SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

COMMISSION FILE NUMBER 0-17297

BTU INTERNATIONAL, INC.

(Exact name of Registrant as specified in its charter)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:

(978) 667-4111

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None Registered

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

      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 þ          No o

      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 the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K.     o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes o          No þ

      The aggregate market value of the shares of Common Stock, $.01 par value, of the Company held by non-affiliates of the Company was $31,822,869 on June 30, 2004.

      Indicate number of shares outstanding of the Registrant’s Common Stock, par value $.01 per share, as of the latest practicable date: As of March 29, 2005: 7,230,063 shares.

DOCUMENTS INCORPORATED HEREIN BY REFERENCE

      The following documents are incorporated herein by reference: Part III — Portions of the Proxy Statement for the 2005 Annual Meeting of Stockholders, both of which are to be filed with the Securities and Exchange Commission.

BTU INTERNATIONAL, INC.

2004 FORM 10-K ANNUAL REPORT

Table Of Contents

PART I

      BTU International designs, manufactures, sells and supports advanced thermal processing systems used primarily for semiconductor packaging, printed circuit boards (PCB) assembly and advanced materials processing. In addition, we produce custom thermal systems for a variety of specialty applications for a wide range of temperatures. We believe we are one of the leading suppliers of thermal systems used by electronics and materials manufacturers.

      Our electronics customers serve the advanced segments of the industry. In the semiconductor market, we participate in both wafer level packaging and die level packaging where the integrated circuits are connected and sealed into a package. In the SMT market, electronic components are attached to the printed circuit boards (PCBs) through the reflow process using our convection soldering systems. In the advanced materials market, our materials customers serve multiple markets in which advanced ceramics and metal alloys are used in end use applications for the automotive, fuel cell, communications and other industries. Our customers typically require high throughput, high yield and highly reliable advanced thermal processing systems with tightly controlled temperature and atmosphere parameters.

      BTU’s products are sold worldwide through a direct technical sales force and through independent sales representatives. Among our top revenue generating customers in 2004 were such industry leaders as Motorola, IBM, Intel Corporation, Solectron Corporation, Silicon Precision Industries (SPIL), Advanced Semiconductor Engineering (ASE), and Celestica Incorporated.

      The principal offices and main manufacturing facility are located at 23 Esquire Road, North Billerica, Massachusetts 01862 USA. Our telephone number is (978) 667-4111. Our new China Manufacturing plant is located at 25 Jia Tai Road, Waigaoqiao Free Trade Zone, Shanghai, 200131, PRC. We also have sales and service facilities throughout North America, Europe and Asia. Our corporate website is www.btu.com.

INDUSTRY BACKGROUND

      Electronics Markets. The electronics markets segments showed strong growth during 2004 and the outlook for the industry is one of long-term growth. The need for increasingly sophisticated electronic devices continues and new technology such as wireless networks, next generation cellular phones and personal digital assistants (PDAs) will continue to drive future demand. Other types of electronic equipment are becoming more complex, including data communications equipment such as switches, routers and servers, broadband access products such as cable modems and Ethernet wireless accessories; and consumer products such as automobile electronics and digital cameras. Integral to the growth in electronics are the advances in technology, which result in producing smaller, lighter and less expensive end products by increasing the performance and reducing the cost, size, weight and power requirements of electronic assemblies, PCBs and semiconductors. In response to these developments, manufacturers are increasingly employing more sophisticated production and assembly techniques requiring more advanced manufacturing equipment.

      Semiconductor Packaging Processes. Semiconductor packaging processes include integrated circuit (IC) manufacturing and IC packaging. Several precision thermal process steps are required in each application. In advanced semiconductor packaging, processing takes place at both the wafer level and die level. At the wafer level, deposited solder must be thermally treated to form perfectly spherical “bumps”. At the die level, these bumps allow the ICs to be bonded to the semiconductor package using precise thermal process. In the PCB assembly process, packaged circuits and other components are attached to PCBs. The attachment process, which creates a permanent physical and electrical bond, is called solder reflow, or surface mount reflow.

      Materials Markets. Advanced materials are very important for sealing, connecting and package brazing for electronics manufacturing. Emerging markets including fuel cell and synthetic gas production

as well as automotive markets require high performance ceramic and metal components. A significant trend is the use of multi-layer configurations that must be designed with very tight dimensional tolerances requiring very sophisticated process control and uniformity. Low Temperature Co-fired Ceramics (LTCC), high temperature ceramics and aluminum powered metals all figure prominently in leading-edge products for these markets.

      In addition, the manufacture of many ceramic products or components, from fuel cell anodes and cathodes to substrates for wireless networking products requires a multi-step thermal process. A binder burnout step in which organics are removed from ceramic laminate materials is followed by a high temperature sintering step that solidifies the ceramic at desired dimensions. Similar sintering processes are used for metal components across a wide variety of applications and for gadolinium and uranium fuel pellet sintering, which take place at temperatures up to 1800°C.

      Across all markets, the need for more versatile, more reliable and more advanced capital equipment persists. In addition, the continued globalization of manufacturing and shift to low cost regions such as China, particularly by electronics producers, has driven the demand for greater value from equipment — a balance of price and performance.

TECHNOLOGICAL CHALLENGES

      Advanced thermal processing systems present significant engineering challenges related to temperature control, atmosphere control, product handling, flux containment and disposal, and high system up time.

      Advanced thermal processing systems maintain accurate and uniform temperatures within their process chambers. The temperature within the process chamber is influenced by the rate at which components are moved through the system and the weight and density of the product. In addition, the thermal processing system’s heat convection rate must be varied and controlled as components and materials are processed. The chamber must also dispense heat uniformly across the product at precise temperatures to ensure maximum process uniformity. Also, products must be heated and cooled at closely preset rates in order to avoid damage caused by thermal stress. With the increasing use of lead free solder processes, the control window for temperature uniformity has gotten significantly more critical.

      Another technological challenge for advanced thermal processing systems is achieving precisely controlled atmospheric conditions within the process chamber. In order to facilitate thermal processing without contamination of or damage to product, many advanced thermal processing systems use a substantially oxygen-free atmosphere of nitrogen or hydrogen in their process chambers. If such gases are used, the entry of contaminating air must be minimized, even though the product enters and exits the system continuously from the ambient atmosphere. Maintaining a pure, safe and controlled atmosphere in the process chamber, while minimizing the consumption of nitrogen or hydrogen gases in order to reduce operating costs, presents significant engineering challenges.

      Handling products in advanced thermal processing systems requires highly reliable conveyance systems that can easily be converted to process a wide variety of products having different specifications, sometimes on side-by-side tracks through the process chamber. The product handling system must also fully support a wide variety of product sizes.

      The mechanical components in advanced thermal processing systems must operate almost continuously in a demanding, elevated temperature environment with frequent thermal cycles. The use of materials that are resistant to high temperature and thermal stress is important to achieving high reliability.

      In applications using flux, the volatile compounds that are vaporized during the thermal processing cycle, must be contained and collected so that they do not condense in the system or damage the environment. The efficient containment, collection and disposal of the flux are important factors in achieving high system up time, high throughput and reliability.

OUR SOLUTION

      We deliver a broad range of advanced thermal processing systems to serve the needs of manufacturers that require high throughput, process yields and reliability with tightly controlled process parameters. Our systems enable our customers to increase throughput and yield for advanced semiconductor packaging, PCB assembly and advance materials by providing precise atmosphere and temperature control. In addition to the high performance of our products, we believe the quality standards of our organization and our worldwide service and support are important to our success with industry leading global manufacturers.

      Atmosphere Uniformity And Control. Our advanced thermal processing systems provide precision control over atmospheric conditions within their process chambers by integrating our gas and physical curtain technologies. Our systems are capable of excluding virtually all oxygen from the critical process steps to maintain the safety and integrity of the process chamber atmosphere. In addition, our systems minimize the consumption of nitrogen or hydrogen, thereby reducing the operating cost of maintaining the atmosphere.

      Accurate and Uniform Temperature. Our high rate convection and fully enclosed coil (FEC) heating modules provide controlled heating capacities across many different applications, thereby enabling our customers to maximize process uniformity and throughput. In addition, our systems apply heat uniformly across the product load, which is critical to ensure optimum processing. Heat up and cool down profiles are also closely controlled for process consistency and the protection of product.

      Repeatability from System to System. We provide a high degree of repeatability from system to system through our atmosphere and temperature controls and the reliability of our systems. This repeatability is achieved through our industry leading Closed Loop Convection technology that ensures the same convection rate regardless of change in altitude or temperature. This is a critical attribute because our customers must achieve uniform manufacturing performance in plants located throughout the world.

      Processing Flexibility. Major electronics manufacturers process many sizes of PCBs and often need rapid product changeover capabilities. Our systems can process PCBs of different sizes with minimal or no reconfiguration. Rapid changeover reduces down time and increases manufacturing volume. In addition, our high temperature products can be configured for multiple process applications allowing for versatility in materials manufacturing.

      Reliability. Our customers place a high premium on reliability. Reliability is a major contributor to low cost of ownership because high up time can increase the productivity of an entire production line. We believe our systems are the most reliable advanced thermal processing systems in the world.

      Worldwide Customer Support. We provide our customers with global technical service support, in depth process engineering support and rapid delivery of our systems and parts. We provide our customer support through our on-site direct service organization and our independent sales and service representatives, supplemented with twenty-four hours a day, seven days a week telephonic support and extensive customer training programs

PRODUCTS

      We supply a broad range of advanced thermal processing systems for electronics and materials manufacturing industries. Our products are used for such applications as semiconductor packaging, PCB assembly, ceramic and metals sintering, thick film firing, fuel pellet sintering and metal brazing. In addition, we have custom product engineering capabilities that allow us to design specific products for unique applications, typically involving high temperatures.

      Advanced Semiconductor Packaging. We sell several systems for the thermal processes used in advanced semiconductor packaging.

      Wafer Bump Reflow. Our TCAS series of continuous belt advanced thermal processing system is rated up to 800°C and is designed for wafer bump reflow. It can operate in a variety of controlled atmospheres including hydrogen using patented gas barrier technology to achieve a safe and high purity

hydrogen atmosphere. Our TCAS systems range in price from $300,000 to $1.2 million for a fully integrated 300mm system.

      BTU offers fully integrated systems for flux coating and reflow of 200 and 300mm wafers. The 300mm systems are available fully compliant with I300i protocol and with SEMI S2 and S8 standards. These integrated systems range in price from $300,000 to $1.2 million.

      Flip Chip Reflow in Package. Flip Chip Reflow provides the physical and electronic bond of the semiconductor device to its package. The PARAGON and PYRAMAX families of advanced convection reflow systems, utilizing our Closed Loop Convection technology, are rated up to 400°C and operate in air or nitrogen atmospheres. The product utilizes impingement technology to transfer heat to the substrate. Using thermal power arrays of five-kilowatt heaters, it can process substrates in dual track configurations, thereby enabling our customers to double production without increasing the machine’s footprint. The family of products is available in three models based on the heated lengths of thermal processing chambers. Heated length is based on the required production rate and loading requirements. The products range in price from $70,000 to $180,000.

      Surface Mount Technology (SMT). We currently sell two families (VIP and PYRAMAX) of advanced thermal processing systems used in the solder reflow and cure stages of PCB (printed circuit board) assembly.

      The new PYRAMAX family of advanced convection reflow systems is designed on a single platform to be rapidly configurable, which reduces the product build cycle, allowing us to meet customer demands for shorter delivery lead times. Pyramax products offer our customers reduced capital cost, lower nitrogen consumption and reduced scheduled maintenance cycles.

      Pyramax provides increased process flexibility due to its ability to process PCBs up to 24 inches wide. Rated up to 400°C, these products are capable of operating in air or nitrogen atmospheres and have increased convection flow for greater performance and lead free processes. Pyramax utilizes impingement technology to transfer heat to the substrate. These systems are offered in 7-zone and 10-zone heated lengths and are capable of processing lead-free solder. They range in price from $40,000 to $150,000.

      The market need for lead free solder reflow presents a unique problem by raising the process temperature critically close to the destruct temperature of the components that are being attached. PYRAMAX’s unique closed loop convection control provides significantly tighter temperature window than those available from any other manufacturer.

      The solder reflow process requires the thermal processing system to manage flux residues that are eliminated during the processing of the PCBs. Pyramax advanced thermal processing systems are equipped with a patented flux management system that isolates the flux outside the main process chamber, thereby helping to maintain the integrity of the atmosphere and facilitate easy disposal.

      Advanced Materials Processing. We sell several systems for the thermal processes used in advanced materials processing.

      Thick Film Resistors and Conductors. FAST FIRE continuous belt advanced thermal processing systems are rated up to 1050°C in air. These systems are used for firing thick film pastes in the production of hybrid circuits and can achieve an across belt temperature uniformity of +/-1°C. Such thermal uniformity is critical in the production of resistor circuits. These systems are available in various belt widths and heated lengths and range in price from $50,000 to $180,000.

      Our TCA continuous belt advanced thermal processing systems, rated up to 1150°C in multiple atmospheres such as nitrogen, hydrogen, forming gas and dissociated ammonia, are used for ceramic sintering, copper termination, glass to metal sealing, metal brazing and many other processes requiring tight atmosphere and temperature control. The TCA utilizes an advanced gas scrubbing system to control the binder remover phase in the termination firing process. Unique features like venturi exhaust and patented eductor technology make TCA essential for advanced materials processing. The TCA is available in various belt widths and heated lengths and ranges in price from $70,000 to $500,000.

      Our Walking Beam system is designed for high volume production applications with very heavy loads. It uses a walking beam transport system to eliminate friction associated with advanced thermal processing systems that use pusher technology. Walking Beam systems are used to sinter gadolinium and uranium pellets used for nuclear fuel generation at temperatures up to 1800°C. This system ranges in price from $500,000 to $2.5 million.

CUSTOM APPLICATIONS

      We design and manufacture custom high temperature systems used in such applications as metals brazing, ceramic sintering and thin film coatings.

      Advanced Ceramic Sintering. BTU’s walking beam thermal processing system is rated up to 1800°C and operates in hydrogen reducing atmospheres primarily used for sintering of multilayer ceramics. In addition, we offer a batch furnace with elevator hearth loading to accomplish precise high temperature ceramic sintering processes such as fuel cell and synthetic gas components requiring tight temperature uniformity to maintain close dimensional tolerances and minimize deformation of the product. The elevator batch system achieves temperature uniformity of +/- 5°C across the load at high throughput rates.

      Convection Batch System. BTU has introduced a new convection batch furnace leveraging our patented eductor technology. The systems are used for processing ceramic and advanced materials such as Ceramics/ LTCC/ MLCC, Fuel Cells and glass separation membranes. We can now uniquely offer customers convection technology at elevated temperatures, providing the customer with dramatic improvements in process uniformity as well as optimum heavy load/high throughput capability. The systems range in price from $70,000 to $750,000.

      We also offer a pusher thermal processing system, which is rated up to 1800°C in a hydrogen-reducing atmosphere. The Pusher is used in lower volume applications for the sintering of ceramics and nuclear fuels. These systems range in price from $500,000 to $1.2 million.

CUSTOMERS

      Many of our principal customers are large-volume global manufacturers that use our products in multiple facilities worldwide. Our customers include industry leaders such as Motorola, IBM, Intel Corporation, Solectron Corporation, Silicon Precision Industries (SPIL), Advanced Semiconductor Engineering (ASE) and Celestica Incorporated.

      Our largest customers have historically accounted for a significant percentage of our net sales. Aggregate net sales to our ten largest customers accounted for approximately 38% of our net sales in 2004. In 2004, no customer accounted for more than 10% of net sales.

SALES AND MARKETING

      We market and sell our products through our direct sales force and independent sales representatives throughout the world. Our Sales and Marketing force is responsible for evaluating the marketplace, generating leads and creating sales programs and literature. Our on-site direct service organization and our independent sales representatives provide ongoing services to customers using our products. These services include implementing continuous improvement tools related both to the cost of our products and to their technical performance. These service functions allow us to market future sales within our current customer base. In addition, our management and sales teams participate in periodic trade conventions, through which we aggressively market our products to potential customers.

      We market our systems and services globally. In 2004, approximately 75% of our net sales originated outside the United States, with Asia Pacific and Europe representing 52% and 20% of net sales, respectively, and 3% to Other Americas.

RESEARCH, DEVELOPMENT AND ENGINEERING

      Our research, development and engineering efforts are directed toward enhancing existing products and developing our next generation of products. Our expenses for research, development and engineering were: $3.6 million in 2002, $3.4 million in 2003 and $3.7 million in 2004. A large percentage of our research, development and engineering expense in 2004 was spent on the development of integrated solutions for wafer bump reflow, development of our convection batch furnace for ceramics and fuel cells, the expansion of our Pyramax solder reflow platform and in support of custom design solutions.

      Close working relationships between our key customers and our product engineering teams enable us to incorporate our customers’ feedback and needs into our product development efforts.

      We have integrated our product design, manufacturing, engineering and after sales support documentation in support of the new product introduction process and lowered research, development and engineering costs.

MANUFACTURING AND SUPPLIERS

      Our principal manufacturing operations consist of final assembly, systems integration and testing at our facility in North Billerica, Massachusetts and Shanghai, China. We outsource the manufacture of many of our subsystems to a number of key suppliers and maintain close relationships with them while also maintaining qualified alternative suppliers in the event we exceed the capacity of our key suppliers and to maintain a cost down focus. In 2004 we completed a new manufacturing plant in Shanghai, China for manufacture of our SMT products as well as local sourcing of materials.

      We continue to invest in software and capital equipment related to our information technology infrastructure and customer support. We have outsourced the manufacture of most of our significant component systems thereby reducing cycle time and increasing our inventory turnover. We adhere closely to the principles of total quality management and have been ISO 9001 certified since 1998 and updated to ISO 9000:2000 in October 2003. Our customers, suppliers and employees are encouraged to provide feedback and suggestions for improvements in products and services.

INTELLECTUAL PROPERTY

      We seek to protect our intellectual property by filing patents on proprietary features of our advanced thermal processing systems and by challenging third parties that we believe infringe on our patents. We also protect our intellectual property rights with nondisclosure and confidentiality agreements with employees, consultants and key customers and with our trademarks, trade secrets and copyrights. As a global supplier of equipment, we recognize that the laws of certain foreign countries may not protect our intellectual property to the same extent as the laws of the United States.

      We license some software programs from third party developers and incorporate them into our products. Generally, these agreements grant us non-exclusive licenses to use the software and terminate only upon a material breach by us. We believe that such licenses are generally available on commercial terms from a number of licensors.

BACKLOG

      Backlog as of December 31, 2004 was $6.4 million, compared to $5.8 million as of December 31, 2003. As of December 31, 2004, we expected to ship our year-end backlog within 40 weeks. Most of our backlog for solder reflow systems is expected to be shipped within 3 to 8 weeks. The backlog of our custom systems is expected to be shipped within 12 to 40 weeks. We include in backlog only those orders for which the customer has issued a purchase order. Due to possible changes in delivery schedules and order cancellations, our backlog at any particular date is not necessarily representative of sales for any subsequent period.

COMPETITION

      Several companies compete with us in selling advanced thermal processing systems. Although price is a factor in buying decisions, we believe that technological leadership, process capability, throughput, environmental safeguards, uptime, mean time-to-repair, cost of ownership and after-sale support have become increasingly important factors. We compete primarily on the basis of these criteria, rather than on the basis of price.

      Our principal competitors for advanced semiconductor packaging and PCB assembly equipment vary by product application. Our principal competitors for advanced semiconductor packaging are Sikama, RTC, and Heller Industries. Our principal competitors for solder reflow systems are Vitronics-Soltec, Inc. (a Dover Technologies Company), Electrovert-Speedline Technologies and Heller Industries. Our high temperature systems for thick film, hybrid circuits, ceramics and other applications compete primarily against systems sold by Lindberg (a Unit of SPX Corp.), SierraTherm Production Furnaces, Inc., Centrotherm and Harper International Corp.

EMPLOYEES

      As of February 28, 2005, we had 250 employees, of whom 60 are engaged in sales, marketing and service, 29 in research, development and engineering, 22 in finance and administration and 139 in operations. None of our employees are represented by a collective bargaining agreement, and we believe that we have satisfactory relations with our employees.

ENVIRONMENTAL

      One of BTU’s core values is protecting the environment in which we operate and the environment in which our equipment operate. Compliance with laws and regulations regarding the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had any material effects on the capital expenditures, earnings or competitive position of the Company. The Company does not anticipate any material capital expenditures for environmental control facilities in 2005.

FACILITIES

      We maintain our headquarters in North Billerica, Massachusetts, where we own a 150,000 square foot manufacturing facility. We currently operate our manufacturing facility on a multi shift basis. In England, we lease a facility for our European sale and service operations. We also rent office space in Paris, France. In Asia, we lease sales and service offices in Shanghai and Beijing, China; Singapore; Penang, Malaysia; and Cavite, Philippines. We recently completed construction of a leased facility in Shanghai, China. We believe that our plants in the USA and China provide sufficient manufacturing capacity into the foreseeable future.

      There were no material legal proceedings pending as of the time of this filing.

      There were no matters submitted to a vote of the Company’s security holders during the fourth quarter of 2004.

      Paul J. van der Wansem returned to his executive position in September 2004 and is now President, Chief Executive Officer and Chairman of our Board of Directors. Since 1979 he has been our Chairman of our Board of Directors. He was also President and Chief Executive Officer from 1979 until July 2002. From 1977 to 1981, he was Vice-President and advisor to the Management Board of Holec, N.V., (a Dutch-Multinational electronics company), and in 1978 started Holec (USA), Inc. and became its President. From 1973 to 1977, he was Management Consultant for The Boston Consulting Group, Inc. (BCG) in Boston, MA. Prior to this he was an Adjunct Director at Citicorp starting in 1970 in Amsterdam, The Netherlands and later at the New York headquarters through April of 1973. Mr. van der Wansem received an undergraduate degree in automotive engineering in England and holds an M.B.A. from IMD, Lausanne, Switzerland.

      Thomas P. Kealy has been Vice President, Corporate Controller and Chief Accounting Officer of our company since February 1991. He has been the Corporate Controller since joining our company in July 1985. Prior to 1985, Mr. Kealy served for 14 years in various financial management positions, including Division Controller for Polaroid Corporation. Earlier he was the Corporate Controller for Coro, Inc. and Lebanon, Inc. Mr. Kealy holds a B.S. in Finance and Accounting from Bentley College and an M.B.A. from Clark University.

      James M. Griffin has been Vice President Sales-Americas of our company since February 2000. Previously, Mr. Griffin was our Director of Sales-North America, and has held a number of positions within our company’s sales organization. He has been with our company for 19 years. Mr. Griffin attended Worcester Polytechnic Institute in the mechanical engineering program.

PART II

      Our common stock has been listed on the Nasdaq National Market System under the symbol “BTUI” since February 7, 1989. The following table sets forth, for the periods indicated, the high and low sale prices of our common stock as reported on the Nasdaq National Market System.

      As of March 29, 2005 there were approximately 483 stockholders of record.

DIVIDEND POLICY

      Our policy is to retain earnings to provide funds for the operation and expansion of our business. We have not paid cash dividends on our common stock and do not anticipate that we will do so in the foreseeable future. The payment of dividends in the future will depend on our growth, profitability, financial condition and other factors that our board of directors may deem relevant.

      The selected consolidated statement of operations data for each of the fiscal years ended December 31, 2002, December 31, 2003 and December 31, 2004 and the selected consolidated balance sheet data as of December 31, 2003 and December 31, 2004 have been derived from our consolidated financial statements audited by independent public accountants, which are included elsewhere in this Form 10-K. The selected consolidated statement of operations data for the fiscal years ended December 31, 2000 and December 31, 2001 and the selected consolidated balance sheet data as of December 31, 2000, December 31, 2001 and December 31, 2002 have been derived from audited financial statements not included in this Form 10-K. This data should be read together with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Form 10-K.

OVERVIEW

      We design, manufacture, sell and support advanced thermal processing systems used primarily for semiconductor packaging, printed circuit boards (PCB) assembly and advanced materials processing. In addition, we produce custom thermal systems for a variety of specialty applications for a wide range of temperatures.

      We derive our net sales from customers around the world. Our customers include large multinational OEM (original equipment manufacturers) and EMS (electronic manufacturing service) providers requiring advanced thermal processing equipment solutions. In 2004, net sales to our five largest customers accounted for 25.7% of our total net sales. Our net sales in 2004 were dispersed worldwide, with approximately 25% to customers in the United States, 52% to Asia Pacific customers, 20% to European customers and 3% to Other Americas. Over the past three years, the percentage of our net sales to international customers was 61% in 2002, 76% in 2003 and 75% in 2004.

Critical Accounting Policies

      The following is a discussion of those accounting policies that the Company deems to be “critical” — that is, they are important to the portrayal of the Company’s financial condition and results, and they reflect management’s reliance on estimates regarding matters that are inherently uncertain.

      Revenue Recognition — The Company recognizes revenue in accordance with the Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements” as updated by SEC Staff Accounting Bulletin No. 104, “Revenue Recognition”. Under these guidelines, revenue is recognized when persuasive evidence of an arrangement exists, shipment has occurred or services rendered, the price is fixed or determinable and payment is reasonably assured. Under these requirements, when the terms of sale include customer acceptance provisions, and compliance with those provisions have not been previously demonstrated, revenues are recognized upon acceptance. Furthermore, revenues for products that require installation for which the installation is essential to functionality or is not deemed inconsequential or perfunctory are recognized upon completion of installation. Revenues for products sold where installation is not essential to functionality and is deemed inconsequential or perfunctory are recognized upon shipment with estimated installation and warranty costs accrued.

      Applying the requirements of SAB No. 101 to future sales arrangements used in the Company’s equipment sales may result in the deferral of the revenue for some equipment sales.

      The Company also has certain sales transactions for products, which are not completed within the normal operating cycle of the business. It is the Company’s policy to account for these transactions using the percentage of completion method for revenue recognition purposes when all of the following criteria exist. (1) The Company has received the Customer’s purchase order or entered into a legally binding contract. (2) The Customer is credit worthy and collection is probable or Customer prepayments are required at product completion milestones or specific dates. (3) The sales value of the product to be delivered is significant in amount when compared to the Company’s other products. (4) Product costs can be reasonably estimated; there is no major technological uncertainty and the total engineering, material procurement, product assembly and test cycle time extend over a period of six months or longer.

      Under the percentage of completion method, revenues and gross margins to date are recognized based upon the ratio of costs incurred to date compared to the latest estimate of total costs to complete the product as a percentage of the total contract revenue for the product. Revisions in costs and gross margin percentage estimates are reflected in the period in which the facts causing the revision become known. Provisions for total estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined.

      Inventory Valuation — The Company’s inventories consist of material, labor and manufacturing overhead costs. The Company determines the cost of inventory based on the first-in, first-out method (FIFO). The Company regularly reviews the quantity of inventories on hand and compares these quantities to the expected usage of each applicable product or product line. The Company’s inventories are adjusted in value to the lower of costs and/or net realizable value. Since the value of the Company’s inventories depends in part on the Company’s estimates of each product’s net realizable value, adjustments may be needed to reflect changes in valuation. Any adjustments the Company is required to make to lower the value of the inventories are recorded as a charge to cost of sales.

      For more information on the Company’s inventory valuation, please see Note 1 to the financial statements included in this report.

RESULTS OF OPERATIONS

      The following table sets forth the percentage of net sales of certain items in our consolidated statements of operations for the periods indicated.

FISCAL YEAR ENDED DECEMBER 31, 2004 AS COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 2003

      Net Sales. Net sales increased 91.8% from $28.5 million in 2003 to $54.6 million in 2004. The 2004 increase in net sales was primarily for the Company’s Surface Mount Technology (114% increase) and Semi Packaging (173% increase) systems as the markets for these products rebounded from the market slowdown of the past few years.

      The percentage of net sales attributable to our customers in the United States decreased in 2004 by 3.7%, net sales attributable to our customers in Europe decreased by 1.0%, net sales attributable to our Asia Pacific customers increased by 4.7% and net sales attributable to our customers in the other Americas remained the same as compared to 2003. The decrease in the percentage of net sales to United States customers reflects the shift in the electronics business to Asia Pacific. This continuing revenue shift from the United States to Asia is indicative of our USA based multinational customers transferring their manufacturing operations from domestic facilities to Asian operations to attain lower costs and be closer to their markets. The Company has moved within this same direction and has established furnace assembly operations in China to attain lower costs and be closer to the expanding Asian market.

      Gross Profit. Gross profit increased 105.5% from $6.4 million in 2003 to $13.1 million in 2004 and, as a percentage of net sales, increased slightly from 22.4% in 2003 to 24.0% in 2004. The increase in gross profit for 2004 was primarily the result of a rebound in the Company’s revenue.

      Selling, General and Administrative. Selling, general and administrative costs increased 22.4% from $9.4 million in 2003 to $11.5 million in 2004, and as a percentage of net sales, decreased from 33.0% to 21.1%. The increase in costs in 2004 was primarily the result of higher commission expenditures to support the Company’s increased sales. The decreases in selling, general, and administrative costs for 2004 versus 2003 as a percentage of net sales was primarily the result of higher revenue and a continuation of expenditures in 2004 for sales, service, marketing and administrative functions near 2003 levels.

      Research, Development and Engineering. Research, development and engineering costs increased 9.1% from $3.4 million in 2003 to $3.7 million in 2004, and as a percentage of net sales, decreased from 11.9% in 2003 to 6.8% in 2004. In 2004, the Company continued it’s spending on new product development to meet the future product needs of its customers.

      Restructuring. In the third quarter of 2004, the Company recorded a $1.6 million restructuring charge. In summary, these charges were the result of a redirection of development programs, resulting in the write-off of assets including the impairment of goodwill from an acquisition, and severance costs, primarily related to the departure of the previous CEO.

      Sagarus Robotics Corporation was acquired in April 2003 with the intent to use the technology acquired to provide BTU supplied robotic automation in its wafer bump processing equipment. The Company’s efforts have proven commercially unsuccessful and BTU decided to supply robotic automation on its equipment from other established automation vendors.

      Approximately $1.3 million of the $1.6 million restructuring charge is related to asset write-offs ($438K goodwill; $676K inventory) and severance costs as a result of a redirection of the Company’s development programs for robotic automation of its wafer bump processing equipment. This $1.3 million portion of the restructuring charge represents the Company’s decision to abandon its plans for BTU supplied robotic automation and instead, offer for sale with its thermal processing equipment commercially available robotics from other existing robotic suppliers.

      The remaining approximately $0.3 million charge is primarily for the severance costs of the former CEO. Payments may continue until September 2005.

      The Company reduced its Billerica, MA work force by 11 employees (7 direct labor, 2 mfg. engineering and 2 finance) with an expected annual savings of $0.6 million. Severance payments for these reductions will end in the first quarter of 2005.

      In the second quarter 2003, the Company reduced its overhead personnel to better align its spending with the reduced level of sales. The $190,000 restructuring charge represents severance costs for the laid-off employees.

      Operating Loss. Operating loss decreased 43.5% from $(6.6) million in 2003 to $(3.7) million in 2004, and as a percentage of net sales, operating loss decreased from (23.2)% in 2003 to (6.8)% 2004. The decrease in operating loss for 2004 was primarily the result of increased net sales.

      Interest (expense). Interest expense increased by 27% from $371,000 in 2003 to $470,000 in 2004 primarily as a result of increased borrowings by the Company on its line of credit with the bank.

      Other income (expense), net. The Company recorded a $154,000 expense in the fourth quarter of 2003 in conjunction with entering into a new mortgage note. The expense represents the prepayment penalty required to terminate the old mortgage note.

      Income Taxes. The Company has recorded a full valuation allowance to offset the deferred tax asset arising principally as a result of the Company’s net operating loss carry forward due to the uncertainty surrounding realization. Accordingly, no income tax benefit is reflected in the statement of operations at December 31, 2004. The Company’s statutory federal income tax rate is 34%.

FISCAL YEAR ENDED DECEMBER 31, 2003 AS COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 2002

      Net Sales. Net sales decreased 7.0% from $30.6 million in 2002 to $28.5 million in 2003. Although total net sales for 2003 were slightly lower than in 2002, quarter on quarter net sales improved from a low of $5.7 million in Q4 2002 to $7.8 million in Q4 2003. The improving quarterly net sales are due to the beginnings of a recovery and increase in demand for the Company’s solder reflow systems. This increase was partially offset by decreases in product shipments of the Company’s advanced materials systems, whose markets have not rebounded.

      The percentage of net sales attributable to our customers in the United States decreased in 2003 by 14.9%, net sales attributable to our customers in Europe increased by 1.6%, net sales attributable to our Asia Pacific customers increased by 16.7% and net sales attributable to our customers in the other Americas decreased by 3.4% as compared to 2002. The decrease in the percentage of net sales to United States and other Americas customers reflects the shift in the electronics business to Asia Pacific. The effect of price discounting primarily for SMT products has materially impacted the change in net sales for the periods presented.

      Gross Profit. Gross profit decreased 33.4% from $9.6 million in 2002 to $6.4 million in 2003 and, as a percentage of net sales, decreased from 31.3% in 2002 to 22.4% in 2003. The decrease in gross profit and gross profit percentage for 2003 was primarily the result of a change in product mix and selling price pressures. In 2003, the Company experienced a decrease in demand for its products in the advanced materials market. The decreased demand resulted in an under absorption of costs in 2003. Even with the increase in demand for solder reflow systems, significant price pressure has continued to depress the margins for solder reflow systems through 2003.

      Selling, General and Administrative. Selling, general and administrative costs decreased 29.8% from $13.4 million in 2002 to $9.4 million in 2003, and as a percentage of net sales, decreased from 43.8% to 33.0%. The decreases in selling, general, and administrative costs for 2003 versus 2002 for both spending and as a percentage of net sales were the result of lower expenditures for sales, service, marketing and administrative functions, as the Company reduced its workforce to reflect the existing sales levels.

      Research, Development and Engineering. Research, development and engineering costs decreased 5.6% from $3.6 million in 2002 to $3.4 million in 2003, and as a percentage of net sales, increased from 11.7% in 2002 to 11.9% in 2003. In 2003, the Company continued it’s spending, at 2002 levels on new product development as it prepares for the future product needs of its customers.

      Restructuring. In the second quarter of 2003, the Company reduced its overhead personnel to better align its spending with the current economic market for its products. The $190,000 restructuring charge represents severance costs for these employees.

      Operating Loss. Operating loss decreased 24.1% from $(8.7) million in 2002 to $(6.6) million in 2003, and as a percentage of net sales, operating loss decreased from (28.6)% in 2002 to (23.2)% 2003. The decrease in operating loss for 2003 is primarily the result of reduced selling, general and administrative spending.

      Other income (expense), net. The Company recorded a $154,000 expense in the fourth quarter of 2003 in conjunction with entering into a new mortgage note. The expense represents the prepayment penalty required to terminate the old mortgage note.

      Income Taxes. Due to the uncertainty surrounding realization, the Company has recorded at December 31, 2003 a full valuation allowance to offset its deferred tax asset arising as a result of its available tax net operating loss carry forward. The income tax benefit of $222,000 reflected in the statement of operations for the year 2003 represents an additional carry back allowance calculated in the Company’s 2002 federal tax return. This carry back claim is a refund of taxes paid in prior periods, which the Company received in the third quarter 2003. The Company’s statutory federal income tax rate is 34%.

LIQUIDITY AND CAPITAL RESOURCES

      As of December 31, 2004, we had $0.4 million in cash and cash equivalents. During 2004, the Company used cash resources of approximately $7.9 million for operating activities. This use of cash was primarily the result of net losses of $4.2 million, an increase in accounts receivable of $3.1 million, an increase in inventory of $5.6 million; offset by a decrease in other assets of $0.5 million, an increases in accounts payable of $2.9 million, increases in accrued expenses of $0.8 million and depreciation of $0.9 million.

      The Company has a secured revolving loan agreement with a US bank that allows for aggregate borrowings, including letters of credit, up to a maximum of $14 million against a borrowing base of secured accounts receivable and inventory. The Company may elect to borrow at interest rates of either the prime rate or a rate pegged to the LIBOR rate in effect from time to time. This loan agreement extends to May 31, 2007 and is subject to maintaining certain financial covenants. At December 31, 2004 borrowings outstanding under this agreement were $2.2 million and the borrowing base formula permitted aggregate borrowings of approximately $8.7 million.

      As a result of a decrease in tangible net worth following the write-off of the $1.6 million restructuring charge at the end of the third quarter of 2004 and an increase in borrowings, the Company was out of compliance with its total liabilities to tangible net worth covenant under the loan agreement at October 3, 2004. The Company was in compliance with all financial covenants at December 31, 2004 and the Company has provided the bank with forecasted financial statements that show the Company is projecting to be in compliance with all financial covenants for all of 2005.

      Although the non-compliance at the end of the third quarter has not been waived, the bank has continued to lend funds to the Company under the terms of the existing loan agreement.

      On March 29, 2005, the bank proposed a waiver for the third quarter 2004 covenant non-compliance which would amend the loan agreement in several respects: the maximum lending under the line of credit would be reduced from $14 million to $12 million; the borrowing base formula would be revised to reduce availability based on inventories and lower the percentage loaned against certain foreign accounts receivable; and the interest rate on borrowings would be increased to prime plus 0.5%. Upon meeting certain profitability goals for 2005, the maximum lending would return to $14 million, the existing availability based on inventories would be reinstated, and the interest rate on borrowings would return to the prime rate. In addition, the bank requested that the Company use its best efforts to obtain for the bank a second mortgage on the Company’s headquarters building and provide the bank with a negative pledge that would prevent any other party from obtaining a second mortgage on the property if the second mortgage could not be obtained.

      The Company is actively discussing the proposed changes to the loan agreement with the bank, and believes it will conclude its discussions with the bank on terms that are acceptable to both parties. Based on its 2005 forecasted business plan, the borrowing base changes and other reductions in availability proposed by the bank would provide sufficient credit for the Company’s anticipated working capital needs for all of 2005. As discussed under “Risk Factors”, the Company will need continued access to working capital to fund its operations.

      The Company entered into a mortgage note in December 2003 that is secured by our real property in Billerica, MA. The mortgage note had an outstanding balance at December 31, 2004 of approximately $5.4 million. The mortgage requires monthly payments of $38,269, which includes interest calculated at the rate of 5.42% per annum. A final balloon payment of approximately $5.1 million is due on December 26, 2006 upon maturity of the mortgage note.

      In 2004, the Company had significant changes in its cash position, borrowings on its line of credit, accounts receivable, inventories and accounts payable. The changes are the result of operating losses and an expansion in working capital to support the rebound in the Company’s markets.

      The Company conducts its UK operations in a facility that is under a long-term operating lease expiring in March 2010. Rent expense under this lease was approximately $200,000 in 2004, $196,000 in 2003, and $170,000 in 2002. The Company has a lease of approximately $200,000 in rent expense per year through March 2010. As of December 31, 2004, the future minimum lease commitment for this facility is $1,050,000, payable as follows: $200,000 for each of the years 2005 through 2009, $50,000 for 2010.

      The Company does not have any material commitments for capital expenditures.

      The Company’s business forecasts project that our cash position, cash flow and our working capital line of credit will be sufficient to meet our corporate, operating and capital requirements throughout 2005.

CONTRACTUAL OBLIGATIONS

      The Company’s contractual obligations at December 31, 2004 were:

OTHER MATTERS

      The impact of inflation and the effect of foreign exchange rate changes during 2004 have not had a material impact on our business and financial results.

RISK FACTORS

      Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission, are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K.

      Our business depends predominantly on the capital expenditures of electronics and semiconductor manufacturers, which in turn depend on current and anticipated market demand for printed circuit board and integrated circuits and the products that use them. The electronics and semiconductor industry has historically been very cyclical and has experienced periodic downturns that have had a material adverse effect on the demand for electronic and semiconductor processing equipment, including equipment that we manufacture and market. The rate of changes in demand is accelerating, rendering the global electronic and semiconductor industry increasingly volatile. During periods of reduced and declining demand, we must be able to quickly and effectively align our costs with prevailing market conditions, as well as motivate and retain key employees. In particular, our inventory levels during periods of reduced demand have at times been higher than optimal, relative to the current levels of production demand. We cannot provide any assurance that we may not be required to make inventory valuation adjustments in future periods. During periods of rapid growth, we must be able to acquire and/or develop sufficient manufacturing capacity to meet customer demand, and hire and assimilate a sufficient number of qualified people. Our business may be adversely affected if we fail to respond to rapidly changing industry cycles in a timely and effective manner.

      In 2004 the Company began manufacturing operations in a new leased facility in Shanghai, China. The volume and variety of the Company’s products produced in China is expected to continue to increase throughout 2005. The successful operation of our China facility is important to restoring our business to profitability and allowing us to remain competitive. We need to address successfully, the transitional leadership, management, technical and administrative organization requirements of doing business in China. If we are not successful in managing our China operation, our business and profitability will be adversely affected. In addition, during 2005, the Company plans to begin the construction of an additional building, which will be leased, and we will need to execute this expansion successfully to realize the benefit of our China operations in 2006 and beyond.

      The Sarbanes-Oxley Act of 2002 imposed many new requirements on public companies, the most significant of which involves the documentation, testing and auditing of our internal control over financial reporting. Although we are not required to be in compliance until our annual report for the year ended December 2006, we must begin now to document and test our internal controls in a way that we have never before been required to do as a small company. We expect this effort will involve substantial time and expense, and we cannot be sure that we will be able to complete the task or that our internal controls will meet the standards that are currently required. If we fail to comply with these requirements involving internal controls, investor confidence in our company might suffer, which could result in a decline in our stock price.

      The electronics market that we serve may have a significantly higher growth. We need access to credit to take advantage of a higher growth rate and allow us to meet the demand for our products. As a result of our non-compliance with a bank covenant at the end of the third quarter of 2004, and as a condition to waiving that non-compliance our bank has proposed additional restrictions on our ability to borrow. Although we believe this proposal provides us with a sufficient amount of credit we need for our 2005 forecasted business plan, it may not be sufficient to allow us to take full advantage of significantly higher increases in orders for our products. In addition, if we do not continue to comply with our bank covenants, we may not be able to borrow and our business would be adversely affected.

      The Company’s manufacturing business system is at end-of-life, potentially posing a risk to the operation of the business. Some of the computer system hardware and software have limited support, which could result in an interruption in business activities. Solutions to address these risks are being developed.

RECENT ACCOUNTING DEVELOPMENTS

      On April 30, 2003, the FASB issued Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“FAS 149”). FAS 149 amends and clarifies the accounting guidance on (1) derivative instruments (including certain derivative instruments embedded in other contracts) and (2) hedging activities that fall within the scope of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). FAS 149 amends FAS 133 to reflect decisions that were made: as part of the process undertaken by the Derivatives Implementation Group (“DIG”), which necessitated amending FAS 133; in connection with

other projects dealing with financial instruments; and regarding implementation issues related to the application of the definition of a derivative. FAS 149 also amends certain other existing pronouncements, which will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. FAS 149 is effective (1) for contracts entered into or modified after September 30, 2003, with certain exceptions, and (2) for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. The adoption of this statement did not have a material impact on the Company’s financial position or results of operations.

      FASB Statement No. 123 (Revised 2004), Share-Based Payment (SFAS 123(R)) was issued in December 2004. SFAS 123(R) replaces SFAS No. 123; Accounting for Stock-Based Compensation (SFAS 123), and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires companies to recognize the compensation cost related to share-based payment transactions with employees in the financial statements. The compensation cost is measured based upon the fair value of the instrument issued. Share-based compensation transactions with employees covered within SFAS 123(R) include stock options, restricted share plans, performance-based awards, share appreciation rights, and employee stock purchase plans. SFAS 123 included a fair-value-based method of accounting for share-based payment transactions with employees, but allowed companies to continue to apply the guidance in APB 25 provided that they disclose in the footnotes to the financial statements the pro forma net income if the fair-value-based method been applied. The Company currently uses the fair value based method for recognition of compensation expense under SFAS 123. SFAS 123(R) requires the use of the modified prospective application transition method. The modified prospective application transition method requires the application of this standard to:

      For unvested awards, the compensation cost related to the remaining “requisite service” that has not been rendered at the effective date will be determined by the compensation cost calculated currently for either recognition under SFAS 123. We will be adopting the modified prospective application of SFAS 123(R). Based on the current options outstanding, we do not anticipate the adoption of this statement to result in the recognition of material additional compensation cost in the year of adoption.

      SFAS No. 151, Inventory Costs — An amendment of ARB No. 43, Chapter 4 (SFAS 151) was issued in November 2004. SFAS 151 reinforces that abnormal levels of idle facility expense, freight, handling costs and spoilage are required to be expensed as incurred and not included in overhead. The statement also requires fixed production overheads be allocated to conversion costs based on the production facility’s normal capacity. The provisions in Statement 151 are effective prospectively for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not expected to have a material impact on the consolidated financial statements.

MARKET RISK DISCLOSURE

      Our primary market risk exposure is in the area of foreign currency exchange rate risk as we are exposed to currency exchange rate fluctuations as they pertain to invoices for parts and labor in our foreign service locations.

      As of December 31, 2004, all of our long-term debt and capital lease obligations are fixed rate financial instruments. Therefore we are not exposed to interest rate risk resulting from variable interest rate of our debt.

      The information required by item 8 of Form 10-K is presented here in the following order:

UNAUDITED QUARTERLY RESULTS OF OPERATIONS

      The following table presents unaudited statement of operations data for each of the eight quarters in the period ended December 31, 2004 with such data expressed as a percentage of net sales for the period indicated. We believe that all necessary adjustments have been included to present fairly the quarterly information when read in conjunction with our consolidated financial statements. The operating results for any quarter are not necessarily indicative of the results for any subsequent period.

SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA

      During the eight quarters in 2003 and 2004, net sales ranged from a high of $15.4 million to a low of $6.7 million. This increase was primarily in the Company’s Surface Mount Technology and Semi Packaging products.

      Gross profits as a percentage of net sales during the last eight quarters began at 27.1% and ended at 27.1%. Gross profit as a percent of net sales during 2004 was unchanged from 2003 due to the product mix, price pressure and the under absorption of overhead.

      Selling, general and administrative costs during the last eight quarters in 2003 and 2004 increased from a low of $2.0 million to a high of $3.2 million. Higher costs were incurred in the last three quarters in 2004 due principally to the increase in commission expense related to the increase in sales. The decrease in S, G & A as a percentage of sales, from 40.2% in 2003 to 18.8% in 2004 was the result of maintained S, G & A expenses at 2003 levels and an increase in net sales.

      Research, development and engineering costs for all 2003 and 2004 quarters remained relatively flat in dollars of spending as the Company maintained its level of expenses.

      Income (loss) from operations decreased during the quarters of 2004 vs. 2003. The decrease in the loss from operations for the year 2004 was primarily the result of the increase in net sales versus 2003.

BTU INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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

BTU INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

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

BTU INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(IN THOUSANDS)

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

BTU INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(IN THOUSANDS)

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

BTU INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

Supplemental disclosures of cash flow information are included in Note 10.

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

BTU INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2004, 2003 AND 2002

      BTU International, Inc. and its wholly owned subsidiaries (the Company) are primarily engaged in the design, manufacture, sale, and service of thermal processing systems, which are used as capital equipment in various manufacturing processes, primarily in the electronics industry.

      The accompanying consolidated financial statements include the accounts of the Company. All material intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The primary estimates used in the consolidated financial statements include percent complete revenue and inventory reserves.

      The Company has classified certain liquid financial instruments, with original maturities of less than three months, as cash equivalents. These financial instruments are carried at cost, which approximates fair value.

      Accounts receivable are stated at the amount management expects to collect from outstanding balances. An allowance for doubtful accounts is provided for those accounts receivable considered to be uncollectible based upon historical experience and management’s evaluation of outstanding accounts receivable at the end of the year. Bad debts are written off against the allowance when identified. Bad debt expense was $0, $0 and $90,000 for 2004, 2003 and 2002, respectively. Although the accounts receivable increased by 51% for 2004 as compared to 2003, the Company has maintained the same year-to-year level of reserve for bad debt at $172,000 because of its low historical write off experience.

      Inventories consist of material, labor and manufacturing overhead and are valued at the lower of cost or net realizable value. Cost is determined by the first-in, first-out (FIFO) method for all inventories.

      Inventories consist of the following (in thousands):

      The Company periodically reviews quantities of inventory on hand and compares these amounts to expected usage of each particular product or product line. In 2004, 2003 and 2002, respectively, $212,300, $200,000 and $411,000 were recorded as a charge to cost of goods sold to provide for excess and obsolete

BTU INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

inventories. The Company also records, as a charge to cost of goods sold, any amounts required to reduce the carrying value of the finished goods inventory to net realizable value. In 2004, 2003, and 2002, respectively, $413,236, $389,000 and $756,000 were recorded as a charge to cost of goods sold to reduce the carrying value of inventory to net realizable value.

      The Company provides for depreciation using the straight-line method over the assets’ useful lives. The estimated useful lives for depreciation purposes are as follows:

      Depreciation expense was $902,000, $1,062,000 and $1,274,000 for the years ended December 31, 2004, 2003 and 2002, respectively.

      Maintenance and repairs are charged to operations as incurred. When equipment and improvements are sold or otherwise disposed of, the asset cost and accumulated depreciation are removed from the accounts, and the resulting gain or loss, if any, is included in the results of operations.

      The Company evaluates long-lived assets such as intangible assets and property, plant and equipment under Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). This statement requires that long-lived asset and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. SFAS 144 requires (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale.

      Other assets consist of the following:

      The Company’s restricted cash represents an interest bearing cash deposit in an escrow account with our mortgage note holder that becomes available upon the Company achieving two consecutive quarters of profitability.

      Deferred financing costs capitalized in 2004, are being amortized over three years, the term of the mortgage note. Amortization on deferred financing costs was $84,000, $13,000 and $25,000 in 2004, 2003 and 2002, respectively. Amortization on intellectual property acquired in 2003 was $39,000 in both 2004

BTU INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

and 2003. The goodwill intellectual property was written-off in the third quarter 2004 as part of the $1.6 million restructuring charge.

      Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. The amounts of deferred tax assets or liabilities are based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

      Assets and liabilities of the Company’s foreign operations are translated from their functional currency into United States dollars at year end exchange rates. Revenue and expense items are translated at weighted average rates of exchange prevailing during the year. Gains and losses arising from translation are accumulated as a separate component of stockholders’ equity, as the functional currency of the subsidiaries is their local currency, and the reporting currency of the Company is the US dollar. Exchange gains and losses (if any) arising from transactions denominated in foreign currencies are included in income as incurred. Such exchange gains or losses were not material during the periods presented.

      The Company has patents in the United States and certain foreign countries for some of its products and processes. No value has been assigned to these patents in the accompanying consolidated financial statements.

      The Company recognizes revenue in accordance with the Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements” as updated by SEC Staff Accounting Bulletin No. 104, “Revenue Recognition”. Under these guidelines, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services rendered, the price is fixed or determinable and payment is reasonably assured. Under these requirements, when the terms of sale include customer acceptance provisions, and compliance with those provisions has not been previously demonstrated, revenues are recognized upon acceptance. Furthermore, revenues for products that require installation for which the installation is essential to functionality or is not deemed inconsequential or perfunctory are recognized upon completion of installation. Revenues for products sold where installation is not essential to functionality and is deemed inconsequential or perfunctory are recognized upon shipment with estimated installation and warranty costs accrued.

      Applying the requirements of SAB No. 101 to future sales arrangements used in the Company’s equipment sales may result in the deferral of the revenue for some equipment sales.

      The Company also has certain sales transactions for products, which are not completed within the normal operating cycle of the business. It is the Company’s policy to account for these transactions using the percentage of completion method for revenue recognition purposes when all of the following criteria exist. (1) The Company has received the Customer’s purchase order or entered into a legally binding contract. (2) The Customer is credit worthy and collection is probable or Customer prepayments are required at product completion milestones or specific dates. (3) The sales value of the product to be delivered is significant in amount when compared to the Company’s other products. (4) Product costs can be reasonably estimated; there is no major technological uncertainty and the total engineering, material procurement, product assembly and test cycle time extend over a period of six months or longer.

BTU INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Under the percentage of completion method, revenues and gross margins to date are recognized based upon the ratio of costs incurred to date compared to the latest estimate of total costs to complete the product as a percentage of the total contract revenue for the product. Revisions in costs and gross margin percentage estimates are reflected in the period in which the facts causing the revision become known. Provisions for total estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. For the year ended 2004, 2003 and 2002, $1,570,165, $639,545 and $432,266, respectively, was recognized as revenue using the percentage of completion method.

      There are no post shipment obligations that could impact revenue recognition.

      The Company accounts for shipping and handling costs billed to customers in accordance with the Emerging Issues Task Force (EITF) Issue 00-10 “Accounting for Shipping and Handling Fees and Cost”. Amounts billed to customers for shipping and handling costs are recorded as revenues with the associated costs reported as cost of goods sold. In 2004 and 2003, $409,630 and $263,107, respectively, were recorded as cost of goods sold. In 2002, $159,966 was recorded as a charge to selling, general, and administrative expense.

      Research, development and engineering costs are charged to expense as incurred.

      Basic Earnings Per Share (EPS) is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common and dilutive potential common shares outstanding during the period, using the treasury stock method. The number of Common shares underlying options outstanding that were not included in the determination of diluted EPS, because their effect would be antidilutive, was 729,139 in 2004, 1,186,395 in 2003 and 1,258,398 in 2002, as of December 31.

      On April 30, 2003, the FASB issued Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“FAS 149”). FAS 149 amends and clarifies the accounting guidance on (1) derivative instruments (including certain derivative instruments embedded in other contracts) and (2) hedging activities that fall within the scope of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). FAS 149 amends FAS 133 to reflect decisions that were made: as part of the process undertaken by the Derivatives Implementation Group (“DIG”), which necessitated amending FAS 133; in connection with other projects dealing with financial instruments; and regarding implementation issues related to the application of the definition of a derivative. FAS 149 also amends certain other existing pronouncements, which will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. FAS 149 is effective (1) for contracts entered into or modified after September 30, 2003, with certain exceptions, and (2) for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. The adoption of this statement did not have a material impact on the Company’s financial position or results of operations.

      FASB Statement No. 123 (Revised 2004), Share-Based Payment (SFAS 123(R)) was issued in December 2004. SFAS 123(R) replaces SFAS No. 123; Accounting for Stock-Based Compensation (SFAS 123), and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires companies to recognize the compensation cost related to share-based payment transactions with employees in the financial statements. The compensation cost is measured based upon

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the fair value of the instrument issued. Share-based compensation transactions with employees covered within SFAS 123(R) include stock options, restricted share plans, performance-based awards, share appreciation rights, and employee stock purchase plans. SFAS 123 included a fair-value-based method of accounting for share-based payment transactions with employees, but allowed companies to continue to apply the guidance in APB 25 provided that they disclose in the footnotes to the financial statements the pro forma net income if the fair-value-based method been applied. The Company currently uses the fair value based method for recognition of compensation expense under SFAS 123. SFAS 123(R) requires the use of the modified prospective application transition method. The modified prospective application transition method requires the application of this standard to:

      For unvested awards, the compensation cost related to the remaining “requisite service” that has not been rendered at the effective date will be determined by the compensation cost calculated currently for either recognition under SFAS 123. We will be adopting the modified prospective application of SFAS 123(R). Based on the current options outstanding, we do not anticipate the adoption of this statement to result in the recognition of material additional compensation cost in the year of adoption.

      SFAS No. 151, Inventory Costs — An amendment of ARB No. 43, Chapter 4 (SFAS 151) was issued in November 2004. SFAS 151 reinforces that abnormal levels of idle facility expense, freight, handling costs and spoilage are required to be expensed as incurred and not included in overhead. The statement also requires fixed production overheads be allocated to conversion costs based on the production facility’s normal capacity. The provisions in Statement 151 are effective prospectively for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not expected to have a material impact on the consolidated financial statements.

      Certain prior year financial statement information has been reclassified to conform with the current year presentation.

      Accrued expenses at December 31, 2004 and 2003 consisted of the following (in thousands):

      The Company provides standard warranty coverage for parts and labor for 12 months and special extended material only coverage on certain other products. The Company sets aside a reserve, charged to

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cost of sales, based on anticipated warranty claims at the time product revenue is recognized. The reserve for warranty covers the estimated costs of material, labor and travel. Actual warranty claims incurred are charged against the accrual. Factors that affect the Company’s product warranty liability include the number of installed units, the anticipated cost of warranty repairs and historical and anticipated rates of warranty claims.

      The following table reflects changes in the Company’s accrued warranty account during the fiscal year ended December 31, 2004:

      The Company has a secured revolving loan agreement with a US bank that allows for aggregate borrowings, including letters of credit, up to a maximum of $14 million against a borrowing base of secured accounts receivable and inventory. The Company may elect to borrow at interest rates of either the prime rate or a rate pegged to the LIBOR rate in effect from time to time. This loan agreement extends to May 31, 2007 and is subject to maintaining certain financial covenants. At December 31, 2004 borrowings outstanding under this agreement were $2.2 million and the borrowing base formula permitted aggregate borrowings of approximately $8.7 million.

      As a result of a decrease in tangible net worth following the write-off of the $1.6 million restructuring charge at the end of the third quarter of 2004 and an increase in borrowings, the Company was out of compliance with its total liabilities to tangible net worth covenant under the loan agreement at October 3, 2004. The Company was in compliance with all financial covenants at December 31, 2004 and the Company has provided the bank with forecasted financial statements that show the Company is projecting to be in compliance with all financial covenants for all of 2005.

      Although the non-compliance at the end of the third quarter has not been waived, the bank has continued to lend funds to the Company under the terms of the existing loan agreement.

      On March 29, 2005, the bank proposed a waiver for the third quarter 2004 covenant non-compliance which would amend the loan agreement in several respects: the maximum lending under the line of credit would be reduced from $14 million to $12 million; the borrowing base formula would be revised to reduce availability based on inventories and lower the percentage loaned against certain foreign accounts receivable; and the interest rate on borrowings would be increased to prime plus 0.5%. Upon meeting certain profitability goals for 2005, the maximum lending would return to $14 million, the existing availability based on inventories would be reinstated, and the interest rate on borrowings would return to the prime rate. In addition, the bank requested that the Company use its best efforts to obtain for the bank a second mortgage on the Company’s headquarters building and provide the bank with a negative pledge that would prevent any other party from obtaining a second mortgage on the property if the second mortgage could not be obtained.

      The Company is actively discussing the proposed changes to the loan agreement with the bank, and believes it will conclude its discussions with the bank on terms that are acceptable to both parties. Based

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on its 2005 forecasted business plan, the borrowing base changes and other reductions in availability proposed by the bank would provide sufficient credit for the Company’s anticipated working capital needs for all of 2005. As discussed under “Risk Factors”, the Company will need continued access to working capital to fund its operations.

      Long Term Debt at December 31, 2004 and 2003 consisted of the following (in thousands):