment Manufacturers (OEM) and aftermarket customers and to a lesser extent the integration of the Company’s sales and marketing distribution activity in Switzerland through a new consolidated subsidiary, II-VI L.O.T. Suisse S.a.r.l. See Note B of the Company’s consolidated financial statements.

OUTLOOK The Company anticipates continued strengthening of its addressable markets in fiscal 2005, and is currently projecting for fiscal 2005 revenues to range from $167 million to $172 million and diluted earnings per share to range from $1.35 to $1.43.

Bookings, revenues and segment earnings (loss) for the Company’s reportable segments are discussed below. Segment earnings is a non-GAAP financial measure and differs from income from operations in that segment earnings excludes certain operational expenses included in other expense – net at reported. Management believes segment earnings to be a useful measure as it reflects the results of segment performance over which management has direct control. See also Note L to the Company’s consolidated financial statements.

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Infrared Optics (millions)

Bookings for fiscal 2004 for Infrared Optics increased 14% to $90.4 million from $79.2 million in fiscal 2003. Strong buying patterns by CO₂ laser original equipment manufacturers worldwide as well as an increase in industrial material processing requiring lasers operating more hours per week, thus replacement demands has allowed us to increase our infrared optics bookings. During fiscal 2004, bookings from United States OEM and aftermarket customers increased 32% and 16% respectively from fiscal 2003. Additionally, bookings in U.S. dollars from our II-VI Japan subsidiary increased 36% evidencing the strengthening of the Far Eastern markets.

Revenues for fiscal 2004 for Infrared Optics increased 19% to $87.6 million from $73.7 million in fiscal 2003. This increase was primarily attributable to increased shipments to both OEM and aftermarket customers worldwide. OEM laser builders continue to introduce higher-powered lasers. A significant portion of laser optics shipments during the year were from CO₂ lasers with output power greater than 5 kilowatts. These innovative laser designs incorporate higher priced complex optical configurations and optical parts.

Segment earnings for fiscal 2004 increased 18% to $23.5 million compared to $20.0 million in fiscal 2003. The improvement in segment earnings was due to a combination of increased sales volume particularly in our II-VI Japan subsidiary, where the strong Yen has helped gross margins, increased manufacturing at the Company’s Asian facilities in Singapore and China, and yield improvement and cost control programs occurring at our various facilities.

Near-Infrared Optics (millions)

Bookings for fiscal 2004 for Near-Infrared Optics increased 22% to $30.2 million from $24.8 million in fiscal 2003. The increase in bookings was primarily due to approximately $4.0 million of bookings for a new product line, ultra-violet (UV) filters used in early warning missile detection. The remaining increase was driven by broad based demand for near-infrared optics in medical, military and instrumentation market segments.

Revenues for fiscal 2004 for Near-Infrared Optics increased 13% to $25.8 million compared to $22.8 million in fiscal 2003. The increase in revenues was primarily due to increased shipments of Near-Infrared Optics products such as waveplates,

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standard optics and crystal products used in medical, military, instrumentation and industrial markets. During fiscal 2004, the Company recognized approximately $0.9 million on sales of the new ultra-violet (UV) filters product line.

Segment earnings for fiscal 2004 increased 41% to $2.4 million from $1.7 million in fiscal 2003. This improvement reflected overall stronger gross margin dollars resulting from the increased sales volume as well as the improved product yields. Cost reductions, resulting from yield improvements in crystal growth and fabrication and the higher revenue levels were sufficient to increase segment earnings for fiscal 2004.

Military Infrared Optics (millions)

Bookings for fiscal 2004 for Military Infrared Optics increased 26% to $29.2 million from $23.1 million in fiscal 2003. The increase in bookings was primarily due to increases in the core military and sapphire window product lines. Core military bookings increased 28% from a year ago due to the need to repair and replace hardware expended or damaged in the war against terror. The sapphire product bookings increased to approximately $5.4 million from $1.4 million in the prior fiscal year as the Company continues to meet customer product demands.

Revenues for fiscal 2004 for Military Infrared Optics increased 10% to $25.3 million compared to $23.0 million in fiscal 2003. The increase in revenues was due to increases in our core military products of approximately 15% due to the need to repair and replace hardware expended or damaged during the Iraq war. The Company also increased its sapphire product revenues by approximately 75% to $4.6 million during fiscal 2004. During fiscal year ended June 30, 2004 revenues of the Military Infrared Optics Large Optics Coating Facility decreased 69% as compared to the prior fiscal year as the Company announced the shutdown of this facility in the second quarter of this fiscal year.

Segment earnings for fiscal 2004 increased to $0.9 million from a loss of $0.1 million in fiscal 2003. The improvement in segment earnings was primarily due to the recognition of $0.3 million of contract expenses as compared to approximately $1.2 million of contract expenses recognized in the prior fiscal year from activities performed on a specific fixed price percentage of completion contract. During the current fiscal year, the Company received a “stop-work order” relating to this contract as the U.S. Government cancelled the entire program relating to the Comanche Helicopter Defense initiatives. The Company expects final contract cancellation efforts on this program to be completed sometime during fiscal year 2005. Additionally, improvements in gross margin from increased sales volume also contributed to the increased segment earnings as compared to the prior year.

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Compound Semiconductor Group (millions)

Combined bookings for fiscal 2004 from these operations increased 41% to $13.0 million as compared to $9.2 million in fiscal 2003. The eV PRODUCTS division recorded bookings in excess of $8.0 million during fiscal year 2004 a 38% increase over the prior fiscal year. This booking growth was driven by stronger demand from the medical and security segments as well as emerging industrial applications. The WBG group’s bookings increased 34% to $4.4 million due to a $1.9 million contract bookings to further the group’s effort in silicon carbide.

Revenues for fiscal 2004 from these operations increased 39% to $12.1 million compared to $8.7 million in 2003. The higher revenues were a direct result of higher shipments of hand-held spectrometers for Homeland Security applications, increased shipment of medical imaging detectors, higher levels of research and development revenues by the Company’s eV PRODUCTS division and increased commercial shipments of silicon carbide (SiC) substrates from the WBG group.

The segment loss for fiscal 2004 of $2.0 million decreased 55% from the segment loss of $4.4 million in fiscal 2003. The decrease in the loss was primarily attributable to increased shipment volume improving incremental gross margins, maintaining controlled cost ramp-up and improved operational efficiencies.

Costs and Expenses

Manufacturing gross margin, which is defined as net sales less cost of goods sold, for fiscal 2004 was $62.6 million or 44% of revenues compared to $47.8 million or 41% of revenues in fiscal 2003. The increased gross margin was caused primarily by the increase in the amount of manufacturing performed at the Company’s Singapore and China facilities, the increase in sales at our II-VI Japan subsidiary, due to the strengthening of the Yen, and the added incremental gross margin from our majority-owned subsidiary II-VI LOT Suisse S.a.r.l. acquired during 2004.

Contract research and development gross margin, which is calculated as contract research and development revenues less expenses, for fiscal 2004 was $1.6 million (18% of research and development revenues), compared to a gross margin of $0.6 million (5% of research and development revenues), for fiscal 2003. The contract research and development revenues and costs are a result of development efforts in the Near-Infrared Optics and the Military Infrared Optics segments as well as activities in the eV PRODUCTS division and the WBG group for the fiscal year ended June 30, 2004. The improvement in the contract research and development gross margin was due to the recognition of approximately $1.2 million of additional expenses in the prior fiscal year from activities performed on a specific fixed price percentage of completion contract in the Military Optics segment. During the fiscal ended June 30, 2004, the Company received a “stop-work order” relating to this contract as the entire Comanche Helicopter Defense Initiatives was cancelled by the U.S. Government. The decrease in contract revenues are primarily due to lower contract activity in the Near-Infrared Optics segment and the WBG Group during the current fiscal year. Contract research and development gross margin is a result of a blend of cost plus fixed fee, cost reimbursement and fixed fee contract activities.

Company-funded internal research and development expenses for fiscal 2004 were $5.0 million or 3% of revenues compared to $2.7 million or 2% of revenues, for fiscal 2003. The higher expense is a direct result of less external contract support of the Company’s WBG group’s efforts in SiC crystal growth technology and processing development. Company-funded internal research and development expenses also include corporate research and development activities in addition to the research and development activities of the eV PRODUCTS division.

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Selling, general and administrative expenses for fiscal 2004 were $34.4 million or 23% of revenues compared to $28.5 million or 22% of revenues for fiscal 2003. The dollar and percentage increases reflect higher salary expenses for the Company’s worldwide profit driven bonus program. The increase in selling, general and administration expense from fiscal 2003 was also attributed to costs associated with the acquisition of a majority interest in II-VI LOT Suisse S.a.r.l. during the second quarter of fiscal year 2004 (see Note B to the Company’s consolidated financial statements). While this acquisition increased the Company’s direct selling expense by approximately 1% of sales as compared to the prior year, this expense increase has been offset by the additional gross margin on sales to end customers in Switzerland.

Interest expense for fiscal 2004 was $0.4 million compared to $0.8 million for fiscal 2003. The decrease in interest expense reflects lower LIBOR based interest rates, as well as a reduction in debt levels throughout the year. At June 30, 2004, total debt was 34% lower as compared to June 30, 2003.

Other expense for fiscal 2004 almost completely offset our other income items. Other expense in 2004 was primarily due to the minority interest in II-VI LOT GmbH and II-VI LOT Suisse S.a.r.l., foreign currency losses as a result of the U.S. dollar’s performance relative to other currencies and losses recognized on disposal property, plant and equipment offset by interest and other income. Other expense in fiscal 2003 was primarily due to the minority interest in II-VI LO.T, the $0.1 million write-off of an investment and foreign currency losses as a result of the U.S. dollar’s performance relative to other currencies offset by royalty income and interest income.

The Company’s effective income tax rate for fiscal 2004 was 29% compared to an effective income tax rate of 28% for fiscal 2003. The Company’s effective income tax rate reflects the Company’s continued benefit from lower tax rates on its Singapore and China operations and a favorable mix of U.S. and foreign income.

Fiscal 2003 Compared to Fiscal 2002

Overview (millions except per share data)

NET EARNINGS Net earnings increased 60% in fiscal 2003 to $11.6 million ($0.81 per share-diluted) from $7.3 million ($0.51 per share-diluted) in fiscal 2002. The major contributor to the net earnings increase was the strong worldwide demand for commercial infrared optics and component products in the industrial sector. Earnings increases also resulted from a variety of factors, including improved production efficiencies, savings achieved through the consolidation of infrared optics operations, increased external research and development funding and reduced interest expense.

BOOKINGS Bookings increased 16% to $136.3 million in fiscal 2003 compared to $117.0 million in fiscal 2002. Order backlog increased 20% to $57.5 million at June 30, 2003 from $48.0 million at June 30, 2002 as a result of bookings outpacing shipments in fiscal 2003. Manufacturing orders comprised approximately 93% of the backlog at June 30, 2003. Manufacturing bookings increased by approximately $18.5 million while contract research and development bookings increased by approximately $0.8 million. The bookings growth was primarily attributable to stronger market demand in the infrared optics market and higher external research and development funding for single crystal SiC development efforts.

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REVENUES Revenues increased 13% to $128.2 million in fiscal 2003 compared to $113.7 million in fiscal 2002. The revenue growth reflected the general strength of our product offering and, more specifically, strong demand in our infrared optics business. The increase in revenues for fiscal 2003 compared to fiscal 2002 was primarily due to stronger shipments of commercial infrared optics to both OEM and aftermarket customers and the integration of the Company’s sales and marketing distribution activity in Germany through II-VI/LOT GmbH (See Note B of the Company’s consolidated financial statements).

Bookings, revenues and segment earnings or (loss) for the Company’s reportable segments are discussed below. See also Note L to the Company’s consolidated financial statements.

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Infrared Optics (millions)

Bookings for fiscal 2003 for Infrared Optics increased 42% to $79.2 million from $55.7 million in fiscal 2002. The improvement was due to overall increases in order volume from OEM and aftermarket customers worldwide. The bookings growth was also attributable to the receipt of single- and multi-year orders from domestic and international OEM customers that had been delayed from fiscal 2002. During fiscal 2003, the OEM manufacturers of both high-power, multi-kilowatt lasers for cutting, welding, drilling and heat treating applications and lower-power lasers for engraving and marking requested products at a rate more consistent with fiscal 2001 business levels explaining the increase in order bookings.

Revenues for fiscal 2003 for Infrared Optics increased 19% to $73.7 million from $61.9 million in fiscal 2002. This increase was primarily attributable to increased shipments to several of the Company’s domestic and international OEM customers, as well as, increased shipments to aftermarket customers. Stronger order intake has translated into stronger revenues for fiscal 2003 as compared to fiscal 2002.

Segment earnings for fiscal 2003 increased 59% to $20.0 million compared to $12.6 million for fiscal 2002. The improvement in segment earnings was due to a combination of increased sales volume, a full year impact of operational consolidation of the commercial infrared optics operations from Laser Power Corporation and the acquisition of a majority interest in a distributor in Germany.

Near-Infrared Optics (millions)

Bookings for fiscal 2003 for Near-Infrared Optics increased 6% to $24.8 million from $23.4 million in fiscal 2002. The increase in bookings was primarily due to stronger demand in commercial bookings in the optics and crystal product lines used in defense and medical applications.

Revenues for fiscal 2003 for Near-Infrared Optics were $22.8 million compared to $22.7 million in fiscal 2002. Commercial revenues increased primarily in the optics and crystal product lines, offset by a decrease in contract revenues from the winding down of the multi-year YAG contract.

Segment earnings for fiscal 2003 increased 31% to $1.7 million from $1.3 million in fiscal 2002. This improvement reflected overall stronger gross margins and improved product yields. Cost reductions particularly in the materials area as

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a result of yield improvements were sufficient to increase gross margins despite the essentially flat revenues for fiscal 2003 compared to fiscal 2002.

Military Infrared Optics (millions)

Bookings for fiscal 2003 for Military Infrared Optics decreased 21% to $23.1 million from $29.3 million in fiscal 2002. The reduction in bookings is primarily due to the delay of the production portion of a customer order for sapphire based products and the receipt of a six month order for Javelin missile domes in fiscal 2003 as compared to a twelve month order received in fiscal 2002.

Revenues for fiscal 2003 for Military Infrared Optics increased 5% to $23.0 million compared to $22.0 million in fiscal 2002. Revenues from a contract for the Air Borne Laser and increased shipments of sapphire based products were the major contributors.

Military Infrared Optics experienced a $0.1 million operating loss in fiscal year 2003 compared to segment earnings of $1.6 million in fiscal 2002. During fiscal 2003 changes in contract estimated costs to complete relating primarily to a development contract resulted in $1.2 million of additional expenses. Additionally, the consolidation of the commercial operations in the fourth quarter of fiscal year 2002 from Laser Power Corporation to other II-VI facilities decreased gross margins in the remaining Military Infrared Optics business segment due to the absorption of costs previously allocated to the Infrared Optics segment.

Compound Semiconductor Group (millions)

Combined bookings for fiscal 2003 for eV PRODUCTS division and WBG group increased 7% to $9.2 million as compared to $8.6 million in fiscal 2002. The increase was due to the receipt of more externally funded contract support for WBG’s efforts in Silicon Carbide development and the initial customer orders for SiC substrates. This increase in bookings for WBG group was partially offset by a decrease in bookings for eV PRODUCTS division due to slow development and deployment of new products by existing and target customers for medical and industrial applications.

Revenues for fiscal 2003 from these operations increased 23% to $8.7 million compared to $7.1 million in fiscal 2002. The higher revenues are a direct result of the higher contract billings, particularly contract research and development of the WBG group.

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The segment loss for fiscal 2003 of $4.4 million increased 7% from the segment loss of $4.1 million in fiscal 2002. The increase in the segment loss was primarily attributable to weakness in demand for products from eV PRODUCTS division. This loss was partially offset by more external contract support of the Company’s efforts in SiC, which offsets the funding needed to be provided by the Company for this activity.

Costs and Expenses

Manufacturing gross margin, for fiscal 2003 was $47.8 million or 41% of revenues compared to $36.3 million or 34% of revenues in fiscal 2002. The increased sales volume for fiscal year 2003 was caused primarily by the operational consolidation late in fiscal 2002 of the infrared optics commercial manufacturing that was previously done at Laser Power Corporation in California to other worldwide manufacturing sites, the acquisition of a majority interest in a distributor in Germany, II-VI/L.O.T. GmbH and lower material costs as a result of yield improvements.

Contract research and development gross margin for fiscal 2003 was $0.6 million (5% of research and development revenues), compared to a gross margin of $0.7 million (9% of research and development revenues), for fiscal 2002. The contract research and development revenues and costs are a result of development efforts in the Near-Infrared Optics and the Military Infrared Optics segments as well as activities in the eV PRODUCTS division and the WBG group for the fiscal year ended June 30, 2003. The increased revenues level for fiscal 2003 is primarily due to revenues from a new SiC development contract. Contract research and development gross margin is a result of a blend of cost plus fixed fee, cost reimbursement and fixed fee contract activities. The reduced gross margin for fiscal 2003 was due primarily to losses of approximately $1.2 million recognized from activities performed on a fixed price percentage of completion development contract in the Military Infrared Optics segment.

Company-funded internal research and development expenses for fiscal 2003 were $2.7 million or 2% of revenues compared to $4.4 million or 4% of revenues, in fiscal 2002. The lower expense is a direct result of more external contract support of the Company’s WBG group’s efforts in SiC crystal growth technology and processing development which offsets the funding needed to be provided by the Company for this activity. Fiscal 2002 included the results of the former Litton Systems, Inc. Silicon Carbide Group from the acquisition date; however the Company did not have a commensurate level of contract revenues in fiscal 2002 to offset the WBG group’s additional costs associated with this business. Company-funded internal research and development expenses also include corporate research and development activities in addition to the research and development activities of the eV PRODUCTS division.

Selling, general and administrative expenses for fiscal 2003 were $28.5 million or 22% of revenues compared to $21.2 million or 19% of revenues for fiscal 2002. The dollar and percentage increases for fiscal year 2003 reflect costs associated with the acquisition of a majority interest in a distributor in Germany, II-VI/L.O.T. GmbH during the first quarter of fiscal 2003 (See Note B to the Company’s consolidated financial statements). While this acquisition has increased the Company’s direct selling expense by approximately 2% of sales, this expense increase has been offset by the additional gross margin on sales to end customers in Germany. In addition to this acquisition of II-VI/L.O.T., the Company recorded higher salary expenses for its worldwide profit driven bonus program.

Interest expense for fiscal 2003 was $0.8 million compared to $1.4 million for fiscal 2002. The decrease in interest expense reflects lower LIBOR based interest rates, as well as a reduction in debt levels throughout the year. At June 30, 2003, total debt was 31% lower as compared to June 30, 2002.

Other expense for fiscal 2003 was $0.3 million compared to $0.4 million for fiscal 2002. Other expense in 2003 was primarily due to the minority interest in II-VI/L.O.T., the $0.1 million write-off of an investment in the second quarter of fiscal 2003 and foreign currency losses as a result of the U.S. dollar’s performance relative to other currencies in fiscal 2003 offset by royalty income and interest income. Other expense in fiscal 2002 related to the closing of operations of Laser Power Corporation in Mexico of $0.4 million, costs related to consolidating several of the Company’s European distribution arrangements of $0.4 million, and the write-off of certain crystal growth equipment and technology of $0.7 million offset by foreign currency gains, royalty income and interest income.

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The Company’s effective income tax rate for fiscal 2003 was 28% compared to an effective income tax rate of 24% for fiscal 2002. The increase in the effective tax rate reflects the completion of an annual external transfer pricing study and the resulting finalization of the allocation of profits around the world. The Company’s effective income tax rate reflects the Company’s continued benefit from lower tax rates on its Singapore and China operations and a favorable mix of U.S. and foreign income.

LIQUIDITY AND CAPITAL RESOURCES

Historically, our primary source of cash has been provided through operations. Other sources of cash include proceeds received from the exercise of stock options and long-term borrowings. Our historical uses of cash have been for capital expenditures, purchases of businesses and payment of principal and interest on outstanding debt obligations. Supplemental information pertaining to our sources and uses of cash is presented as follows:

Sources (uses) of Cash:

In fiscal 2004, net cash provided by operating activities of $30.4 million and $1.3 million of proceeds from the exercise of stock options was used primarily to fund expenditures of $12.7 million for property, plant and equipment, $1.8 million for the acquisition of a 75% majority interest in II-VI LOT Suisse S.a.r.l., $2.0 million for the purchase of assets related to the ultra-violet filter product line and $8.4 million to pay down debt. Cash generated for fiscal 2004 plus cash on hand at the beginning of the fiscal year resulted in a cash position of $21.7 million at June 30, 2004.

The Company had available $16.6 million and $15.4 million under its line of credit option of the credit facility as of June 30, 2004 and 2003, respectively. At June 30, 2004 and 2003, total outstanding letters of credit supported by the facility were $0.4 million and $0.1 million, respectively. The Company is obligated to pay $1.9 million on the first day of each fiscal quarter until the term loan portion of the credit facility, which was $9.4 million as of June 30, 2004 and 2003, is repaid. At June 30, 2004, $12.4 million remained outstanding on the credit facility. Our current credit facility is scheduled to expire in August 2005 and we expect to have a new credit facility in place by that time.

Our cash position, borrowing capacity and debt obligations are as follows:

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The Company believes cash flow from operations, existing cash reserves and available borrowing capacity will be sufficient to fund its working capital needs, capital expenditures, scheduled debt payments and internal growth for fiscal 2005.

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OFF-BALANCE SHEETS ARRANGEMENTS

None.

TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

RISK FACTORS

We Depend on Highly Complex Manufacturing Processes Which Require Products from Limited Sources of Supply

We utilize high quality, optical grade ZnSe in the production of a majority of our products. We are a leading producer of ZnSe for our internal use and for external sale. The production of ZnSe is a complex process requiring production in a highly controlled environment. A number of factors, including defective or contaminated materials, could adversely affect our ability to achieve acceptable manufacturing yields of high quality ZnSe. ZnSe is available from only one outside source where quantity and qualities may be limited. The unavailability of necessary amounts of high quality ZnSe would have a material adverse effect upon us. There can be no assurance that we will not experience manufacturing yield inefficiencies which could have a material adverse effect on our business, results of operations or financial condition.

We produce Hydrogen Selenide gas which is used in our production of ZnSe. There are risks inherent in the production and handling of such material. Our inability to effectively handle Hydrogen Selenide could require us to curtail our production of Hydrogen Selenide. Hydrogen Selenide can be obtained from one outside source. The cost of purchasing such material is greater than the cost of internal production. As a result, purchasing a substantial portion of such material from the outside source would increase our production costs of ZnSe. Therefore, our inability to internally produce Hydrogen Selenide could have a material adverse effect on our business, results of operations or financial condition.

In addition, we utilize other high purity, relatively uncommon materials and compounds to manufacture our products. Failure of our suppliers to deliver sufficient quantities of these necessary materials on a timely basis could have a material adverse effect on our business, results of operations or financial condition.

International Sales Account for a Significant Portion of Our Revenues

Sales to customers in countries other than the United States accounted for approximately 41%, 41% and 39% of revenues during the years ended June 30, 2004, 2003 and 2002, respectively. We anticipate that international sales will continue to account for a significant portion of our revenues for the foreseeable future. In addition, we manufacture products in Singapore and China and maintain direct sales offices in Germany, Japan, Switzerland, the UK and Belgium. Sales and operations outside of the United States are subject to certain inherent risks, including fluctuations in the value of the U.S. dollar relative to foreign currencies, tariffs, quotas, taxes and other market barriers, political and economic instability, restrictions on the export or import of technology, potentially limited intellectual property protection, difficulties in staffing and managing international operations and potentially adverse tax consequences. There can be no assurance

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that any of these factors will not have a material adverse effect on our business, financial condition or results of operations. In particular, although our international sales, other than in Germany, Japan, Belgium and the UK, are denominated in U.S. dollars, currency exchange fluctuations in countries where we do business could have a material adverse affect on our business, financial condition or results of operations, by rendering us less price-competitive than foreign manufacturers. Our sales in Japan are denominated in yen and, accordingly, are affected by fluctuations in the dollar/yen currency exchange rates. We generally reduce our exposure to such fluctuations through forward exchange agreements hedging approximately 75% of our sales in Japan. We do not engage in the speculative trading of financial derivatives. There can be no assurance, however, that our practices will reduce or eliminate the risk of fluctuation in the dollar/yen currency exchange rate.

We May Encounter Substantial Competition

We may encounter substantial competition from other companies in the same market, including established companies with substantial resources. Some of our competitors may have financial, technical, marketing or other capabilities more extensive than ours and may be able to respond more quickly than we can to new or emerging technologies and other competitive pressures. We may not be able to compete successfully against our present or future competitors, and competition may adversely affect our business, financial condition or operating results.

There Are Limitations on the Protection of Our Intellectual Property

We rely on a combination of trade secrets, patents, copyright and trademark laws and employee non-competition and nondisclosure agreements to protect our intellectual property rights. There can be no assurance that the steps taken by us will be adequate to prevent misappropriation of our technology. Furthermore, there can be no assurance that, in the future, third parties will not assert infringement claims against us. Asserting our rights or defending against third-party claims could involve substantial expense, thus materially and adversely affecting our business, results of operations or financial condition. In the event a third party were successful in a claim that one of our processes infringed its proprietary rights, we may have to pay substantial damages or royalties, or expend substantial amounts in order to obtain a license or modify the process so that it no longer infringes such proprietary rights, any of which could have an adverse effect on our business, results of operations or financial condition.

Our Success Depends on the Ability to Retain Key Personnel

We are highly dependent upon the experience and continuing services of certain scientists, engineers, production and management personnel. Competition for the services of these personnel is intense, and there can be no assurance that we will be able to retain or attract the personnel necessary for our success. The loss of the services of our key personnel could have a material adverse effect on our business, results of operations or financial condition.

Failure to Keep Pace with Industry Developments May Adversely Affect Our Operations

We are engaged in industries which will be affected by future developments. The introduction of products or processes utilizing new developments could render existing products or processes obsolete or unmarketable. Our continued success will depend upon our ability to develop and introduce on a timely and cost-effective basis new products, processes and applications that keep pace with developments and address increasingly sophisticated customer requirements. There can be no assurance that we will be successful in identifying, developing and marketing new products, applications and processes and product or process enhancements, that we will not experience difficulties that could delay or prevent the successful development, introduction and marketing of product or process enhancements or new products, applications or processes, or that our products, applications or processes will adequately meet the requirements of the marketplace and achieve market acceptance. Our business, results of operations and financial condition could be materially and adversely affected if we were to incur delays in developing new products, applications or processes or product or process enhancements or if we did not gain market acceptance.

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Our Success Depends on New Products and Processes

In order to meet our strategic objectives, we must continue to develop, manufacture and market new products, develop new processes and improve existing processes. As a result, we expect to continue to make significant investments in research and development and to continue to consider from time to time the strategic acquisition of businesses, products, or technologies complementary to our business. Our success in developing, introducing and selling new and enhanced products depends upon a variety of factors including product selection, timely and efficient completion of product design and development, timely and efficient implementation of manufacturing and assembly processes, effective sales and marketing, and product performance in the field. There can be no assurance that we will be able to develop and introduce new products or enhancements to our existing products and processes in a manner which satisfies customer needs or achieves market acceptance. The failure to do so could have a material adverse effect on our ability to grow our business.

We May Expand Product Lines and Markets by Acquiring Other Businesses

Our business strategy includes expanding our product lines and markets through internal product development and acquisitions. Any acquisition may result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities, and amortization expense related to intangible assets acquired, any of which could have a material adverse effect on our business, financial condition or results of operations. In addition, acquired businesses may be experiencing operating losses. Any acquisition will involve numerous risks, including difficulties in the assimilation of the acquired company’s operations and products, uncertainties associated with operating in new markets and working with new customers, and the potential loss of the acquired company’s key employees.

The following information relates to acquisitions made over the last ten years:

Our Revenues May Suffer if General Economic Conditions Worsen

Our revenues and earnings may be affected by general economic factors, such as inflation, currency fluctuations and employment levels, resulting in a temporary or longer-term overall decline in demand for our products. Therefore, any significant downturn or recession in the United States or other countries could have a material adverse effect on our business, financial condition and results of operations.

Our Business is Dependent on Other Cyclical Industries

Our business is significantly dependent on the demand for products produced by end-users of industrial lasers. Many of these end-users are in industries that historically have experienced a highly cyclical demand for their products. As a result, demand for our products and our results of operations are subject to cyclical fluctuations.

Our Revenues are Subject to Potential Seasonal Fluctuations

Due to our customers’ buying patterns, particularly in Europe, revenues for our first fiscal quarter ending in September could be below those in the preceding quarter. Our first fiscal quarter results often are dependent upon the sales made in the last month of the quarter.

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Exposure to Government Markets

With the acquisition of Laser Power Corporation, specifically the military infrared optics business of Exotic Electro-Optics, sales to customers in the defense industry have increased. These customers in turn generally contract with a governmental entity, typically the U.S. government. Most governmental programs are subject to funding approval and can be modified or terminated with no warning upon the determination of a legislative or administrative body. The loss or failure to obtain certain contracts or a loss of a major government customer could have a material adverse effect on our business, financial condition and results of operations.

Our Stock Price May Fluctuate

Future announcements concerning us, our competitors or customers, quarterly variations in operating results, announcements of technological innovations, the introduction of new products or changes in product pricing policies by us or our competitors, seasonal or other variations in anticipated or actual results of operations, changes in earnings estimates by analysts or reports regarding our industries in the financial press or investment advisory publications, among other factors, could cause the market price of our stock to fluctuate substantially. In addition, stock prices may fluctuate widely for reasons which may be unrelated to operating results. These fluctuations, as well as general economic, political and market conditions such as recessions, military conflicts or market or market-sector declines, may materially and adversely affect the market price of our common stock. In addition, any information concerning us, including projections of future operating results, appearing in investment advisory publications or on-line bulletin boards or otherwise emanating from a source other than us could in the future contribute to volatility in the market price of our common stock.

Provisions in our Articles of Incorporation and By-Laws May Limit the Price that Certain Investors May be Willing to Pay in the Future for Shares of Our Common Stock

Our articles of incorporation and by-laws contain provisions which could make us a less attractive target for a hostile takeover or make it more difficult or discourage a merger proposal, a tender offer or a proxy contest. This could limit the price that certain investors might be willing to pay in the future for shares of our common stock. The provisions include:

In addition, the Pennsylvania Business Corporation Law contains provisions which may have the effect of delaying or preventing a change in our control.

During fiscal 2004, the Company’s Board of Directors voted to terminate its Shareholder Rights Plan which was adopted in 2001. The Company repurchased the rights at the redemption price of one cent ($0.01) per right. The Company paid approximately $141,000 for the repurchase of the shareholder rights.

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We Are Subject to Stringent Environmental Regulation

We use or generate certain hazardous substances in our research and manufacturing facilities. We believe that our handling of such substances is in material compliance with applicable local, state and federal environmental, safety and health regulations at each operating location. We invest substantially in proper protective equipment, process controls and specialized training to minimize risks to employees, surrounding communities and the environment due to the presence and handling of such hazardous substances. We annually conduct employee physical examinations and workplace air monitoring regarding such substances. When exposure problems or potential exposure problems have been indicated, corrective actions have been implemented and re-occurrence has been minimal or non-existent. We do not carry environmental impairment insurance.

Relative to its generation and use of the extremely hazardous substance Hydrogen Selenide, we have in place an emergency response plan. Special attention has been given to all procedures pertaining to this gaseous material to minimize the chances of its accidental release to the atmosphere.

With respect to the use, storage and disposal of the low-level radioactive material Thorium Fluoride, our facilities and procedures have been inspected and licensed by the Nuclear Regulatory Commission. This material is utilized in our thin-film coatings. Thorium bearing by-products are collected and shipped as solid waste to a government-approved low-level radioactive waste disposal site in Clive, Utah.

The generation, use, collection, storage and disposal of all other hazardous by-products, such as suspended solids containing heavy metals or airborne particulates, are believed by us to be in material compliance with regulations. We believe that all of the permits and licenses required for operation of our business are in place. Although we do not know of any material environmental, safety or health problems in our properties or processes, there can be no assurance that problems will not develop in the future which could have a material adverse effect on our business, results of operations or financial condition.

Some Laser Systems Are Complex in Design and May Contain Defects that Are Not Detected Until Deployed Which Could Increase Our Costs and/or Reduce Our Revenues

Laser systems are inherently complex in design and require ongoing regular maintenance. The manufacture of lasers, laser products and systems involves a highly complex and precise process. As a result of the technical complexity of our products, changes in our or our suppliers’ manufacturing processes or in the use of defective or contaminated materials by us or our suppliers could result in a material adverse effect on our ability to achieve acceptable manufacturing yields and product reliability. To the extent that we do not achieve such yields or product reliability, our business, operating results, financial condition and customer relationships could be adversely affected. Our customers may discover defects in our products after the products have been fully deployed and operated under peak stress conditions. In addition, some of our products are combined with products from other vendors, which may contain defects. Should problems occur, it may be difficult to identify the source of the problem. If we are unable to fix defects or other problems, we could experience, among other things:

The occurrence of any one or more of the foregoing factors could have an adverse effect on our business, results of operations or financial condition.

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Recently Issued Financial Accounting Standards

In December 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46R, “Consolidation of Variable Interest Entities.” Interpretation No. 46R requires unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse the risks and rewards of ownership among their owners and other parties involved. Based on the results of our evaluation of the revised interpretation, this interpretation has no financial impact on the Company’s financial position or results of operations.

MARKET RISKS

The Company is exposed to market risks arising from adverse changes in foreign currency exchange rates and interest rates. In the normal course of business, the Company uses a variety of techniques and derivative financial instruments as part of its overall risk management strategy primarily focused on its exposure to the Japanese Yen. No significant changes have occurred in the techniques and instruments used other than those described below.

In addition, the Company has transactions denominated in Euros and Pounds Sterling. As a result of the Company’s hedging activities discussed below, changes in the foreign currency exchange rates of these currencies did not have a material impact on the results of operations for fiscal year 2004.

Foreign Exchange Risks

In the normal course of business, the Company enters into foreign currency forward exchange contracts with its banks. The purpose of these contracts is to hedge ordinary business risks regarding foreign currencies on product sales. Foreign currency exchange contracts are used to limit transactional exposure to changes in currency rates. The Company enters into foreign currency forward contracts that permit it to sell specified amounts of foreign currencies expected to be received from its export sales for pre-established U.S. dollar amounts at specified dates. The forward contracts are denominated in the same foreign currencies in which export sales are denominated. These contracts provide the Company with an economic hedge in which settlement will occur in future periods and which otherwise would expose the Company to foreign currency risk. The Company monitors its positions and the credit ratings of the parties to these contracts. While the Company may be exposed to potential losses due to risk in the event of non-performance by the counterparties to these financial instruments, it does not anticipate such losses. The Company entered into a low interest rate, 300 million Yen loan with PNC Bank in September 2002 in an effort to minimize the foreign currency exposure in Japan. A change in the interest rate of 1% for this Yen loan would have changed the interest expense by approximately $26,000 and a 10% change in the Yen to dollar exchange rate would have changed revenues in the range from a decrease of $1,686,000 to an increase of $1,894,000 for the year ended June 30, 2004.

For II-VI Singapore Pte., Ltd. and its subsidiaries, the functional currency is the U.S. dollar. Gains and losses on the remeasurement of the local currency financial statements are included in net earnings. Foreign currency remeasurement gains (losses) were $0.5 million, ($0.2) million and ($0.5) million for the years ended June 30, 2004, 2003 and 2002, respectively.

For all other foreign subsidiaries, the functional currency is the local currency. Assets and liabilities of those operations are translated into U.S. dollars using period-end exchange rate; while income and expenses are translated using the average exchange rates for the reporting period. Translation adjustments are recorded as accumulated other comprehensive income within shareholders’ equity.

Interest Rate Risks

On March 9, 2004, the Company entered into a one-year interest rate cap, replacing an existing interest rate cap that matured on March 5, 2004, with a notional amount of $5.6 million as required under the terms of its current credit agreement in order to limit interest rate exposure on one-half of the then outstanding balance of the term loan. As of June 30, 2004, the total borrowings of $15.5 million included $9.4 million under the term loan option, $3.0 million under the line of credit option, $2.7 million Japanese Yen loan and a $0.4 million Pennsylvania Industrial Development Authority (PIDA) term note. As such, the Company is exposed to changes in interest rates. A change in the interest rate of 1% would have changed the interest expense by approximately $196,000 for the fiscal year ended June 30, 2004.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of II-VI Incorporated and Subsidiaries:

We have audited the accompanying consolidated balance sheets of II-VI Incorporated and subsidiaries (the “Company”) as of June 30, 2004 and 2003, and the related consolidated statements of earnings, shareholders’ equity, comprehensive income and cash flows for each of the three years in the period ended June 30, 2004. Our audits also included the financial statement schedule listed in Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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, such consolidated financial statements present fairly, in all material respects, the financial position of II-VI Incorporated and subsidiaries as of June 30, 2004 and 2003 and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2004 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for goodwill amortization in fiscal 2002.

/s/ Deloitte & Touche LLP

Pittsburgh, Pennsylvania

September 10, 2004

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CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF EARNINGS

See Notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY