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BTU INTERNATIONAL INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 12, 2014

BTU International, Inc. (the "Company"), which was founded in 1950, was incorporated as a Delaware corporation in 1981 and is headquartered in North Billerica, Massachusetts. The Company operates as a single business segment called Thermal Processing Capital Equipment. The Company's business consists of designing, manufacturing, selling and servicing thermal processing equipment and related process controls for use in the electronics, alternative energy, automotive and other industries. This includes the supply of solder reflow systems used for surface mount applications in printed circuit board assembly and semiconductor packaging applications. Thermal processing equipment is used in low temperature curing/encapsulation, hybrid integrated circuit manufacturing, integrated circuit packaging and sealing, and processing multi-chip modules. In addition, the equipment is used for solar cell processing, sintering nuclear fuel for commercial power generation, brazing and sintering of ceramics and powdered metals, and depositing precise thin film coatings. The Company's customers are multinational original equipment manufacturers and contract manufacturing companies. The Company's customers require high throughput, high yield and highly reliable thermal processing systems with tightly controlled temperature and atmospheric parameters. In electronics assembly, the Company's convection solder reflow systems are used to attach electronic components to the printed circuit boards, primarily in the advanced, high-density, surface mount segments of this market. In the semiconductor market, the Company participates in both wafer level and die level packaging, where its thermal processing systems are used to connect and seal integrated circuits into a package. In the alternative energy market, the Company offers processing equipment for the production of both silicon solar cells and thin film photovoltaics. The Company is also the key provider for customers who use its thermal systems for the processing of nuclear fuel.



RESULTS OF OPERATIONS

Three months ended June 29, 2014 compared to the three months ended June 30, 2013.

The following table sets forth certain items in the Company's Consolidated Statements of Operations as a percentage of net sales for the periods indicated.

Summary Condensed Consolidated Statements of Operations

Three Months Ended June 29, 2014 June 30, 2013 ($ in thousands) % of % of Percent Net Sales Net Sales Change Net sales $ 16,435 100.0 % $ 14,244 100.0 % 15.4 % Cost of goods sold 9,559 58.2 % 8,850 62.1 % 8.0 % Gross profit 6,876 41.8 % 5,394 37.9 % 27.5 % Selling, general and administrative expenses 5,091 31.0 % 4,355 30.6 % 16.9 % Research, development and engineering expenses 1,029 6.3 % 1,017 7.1 % 1.2 % Operating income 756 4.6 % 22 0.2 % 3336.4 % Income (loss) before provision for income taxes 723 4.4 % (107 ) (0.8 )% (775.7 )% Provision for income taxes 129 0.8 % 154 1.1 % (16.2 )% Net income (loss) $ 594 3.6 % $ (261 ) (1.8 )% (327.6 )% Net Sales. Net sales for the second quarter of 2014 were $16.4 million representing an increase of $2.2 million, or 15.4%, as compared to the same period in the prior year. Net sales of electronic market systems increased by $0.6 million, or 4.6%, as compared to the same period in the prior year. Net sales of alternative energy systems increased by $0.3 million, as compared to the same period in the prior year. Net sales for other market systems, parts and service increased by $1.3 million, or 93.2%, as compared to the same period in the prior year. The electronic market systems increase represents an increase in demand for Surface Mount Technology systems, particularly in Asia. The increase in alternative energy sales is mainly due to increased nuclear product sales. The Company's overall alternative energy sales continue to be low due to the continued weakness of the worldwide solar industry which started in the second quarter of 2011. The increase in sales in the other market systems, parts and service is primarily due to $1.1 million in other market custom sales in the second quarter of 2014 compared to no other market custom sales in the second quarter of 2013. 12



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The following table sets forth, for the periods indicated, revenues from sales into select geographies expressed in dollars per thousand and as a percentage of total revenue. The values shown represent the amount sold into each of the listed geographical areas. Three Months Ended June 29, 2014 June 30, 2013 ($ in thousands) % of % of $ Revenues $ Revenues United States $ 2,255 13.7 % $ 1,836 12.9 % Europe, Near East 1,994 12.1 % 867 6.1 % Asia Pacific 10,569 64.3 % 10,810 75.9 % Other Americas 1,617 9.9 % 731 5.1 % Total Revenue $ 16,435$ 14,244 Gross Profit. In the second quarter of 2014, gross profit was $6.9 million, an increase of $1.5 million, as compared to the same period in the prior year due primarily to the 15.4% increase in net sales. In the second quarter of 2014, gross profit as a percentage of sales increased to 41.8% as compared to 37.9% in the same period in the prior year. This increase in the second quarter of 2014 was mainly the result of product sales mix, lower inventory reserves and lower under-absorption in the Company's factories as compared to the same period in the prior year. Selling, General and Administrative (SG&A). SG&A second quarter 2014 expenses of $5.1 million increased by $0.7 million as compared to the same period in the prior year. The prior year comparable period had bad debt recovery income, which did not occur in the second quarter of 2014. Additionally, compared to the prior year comparable period, there was an increase in legal expense as well as an increase in warranty expense due to increased sales volume for the second quarter of 2014. Research, Development and Engineering (RD&E). RD&E second quarter 2014 expenses of $1.0 million remained relatively flat as compared to the same period in the prior year. Interest Income (Expense). In the second quarter of 2014, net interest expense remained relatively flat at $0.1 million as compared to the same period in the prior year. Foreign Exchange Income (Loss). The foreign exchange gain in the second quarter of 2014 was $41,000 as compared to a loss of $38,000 in the same period in the prior year. The net exchange gain or loss is primarily the result of foreign currency transactions in the Company's foreign operations for the applicable period. Income Taxes. For the three months ended June 29, 2014, the Company recorded an income tax provision of $129,000 as compared to an income tax provision of $154,000 for the same period in the prior year. The Company's income tax provision primarily relates to withholding taxes. The significant fluctuations in the Company's quarterly tax rate, as a percent of consolidated pre-tax income or loss, are the result of the different statutory tax rates in each of the Company's non-U.S. locations and the fluctuations of pre-tax income (loss) generated in these jurisdictions. A portion of the consolidated annual tax provision relates to Chinese withholding taxes which are not directly related to pre-tax income in China. Chinese withholding taxes primarily result from corporate royalty charges on net sales of the Company's Chinese manufacturing subsidiary. U.S. taxes have had no impact on the rate fluctuation as the U.S. entity operates at a loss for which no benefit is recognized due to valuation allowance. 13



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RESULTS OF OPERATIONS

Six months ended June 29, 2014 compared to the six months ended June 30, 2013.

The following table sets forth certain items in the Company's Consolidated Statements of Operations as a percentage of net sales for the periods indicated.

Summary Condensed Consolidated Statements of Operations

Six Months Ended June 29, 2014 June 30, 2013 ($ in thousands) % of % of Percent net sales net sales change Net sales $ 28,120 100.0 % $ 24,747 100.0 % 13.6 % Cost of goods sold 17,085 60.8 % 16,623 67.2 % 2.8 % Gross profit 11,035 39.2 % 8,124 32.8 % 35.8 % Selling, general and administrative expenses 9,701 34.5 % 9,009 36.4 % 7.7 % Research, development and engineering expenses 2,240 8.0 % 2,151 8.7 % 4.1 % Operating loss (906 ) (3.2 )% (3,036 ) (12.3 )% (70.2 )% Loss before provision for income taxes (994 ) (3.5 )% (3,301 ) (13.3 )% (69.9 )% Provision for income taxes 198 0.7 % 85 0.3 % 132.9 % Net loss $ (1,192 ) (4.2 )% $ (3,386 ) (13.7 )% (64.8 )% Net Sales. Net sales for the first six months of 2014 were $28.1 million representing an increase of $3.4 million, or 13.6%, as compared to the same period in the prior year. Net sales of electronic market systems increased by $1.4 million, or 6.8%, and net sales of alternative energy systems increased by $0.9 million, as compared to the same period in the prior year. Net sales for the Company's other market systems, parts and service sales increased by $1.0 million, or 32.0%, as compared to the same period in the prior year. The electronic market systems increase represents an increase in demand for Surface Mount Technology systems, particularly in Asia. The increase in alternative energy sales is mainly due to increased nuclear product sales. The Company's overall alternative energy sales continue to be low due to the continued weakness of the worldwide solar industry which started in the second quarter of 2011. The increase in sales in the other market systems and parts and service is primarily due to $1.1 million of other market custom sales in the first six months of 2014 compared to no other market custom sales in the first six months of 2013. The following table sets forth, for the periods indicated, revenues from sales into select geographies expressed as a percentage of total revenues. The values shown represent the amount sold into each of the listed geographical areas. Six Months Ended June 29, 2014 June 30, 2013 ($ in thousands) % of % of $ revenues $ revenues United States $ 4,429 15.8 % $ 3,976 16.1 % Europe, Near East 4,917 17.5 % 2,688 10.8 % Asia Pacific 16,426 58.4 % 16,449 66.5 % Other Americas 2,348 8.3 % 1,634 6.6 % Total Revenue $ 28,120$ 24,747 Gross Profit. The first six months of 2014 gross profit of $11.0 million increased by $2.9 million compared to the first six months of 2013 due primarily to the 13.6% increase in net sales. In the first six months of 2014, gross profit as a percentage of sales increased to 39.2% as compared to 32.8% in the same period in 2013, due primarily to product mix and improved overhead under absorption at our factories combined with lower inventory write-downs. The Company assesses inventory at each period end and records inventory write-downs as appropriate based on market conditions. Selling, General and Administrative (SG&A). SG&A first six months of 2014 expenses of $9.7 million increased by $0.7 million compared to the same period in the prior year. The prior year comparable period had bad debt recovery income, which did not occur in the first six months of 2014. Additionally, compared to the prior year comparable period, there was an increase in legal expense as well as an increase in warranty expense due to increased sales volume for the first six months of 2014.



Research, Development and Engineering (RD&E). RD&E first six months of 2014 expenses of $2.2 million remained relatively flat as compared to the same period in the prior year.

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Interest Income (Expense). In the first six months of 2014, net interest expense remained relatively flat at $0.2 million as compared to the same period in 2013.

Foreign Exchange Income (Loss). The foreign exchange gain in the first six months of 2014 was $56,000 as compared to a loss of $114,000 in the same period in the prior year. The net exchange gain or loss is primarily the result of foreign currency transactions in the Company's foreign operations in the applicable period.

Income Taxes. For the six months ended June 29, 2014, the Company recorded an income tax provision of $198,000 compared to a provision of $85,000 in the same period in the prior year. The Company's income tax provision primarily relates to withholding taxes. The significant fluctuations in the Company's quarterly tax rate, as a percent of consolidated pre-tax income or loss, are the result of the different statutory tax rates in each of the Company's non-U.S. locations and the fluctuations of pre-tax income (loss) generated in these jurisdictions. A portion of the consolidated annual tax provision relates to Chinese withholding taxes which are not directly related to pre-tax income in China. Chinese withholding taxes primarily result from corporate royalty charges on net sales of the Company's Chinese manufacturing subsidiary. U.S. taxes have had no impact on the rate fluctuation as the U.S. entity operates at a loss for which no benefit is recognized due to valuation allowance.



LIQUIDITY AND CAPITAL RESOURCES

In 2013, the Company's net cash used in operating activities was $5.8 million. In the first six months of 2014, the Company's net cash used in operating activities was $3.8 million. We recorded an operating loss of $9.7 million in 2013. Our operating loss was $0.9 million in the first six months of 2014. On June 29, 2014, the Company had cash and cash equivalents of approximately $10.0 million, a decrease of $4.0 million, compared to $14.0 million at December 31, 2013. During the six months ended June 29, 2014, the Company used net cash of approximately $3.8 million for operating activities. This use of cash was primarily the result of a net loss of $1.2 million, a decrease in deferred revenue of $0.9 million, an increase in accounts receivable of $2.5 million, an increase in inventory of $2.4 million, an increase in other assets of $0.6 million and a decrease in accrued expenses of $0.6 million; offset by an increase in accounts payable of $3.0 million, a decrease in other current assets of $0.2 million and the adding back of non-cash expenses for depreciation and amortization of $0.6 million, stock-based compensation of $0.3 million, and inventory provisions of $0.2 million. In recent years, the Company's sales have declined as we continue to experience a significant downturn in the solar industry. The electronics and semiconductor industries have historically been cyclical and have experienced periodic downturns which affect the demand for equipment that we manufacture and market. If the solar market does not improve, or if our products do not gain the acceptance we have planned, our cash resources will not allow us to continue making investments in the solar market and we will need to take action to restructure the Company. To conserve cash and manage the Company's liquidity, the Company has implemented certain expense reductions throughout 2013 and 2014. The Company will continue to assess its cost structure as it relates to its revenues and cash position in 2014, and may take further actions as it deems necessary. As of June 29, 2014, the Company has no material commitments relating to capital expenditures. There were no significant changes in the Company's commitments from those that were outlined in the "Contractual Obligations" section of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013. The Company's total current assets at June 29, 2014 were $36.6 million, current liabilities were $15.7 million and long-term debt was $7.0 million. Management believes it has sufficient resources to fund its planned operations over the next 12 months. Mortgage Note On March 30, 2006, the Company entered into a $10 million mortgage note secured by its real property in Billerica, Massachusetts, which had an initial maturity date of December 23, 2015. On September 9, 2010, the Company signed a First Loan Modification Agreement relating to the mortgage note, which reduced the annual interest rate from 6.84% to 5.50% and the monthly payment from $76,280 to $69,000 On September 26, 2013, the Company signed a Second Loan Modification Agreement relating to the mortgage note, which extended the maturity date from December 23, 2015 to September 26, 2023. The modification also reduced the annual interest rate from 5.50% to 4.43% through September 26, 2018, at which time the interest rate will be adjusted to a per annum fixed rate equal to the aggregate of the FHLB Five Year Classic Advance Rate plus two hundred forty basis points. The current monthly payment was reduced from $69,000 to $57,997. The mortgage note had an outstanding balance on June 29, 2014 of approximately $7.4 million. All outstanding principal and accrued and unpaid interest will be due and payable on the maturity date.



Letters of Credit

On August 31, 2009, the Company entered into a pledge and assignment agreement with a bank, pursuant to which the bank agreed to issue letters of credit which the Company will cash collateralize via restricted cash deposits at the bank. As of June 29, 2014, the value of the outstanding letters of credit issued by the bank for the Company was $254,084. This restricted cash value is included in the Company's balance sheet in other current assets. 15



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CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT ESTIMATES

During the six months ended June 29, 2014, there have been no significant changes to the items disclosed as the Company's critical accounting policies and estimates in the "Critical Accounting Policies and Significant Estimates" section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013. FORWARD LOOKING STATEMENTS This report contains forward-looking statements, including without limitation statements about the Company's expectation for minimal revenue from solar equipment in 2014 and the sufficiency of its cash position and cash flows. The words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "may," "intends," "believes," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are neither promises nor guarantees but rather are subject to risks and uncertainties described in this report and other reports the Company has filed with the SEC, which could cause actual results to differ materially from those described in the forward-looking statements. Such statements are made pursuant to the "safe harbor" provisions established by the federal securities laws, and are based on the assumptions and expectations of the Company's management at the time such statements are made. Important factors that could cause actual results to differ include, but are not limited to, the condition of the world economy, the timely availability and acceptance of new products in the electronics, semiconductor and alternative energy generation industries, manufacturing problems with the Company's foreign operations in China, the impact of competitive products and pricing, particularly from companies in Asia, and other risks detailed under the section entitled "Risk Factors" in the Company's most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission. Actual results may vary materially. Unless otherwise required by law, the Company disclaims any obligation to revise or update this information in order to reflect future events or developments, whether or not anticipated. Accordingly, you should not place undue reliance on any forward-looking statements, which speak only as of the date made.


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