ITEQ INC, 424B4, 1997-05-21

ITEQ INC
424B4, 1997-05-21
INDUSTRIAL & COMMERCIAL FANS & BLOWERS & AIR PURIFING EQUIP

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<PAGE> 1

LOGO Filed Pursuant to Rule 424(b)(4)
Registration No. 333-23245

- --------------------------------------------------------------------------------
5,050,000 SHARES
COMMON STOCK
- --------------------------------------------------------------------------------
Of the 5,050,000 shares of Common Stock offered hereby (the "Offering"),
4,300,000 shares are being sold by ITEQ, Inc. ("ITEQ" or the "Company") and
750,000 shares are being sold by certain stockholders of the Company (the
"Selling Stockholders"), certain of which shares may be sold in the United
Kingdom or otherwise outside of the United States. The Company will not receive
any of the proceeds from the sale of Common Stock by the Selling Stockholders.
See "Selling Stockholders."

The Common Stock is quoted on the Nasdaq National Market under the symbol
"ITEQ." On May 20, 1997, the last reported sale price of the Common Stock on the
Nasdaq National Market was $6 15/16 per share. See "Price Range of Common
Stock."

FOR INFORMATION CONCERNING CERTAIN FACTORS WHICH SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 6.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(1)(2) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per Share $6.875 $.43 $6.445 $6.445
Total(3) $34,718,750 $2,171,500 $27,713,500 $4,833,750
</TABLE>

(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other matters.
(2) Before deducting expenses of the Offering payable by the Company estimated
at $550,000.

(3) The Company has granted to the Underwriters a 30-day option to purchase up
to an additional 757,500 shares of Common Stock, solely to cover
over-allotments, if any. If all such shares are purchased, the total Price
to Public, Underwriting Discount, and Proceeds to the Company will be
$39,926,563, $2,497,225, and $32,595,588, respectively. See "Underwriting."

The shares of Common Stock are offered severally by the Underwriters, subject to
prior sale, when, as and if delivered to and accepted by them and subject to the
approval of certain legal matters by counsel and certain other conditions. The
Underwriters reserve the right to withdraw, cancel or modify such offer and to
reject orders in whole or in part. It is expected that delivery of the shares of
Common Stock will be made in New York, New York against payment therefor on or
about May 27, 1997.

DEUTSCHE MORGAN GRENFELL

EVEREN SECURITIES, INC.
SANDERS MORRIS MUNDY

The date of this Prospectus is May 20, 1997

<PAGE> 2

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING AND
MAY BID FOR AND PURCHASE SHARES OF COMMON STOCK IN THE OPEN MARKET. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."

2
<PAGE> 3

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information herein and in the
consolidated financial statements, including the notes thereto, appearing
elsewhere in this Prospectus. Unless otherwise indicated, all references to the
"Company" or to "ITEQ" refer to ITEQ, Inc., its predecessors and subsidiaries,
and all information in this Prospectus assumes that the Underwriters'
over-allotment option will not be exercised. See "Underwriting."

THE COMPANY

GENERAL

ITEQ is a rapidly growing provider of manufactured equipment, engineered
systems and services used in the processing, treatment and movement of gases and
liquids. It is the leading domestic manufacturer of shell and tube heat
exchangers, principally for petrochemical and refining applications, and a
leading producer of baghouses, scrubbers, fans and other filtration systems and
components for environmental and general industrial applications. ITEQ also
manufactures specialized process equipment, such as reactors, blenders, stacks,
towers, columns and pressure vessels, principally for the refining,
petrochemical and plastics industries. The Company operates internationally,
with its equipment, systems and services sold or utilized in over 30 countries
worldwide.

ITEQ believes that through acquisitions of complementary businesses it has
been able to capitalize on its relationships with existing customers through
cross-selling opportunities. Additionally, through its international
distribution network and broad offering of products and services, the Company
has benefitted from its customers' continuing consolidation of their sources of
supply.

In recent years, annual worldwide capital expenditures for hydrocarbon
process equipment and industrial air filtration equipment have averaged
approximately $40 billion, of which approximately 30% represents the domestic
market. Although there is no dominant manufacturer of equipment and systems for
the highly fragmented domestic markets served by the Company, ITEQ is the
largest domestic manufacturer of shell and tube heat exchangers, with a market
share of approximately 15%. Similarly, ITEQ believes it is one of the largest
domestic producers of certain industrial air filtration products for the
selected niche markets served and that its presence in the hydrocarbon process
equipment market is significant, particularly for thin-wall, large-diameter
vessels.

BUSINESS STRATEGY

The Company aspires to be a leading provider of manufactured equipment,
engineered systems and services used in the niche industrial markets in which it
operates and to expand its markets through acquisitions of complementary product
and service lines. ITEQ has experienced rapid growth since its inception in 1990
through a combination of strategic acquisitions and internal growth.

Acquisition Strategy. ITEQ pursues a strategy of acquiring leading
providers of complementary manufactured products and services in highly
fragmented industrial equipment markets, with a view to further consolidating
those markets. ITEQ believes it is one of the few domestic acquirers and
consolidators of businesses in those markets. In general, ITEQ pursues the
acquisition of businesses which satisfy most of the following criteria:

- Well managed, typically privately-held, domestic companies serving niche
industrial markets.

- Large defensible share of their respective markets, involving proven
technologies.

- Provide complementary products and services which afford cross-selling
opportunities or are direct competitors.

- Significant installed product bases and long operating histories.

- Potential for significant expansion into international markets.
3
<PAGE> 4

- Predictable cash flow and earnings potential.

- Potential for internal synergies and economies of scale.

ITEQ has made seven acquisitions to date, including the acquisition of
Ohmstede, Inc. ("Ohmstede") in November 1996, which contributed approximately
$100.2 million to the Company's pro forma 1996 revenues of $193.9 million. The
Company continually screens potential acquisition candidates, and ITEQ believes
that further acquisitions are likely in future periods, although no assurance
can be given that any additional acquisitions will be completed.

Internal Growth. The Company has experienced significant internal growth
in recent years despite operating in mature markets. This growth has resulted
from the Company's strategy of gaining additional market share by selling its
products, and those acquired through acquisitions, to existing and new customers
and industries, introducing new products, and developing its international
markets. In addition, each of the acquired businesses has a substantial
installed base of products, and ITEQ has achieved further revenue increases
through additional emphasis on the maintenance and refurbishment aftermarkets.

Increasingly, and consistent with ITEQ's overall growth strategy, major
industrial concerns are consolidating their sources of supply for goods and
services in an effort to obtain worldwide single-source suppliers for broad
ranges of systems, equipment and services. In fragmented markets such as those
served by the Company, further industry consolidation is to be expected. At
present, the Company believes that no other supplier of products and services to
the niche markets presently served offers as broad an array of products and
services as those offered by the Company. ITEQ believes its current product
lines and its acquisition strategy position it to benefit from this ongoing
trend.

---------------------

The Company was incorporated in Delaware in 1990 under the name Air-Cure
Environmental, Inc. The Company changed its name in 1995 to Air-Cure
Technologies, Inc., and in March 1997, the Company changed its name to ITEQ,
Inc. The ITEQ name stands for "international, technologies and equipment." The
Company's principal executive offices are located at 2727 Allen Parkway, Suite
760, Houston, Texas 77019, and its telephone number is (713) 285-2700.

---------------------

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company.................... 4,300,000 shares
Common Stock offered by the Selling Stockholders....... 750,000 shares
Common Stock to be outstanding after the Offering(1)... 16,195,793 shares
Use of proceeds by the Company......................... To repay outstanding indebtedness
and to fund the acquisition of
Exell, Inc. See "Use of Proceeds."
Nasdaq National Market symbol.......................... ITEQ
</TABLE>

- ---------------

(1) Does not include 2,754,688 shares of Common Stock issuable upon exercise of
outstanding options and warrants.
4
<PAGE> 5

SUMMARY FINANCIAL DATA
The following presents summary historical financial data of the Company as
of the date and for the periods presented, and as adjusted for the sale of the
Common Stock by the Company offered hereby and the application of the net
proceeds therefrom solely to repay indebtedness and not for the proposed
acquisition of Exell, Inc. See "Use of Proceeds" and "Capitalization." The pro
forma financial data set forth below gives effect to the acquisition of Ohmstede
as if it had been consummated on January 1, 1996. The pro forma data is derived
from the historical financial statements of the Company giving effect to the
Ohmstede acquisition under the purchase method of accounting and is based on
assumptions and adjustments described in the Unaudited Pro Forma Combined
Financial Information contained elsewhere in this Prospectus. The results of
Ohmstede are included in the Company's historical results for the three months
ended March 31, 1997, and therefore pro forma financial data for this period is
not included.

<TABLE>
<CAPTION>
THREE
MONTHS
PRO FORMA ENDED
YEAR ENDED DECEMBER 31, YEAR ENDED ---------
------------------------------- DECEMBER 31, MARCH 31,
1994 1995 1996 1996 1997
-------- --------- -------- ------------ ---------
AS AS
RESTATED(1) RESTATED(1) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.............................................. $61,826 $113,164 $110,804 $193,928 $48,494
Cost of revenues(2)................................... 49,135 93,262 88,949(3) 152,743(3) 38,870
------- -------- -------- -------- -------
Gross profit.......................................... 12,691 19,902 21,855 41,185 9,624
Selling, general and administrative costs............. 8,926 11,645 11,977 21,400 4,807
Sales commissions..................................... 1,327 2,477 2,755 3,092 645
Depreciation and amortization......................... 845 1,009 1,146 2,118 481
Merger costs, restructuring charges and other
nonrecurring costs.................................. -- 1,335 3,704 3,704 --
Interest expense, net................................. 888 1,502 2,660 7,851 1,807
Other income.......................................... 112 326 305 589 102
------- -------- -------- -------- -------
Earnings (loss) before provision for income taxes..... 817 2,260 (82) 3,609 1,986
------- -------- -------- -------- -------
Provision for income taxes............................ 338 1,500 4 1,356 813
------- -------- -------- -------- -------
Net earnings (loss)................................... $ 479 $ 760 $ (86) $ 2,253 $ 1,173
======= ======== ======== ======== =======
Net earnings (loss) per common share.................. $ .04 $ .07 $ (.01) $ .19 $ .10
======= ======== ======== ======== =======
Weighted average common and common equivalent shares
outstanding......................................... 10,891 11,552 11,481 11,604 12,272

OTHER DATA:
EBITDA(4)............................................. $ 3,218 $ 6,728 $ 8,847 $ 19,556 $ 4,274
Capital expenditures.................................. 657 932 991 3,516 490
</TABLE>

<TABLE>
<CAPTION>
MARCH 31, 1997
-----------------------
AS
ACTUAL ADJUSTED
-------- -----------
<S> <C> <C>
(UNAUDITED)

<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Working capital............................................. $ 22,706 $ 22,706
Total assets................................................ 128,294 128,294
Total debt.................................................. 63,356 35,951
Stockholders' equity........................................ 25,241 52,646
Percentage of total debt to total capitalization............ 72% 41%
</TABLE>

- ---------------

(1) See Note 1 to the Consolidated Financial Statements.

(2) Includes depreciation and amortization of $668, $622, $719, $1,574 and $275
for the years ended December 31, 1994, 1995 and 1996, pro forma year ended
December 31, 1996, and the three months ended March 31, 1997, respectively.

(3) Includes $700 of restructuring charges. See Note 3 to the Consolidated
Financial Statements.

(4) EBITDA represents income before interest expense, provision for income
taxes, depreciation and amortization, and merger costs, restructuring
charges and other nonrecurring costs; the manner in which EBITDA is
calculated in this Prospectus may differ from such calculations by other
entities. EBITDA is presented for informational purposes and not as an
alternative measure of operating results or cash flow from operations (as
determined in accordance with generally accepted accounting principles).
5
<PAGE> 6

RISK FACTORS

Prospective investors should carefully consider the following factors, as
well as the other information contained in this Prospectus. This Prospectus
includes "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. All statements other than statements of historical
facts included in this Prospectus regarding the Company's financial position,
business strategy, and plans and objectives of management for future operations
are forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it can
give no assurance that such expectations will prove to have been correct.
Important factors that could cause actual results to differ materially from the
Company's expectations ("Cautionary Statements") are disclosed in the risk
factors set forth below, in "Recent Developments" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and elsewhere in
this Prospectus and the documents incorporated herein by reference. All
subsequent written and oral forward-looking statements attributable to the
Company, or persons acting on its behalf, are expressly qualified in their
entirety by the Cautionary Statements.

DEPENDENCE ON INDUSTRY SPENDING; SEASONALITY

The prospects for the Company depend upon the level of capital and
maintenance expenditures by its industrial customers, in particular those by
petrochemical and refining concerns. These industries historically have been
cyclical in nature and vulnerable to general downturns in the economy. Decreases
in industry spending could have a significant adverse effect upon the demand for
the Company's products and services and the Company's results of operations.

The Company historically has experienced quarterly fluctuations in its
operating results. Operating results in any quarter are dependent upon the
timing of equipment and system sales, which may vary considerably among
quarters. In recent years, the Company has experienced greater revenues and net
income in its second and third quarters, partially as a result of the budgetary
and procurement processes of its customers.

ACQUISITIONS; INTEGRATION OF OPERATIONS

Since 1990 the Company has completed seven acquisitions of businesses in
pursuit of its strategic objectives. The Company plans to continue to pursue
acquisitions that complement its existing products and services. The Company's
acquisition strategy involves the potential risks inherent in assessing the
value, strengths, weaknesses, contingent or other liabilities and potential
profitability of acquisition candidates and in integrating the operations of
acquired companies. Although the Company generally has been successful in
pursuing these acquisitions, there can be no assurance that acquisition
opportunities will continue to be available, that the Company will have access
to the capital required to finance potential acquisitions, that the Company will
continue to acquire businesses or that any business acquired will be integrated
successfully or prove profitable.

LEVERAGE AND LIQUIDITY

At March 31, 1997, after giving effect to the issuance of the Common Stock
offered hereby and the application of the net proceeds therefrom to repay
indebtedness, the Company would have had total indebtedness of approximately
$36.0 million and debt as a percentage of total capitalization of 41% ($46.4
million and 47%, assuming the pending acquisition of Exell is consummated
utilizing additional borrowings to fund the purchase). See
"Business -- Acquisition History and Prospects -- Pending Acquisition." The
degree to which the Company will be leveraged could have important consequences,
including the following: (i) the possible impairment of the Company's ability to
obtain financing in the future for working capital, capital expenditures and
general corporate purposes; (ii) the necessity for a substantial portion of the
Company's cash flow from operations to be dedicated to the payment of

6
<PAGE> 7

principal and interest on its indebtedness; and (iii) the potential for
increased vulnerability of the Company to economic downturns and possible
limitation of its ability to withstand competitive pressures.

Based on current operations, the Company expects that it will be able to
service the interest and principal obligations on its indebtedness as well as
its working capital needs and to fund its capital expenditures and other
operating expenses out of cash flow from operations and available borrowings
under its principal credit facility. However, there can be no assurance that the
Company's business will continue to generate cash flow at levels sufficient to
meet these requirements. The Company's ability to meet its debt service
obligations will be dependent upon its future performance which, in turn, will
be subject to future economic conditions and to financial, business and other
factors, many of which are beyond the Company's control.

COMPETITION

The Company's markets are fragmented and highly competitive. The Company
competes with many United States-based and international companies in its global
markets. Although none of the Company's competitors is considered dominant,
there are competitors that have significantly greater resources than the
Company, which, among other things, could be a competitive disadvantage to the
Company in securing certain projects. See "Business -- Market Conditions and
Competition."

INTERNATIONAL EXPANSION

The Company's successful expansion into foreign markets will depend on
numerous factors, many of which are beyond its control. In addition, foreign
expansion may increase the Company's exposure to certain risks inherent in doing
business outside the United States, including currency fluctuations,
restrictions on the repatriation of profits, compliance with foreign laws and
standards and political risks. Although most of the Company's contracts with
respect to international sales to date have been denominated in United States
dollars, no assurance can be made that future contracts will be denominated in
United States dollars; therefore, the Company may be subject to foreign exchange
risks in the future. The Company does not presently hedge exchange rate
fluctuations but in the future may hedge economic exposures. The Company does
not intend to enter into speculative hedge transactions.

POTENTIAL FOR PRODUCT LIABILITY CLAIMS

Certain of the Company's products are used in potentially hazardous
environments. Although the Company has not been required to pay any product
liability claims to date, and the Company carries insurance in amounts that it
considers adequate, catastrophic occurrences at locations where the Company's
products are used could in the future result in significant product liability
claims against the Company.

ENVIRONMENTAL REGULATIONS

The Company is subject to various foreign, federal, state and local laws
and regulations relating to the protection of the environment. These laws may
provide for retroactive, strict liability for damages to natural resources or
threats to public health and safety, rendering a party liable for the
environmental damage without regard to its negligence or fault. Sanctions for
noncompliance may include revocation of permits, corrective action orders,
administrative or civil penalties and criminal prosecution. The Company's
business involves environmental management and issues typically associated with
historical manufacturing operations. To date, the Company's cost of complying
with environmental laws and regulations has not been material, but the fact that
such laws or regulations are changed frequently makes predicting the cost or
impact of such laws and regulations on its future operations uncertain. The
modification of existing laws or regulations or the adoption of new laws or
regulations affecting the Company's operations could adversely affect the
Company.

7
<PAGE> 8

RECENT DEVELOPMENTS

Acquisition of Ohmstede. In November 1996, the Company purchased Ohmstede,
the largest domestic manufacturer of shell and tube heat exchangers with 1996
calendar year revenues of approximately $100.2 million, for an aggregate cash
purchase price of approximately $52.9 million including transaction costs.
Founded in 1905, Ohmstede has been marketing custom designed and manufactured
heat exchangers to the petroleum refining and petrochemical processing
industries for more than 40 years. The acquisition of Ohmstede has resulted in:
(i) increased 1996 earnings on a pro forma basis; (ii) strengthened name
recognition for the Company as a result of Ohmstede's long operating history and
leading position in the domestic heat exchanger market; (iii) additional
customer relationships for the Company, thereby offering potential for increased
cross-selling of Company products; (iv) expanded international sales
opportunities, as Ohmstede's products can be offered through the Company's
international distribution network; (v) increased aftermarket business as a
result of Ohmstede's substantial installed base of products; and (vi) more
efficient use of the Company's Allied Industries' plant capacity, which enables
Ohmstede to manufacture large heat exchangers which it previously did not have
the capacity to produce. As of the acquisition, Ohmstede's operations were
conducted from plants located in Beaumont, Corpus Christi, and LaPorte, Texas
and in Lake Charles and St. Gabriel, Louisiana. The five plants, all of which
are owned, encompass approximately 385,000 square feet of manufacturing space
and employed approximately 600 people at December 31, 1996.

Proposed Acquisition of Exell. In April 1997, the Company entered into an
agreement to purchase Exell, Inc. and an affiliated partnership (collectively,
"Exell") for a combined cash purchase price of approximately $10.4 million,
subject to reduction for certain adjustments. Exell is a manufacturer of shell
and tube heat exchangers and a principal competitor of the Company's Ohmstede
heat exchanger manufacturing operation. If consummated, the acquisition of Exell
will strengthen the Company's leadership position in the domestic shell and tube
heat exchanger market and offer cross-selling opportunities with Exell's
customer base. In addition, ITEQ believes the acquisition may result in cost
savings through economies of scale when combined with Ohmstede's operations. For
its fiscal year ended September 30, 1996, Exell reported revenues of $25.0
million. The Company expects the transaction to be accretive to 1997 earnings
per share. The transaction is presently scheduled to close by June 30, 1997, but
remains subject to the satisfaction of customary contractual conditions and
certain regulatory approvals, and there can be no assurance that the transaction
will be consummated. See "Use of Proceeds" and "Business -- Acquisition History
and Prospects."

USE OF PROCEEDS

The net proceeds to the Company from the sale of the Common Stock offered
hereby are estimated to be $27.4 million ($32.3 million if the over-allotment
option is exercised in full), after deducting the underwriting discount and
estimated expenses payable by the Company. The Company will not receive any of
the proceeds from the sale of the shares of Common Stock by the Selling
Stockholders.

Up to $10.4 million of the net proceeds to the Company will be used to fund
the pending acquisition of Exell or repay indebtedness incurred to fund such
acquisition, and the balance of the net proceeds will be used to reduce
indebtedness under its revolving line of credit ("Revolving Credit Facility")
and term loan ("Term Loan"), incurred to fund a portion of the Ohmstede purchase
price and to refinance the Company's then existing credit facilities. Borrowings
under the Revolving Credit Facility and Term Loan bear interest at the
applicable offshore rate or base rate (as defined), plus a spread ranging from
.25% to 3%, depending on the leverage ratio of the Company. At December 31,
1996, the interest rates in effect for the Revolving Credit Facility and Term
Loan were 8.9% per annum and 8.6% per annum, respectively. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."

8
<PAGE> 9

PRICE RANGE OF COMMON STOCK

The Common Stock is traded on the Nasdaq National Market under the symbol
"ITEQ." The high and low bid prices per share for the periods indicated were as
follows:

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1995
First Quarter............................................. 3 3/8 2 1/4
Second Quarter............................................ 2 15/16 1 3/4
Third Quarter............................................. 4 3/4 2 5/16
Fourth Quarter............................................ 4 3/8 3 3/16
1996
First Quarter............................................. 4 1/2 3 1/4
Second Quarter............................................ 4 1/4 3 3/8
Third Quarter............................................. 5 1/8 2 7/8
Fourth Quarter............................................ 5 4 1/8
1997
First Quarter............................................. 7 1/2 4 1/2
Second Quarter (through May 20, 1997)..................... 7 1/8 5 5/8
</TABLE>

All of the foregoing prices reflect interdealer quotations without retail
markups, markdowns or commissions and may not represent actual transactions.

On May 20, 1997, the last reported sale price for the Common Stock, as
quoted by the Nasdaq National Market, was $6 15/16 per share. As of the same
date, there were approximately 160 holders of record of the Common Stock, and
the Company estimates that there were over 2,000 beneficial owners of Common
Stock.

DIVIDEND POLICY

The Company has never declared or paid cash dividends on the Common Stock.
The Company intends to retain any future earnings for reinvestment in its
business and does not intend to pay cash dividends in the foreseeable future.
Furthermore, the Company is prohibited from declaring or paying cash dividends
on its capital stock under the terms of certain of the Company's indebtedness.

9
<PAGE> 10

CAPITALIZATION

The following table sets forth the capitalization of the Company (i) as of
March 31, 1997, and (ii) as adjusted to reflect the sale by the Company of
4,300,000 shares of Common Stock offered hereby and the application of the
estimated net proceeds therefrom solely to repay indebtedness and not for the
proposed acquisition of Exell. This table should be read in conjunction with
"Use of Proceeds," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements included
elsewhere in this Prospectus.

<TABLE>
<CAPTION>
AS OF MARCH 31, 1997
---------------------
ACTUAL AS ADJUSTED
------- -----------
<S> <C> <C>
(UNAUDITED)

<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Current maturities of long-term obligations................. $ 6,012 $ 6,012
Borrowings under line of credit............................. 17,000 2,095
Other long-term obligations, less current maturities........ 27,548 15,048
Subordinated notes.......................................... 12,796 12,796
------- -------
Total debt................................................ 63,356 35,951
------- -------
Stockholders' equity:
Preferred stock, $.01 par value; 1,000 shares authorized;
no shares outstanding.................................. -- --
Common stock, $.001 par value; 30,000 shares authorized:
Issued and outstanding -- 11,838 shares
As adjusted -- 16,188 shares........................... 12 16
Additional paid-in capital................................ 24,400 51,801
Retained earnings......................................... 1,129 1,129
Translation adjustment.................................... (300) (300)
------- -------
Total stockholders' equity............................. 25,241 52,646
------- -------
Total capitalization.............................. $88,597 $88,597
======= =======
</TABLE>

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<PAGE> 11

SELECTED HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA

The following selected historical financial data for each of the years
ended March 31, 1992 and 1993, the nine month period ended December 31, 1993,
and the years ended December 31, 1994, 1995 and 1996 is derived from the audited
consolidated financial statements of the Company. The pro forma combined
operating data for the year ended 1996 was prepared utilizing the historical and
unaudited financial statements of the Company and Ohmstede and assumes that the
acquisition of Ohmstede occurred on January 1, 1996. The results of Ohmstede are
included in the Company's historical results of operations for the three months
ended March 31, 1997, and therefore pro forma financial data for this period is
not included. The historical financial data for the three months ended March 31,
1997 is derived from the unaudited consolidated financial statements of the
Company. In the opinion of management, this data contains all adjustments,
consisting of only normal recurring adjustments, necessary to present fairly the
three months ended March 31, 1997. Historical and pro forma results of
operations, percentage fluctuations and any trends that may be inferred from the
data below are not necessarily indicative of the results of operations for any
future period. The selected financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," the Unaudited Pro Forma Combined Financial
Information and the Consolidated Financial Statements and notes thereto included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
FISCAL FISCAL YEAR ENDED DECEMBER 31,
YEAR YEAR NINE MONTHS ------------------------------------ PRO FORMA
ENDED ENDED ENDED 1994 1995 YEAR ENDED
MARCH 31, MARCH 31, DECEMBER 31, AS AS DECEMBER 31,
1992 1993 1993 RESTATED(1) RESTATED(1) 1996 1996
--------- --------- ------------ ----------- ----------- -------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Revenue....................... $7,026 $12,790 $27,859 $61,826 $113,164 $110,804 $193,928
Cost of revenues(2)........... 5,339 9,821 20,725 49,135 93,262 88,949(3) 152,743(3)
------ ------- ------- ------- -------- -------- --------
Gross profit................ 1,687 2,969 7,134 12,691 19,902 21,855 41,185
Selling, general and
administrative expenses..... 1,645 3,843 5,677 8,926 11,645 11,977 21,400
Sales commissions............. -- -- -- 1,327 2,477 2,755 3,092
Depreciation and
amortization................ 123 363 688 845 1,009 1,146 2,118
Merger costs, restructuring
charges and other
nonrecurring costs.......... -- -- -- -- 1,335 3,704 3,704
------ ------- ------- ------- -------- -------- --------
Operating profit(loss)...... (81) (1,237) 769 1,593 3,436 2,273 10,871
Interest expense, net......... (48) (15) (192) (888) (1,502) (2,660) (7,851)
Other income (expense)........ 164 31 128 112 326 305 589
------ ------- ------- ------- -------- -------- --------
Earnings (loss) before
provision (benefit) for
income taxes................ 35 (1,221) 705 817 2,260 (82) 3,609
Provision (benefit) for income
taxes....................... 14 (396) 234 338 1,500 4 1,356
------ ------- ------- ------- -------- -------- --------
Net earnings (loss)......... $ 21 $ (825) $ 471 $ 479 $ 760 $ (86) $ 2,253
====== ======= ======= ======= ======== ======== ========
Net earnings (loss) per common
share....................... $ .01 $ (.22) $ .08 $ .04 $ .07 $ (.01) $ .19
====== ======= ======= ======= ======== ======== ========
Weighted average common and
common equivalent shares
outstanding................. 2,991 3,763 5,928 10,891 11,552 11,481 11,604

<CAPTION>
THREE
MONTHS
ENDED
MARCH 31,
1997
-----------
(UNAUDITED)
<S> <C>
OPERATING DATA:
Revenue....................... $48,494
Cost of revenues(2)........... 38,870
-------
Gross profit................ 9,624
Selling, general and
administrative expenses..... 4,807
Sales commissions............. 645
Depreciation and
amortization................ 481
Merger costs, restructuring
charges and other
nonrecurring costs.......... --
-------
Operating profit(loss)...... 3,691
Interest expense, net......... (1,807)
Other income (expense)........ 102
-------
Earnings (loss) before
provision (benefit) for
income taxes................ 1,986
Provision (benefit) for income
taxes....................... 813
-------
Net earnings (loss)......... $ 1,173
=======
Net earnings (loss) per common
share....................... $ .10
=======
Weighted average common and
common equivalent shares
outstanding................. 12,272
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1994 1995
MARCH 31, MARCH 31, AS AS MARCH 31,
1992 1993 1993 RESTATED(1) RESTATED(1) 1996 1997
--------- --------- ------------ ----------- ----------- -------- ------------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital............... $3,382 $ 4,038 $ 4,197 $ 7,964 $ 17,834 $ 29,851 $ 22,706
Total assets.................. 7,344 26,585 25,887 52,800 70,844 136,388 128,294
Short-term borrowings and
current maturities.......... 1,694 1,569 981 2,468 3,347 6,012 6,012
Long-term obligations and
other, less current
maturities.................. 4 2,129 983 8,305 18,208 67,141 57,344
Stockholders' equity.......... 5,404 14,540 14,627 21,474 21,403 23,253 25,241

<S> <C>
BALANCE SHEET DATA:
Working capital...............
Total assets..................
Short-term borrowings and
current maturities..........
Long-term obligations and
other, less current
maturities..................
Stockholders' equity..........
</TABLE>

- ---------------

(1) See Note 1 to the Consolidated Financial Statements.

(2) Includes depreciation and amortization of $668, $622, $719, $1,574 and $275
for the years ended December 31, 1994, 1995 and 1996, the pro forma year
ended December 31, 1996, and the three months ended March 31, 1997,
respectively.

(3) Includes $700 in restructuring costs. See Note 3 to the Consolidated
Financial Statements.

11
<PAGE> 12

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the "Selected
Historical and Pro Forma Combined Financial Data" and the Company's Consolidated
Financial Statements and the notes thereto included elsewhere herein. All
statements other than statements of historical facts included in the following
discussion regarding the Company's financial position, business strategy, and
plans of management for future operations are forward-looking statements.
Although the Company believes that the expectations reflected in such
forward-looking statements are reasonable, it can give no assurance that such
expectations will prove to have been correct.

GENERAL

Since its inception in 1990 the Company has acquired seven businesses. Due
to the magnitude of these acquisitions and the integration of the acquired
operations with the Company's existing businesses, results of operations for
prior periods are not necessarily comparable with or indicative of results of
operations for current or future periods.

The Company acquired Amerex, Inc. and Amerex Industries, Inc.
(collectively, "Amerex") and VIC Environmental Systems, Inc. ("VIC") in May
1994, each of which was accounted for as a purchase. In December 1995, the
Company acquired Allied Industries, Inc. ("Allied") in a transaction that was
accounted for as a pooling-of-interests. Effective November 1, 1996, the Company
completed the Ohmstede acquisition in a transaction that was accounted for as a
purchase.

In 1997, the Company combined the Allied and Ohmstede operations to (i)
permit Ohmstede to efficiently manufacture large heat exchangers at Allied's
plant and thus enter a product class which Ohmstede was not previously equipped
to handle; (ii) encourage a unified cross-selling effort to customers of both
product lines; (iii) utilize Allied's international distribution network to
enhance Ohmstede's international marketing efforts; and (iv) reduce combined
operating costs.

The Company records revenues from long-term contracts using the
percentage-of-completion method. Under this method, the Company recognizes as
revenues that portion of the total contract price which the cost of work
completed to date bears to the estimated total cost of the work included in the
contract. Because contracts may extend over more than one fiscal period,
revisions of cost and profit estimates are made periodically and are reflected
in the accounting period in which they are determined. If the estimate of total
costs on a contract indicates a loss, the total anticipated loss is recognized
immediately. Contract costs include all direct material, labor and
subcontracting costs and those indirect costs related to contract performance,
such as supplies, tools and repairs.

The Company recognizes revenue from certain short-term contracts using the
completed contract method. Revenue is recognized when a project is substantially
complete. The contracts under this revenue recognition method are typically less
than three months in duration.

During the fourth quarter of 1996, effective January 1, 1996, the Company
estimated percentage-of-completion for the materials portion of its long-term
contracts at Allied based on when the material was placed into production,
whereas previously such estimates were based on when the liability for the cost
of the material was legally incurred. The new method of applying the
percentage-of-completion accounting method was adopted to better reflect the
economics of Allied's revenue and profit earnings process, and financial
statements of prior years and interim periods have been restated to apply the
revised method retroactively.

12
<PAGE> 13

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 1997 COMPARED WITH THREE MONTHS ENDED MARCH 31,
1996

Revenues

Revenues for the three months ended March 31, 1997 increased $26.4 million,
or 119%, to $48.5 million from $22.1 million for the three months ended March
31, 1996. The increase was primarily attributable to the November 1996
acquisition of Ohmstede, which contributed revenues of $30.0 million for the
three months ended March 31, 1997. This increase was partially offset by the
disposition in November 1996 of Air-Cure, Inc. ("ACI") and Pipkorn, Inc.
("Pipkorn"), both of which were formerly subsidiaries of the Company. In the
first quarter of 1996, ACI and Pipkorn contributed $1.2 million in revenues. The
revenues of the Company's Singapore subsidiary declined $1.0 million in 1997 to
$1.1 million compared to $2.1 million in 1996, due to a temporary decrease in
sales to the microelectronics industry.

Gross Profits

The Company's gross profits for the three months ended March 31, 1997
increased $4.9 million, or 104%, to $9.6 million compared to $4.7 million in
1996. Ohmstede's gross profit of $6.7 million for the three months ended March
31, 1997 was partially offset by (i) the sale of ACI and Pipkorn, which
contributed $0.2 million of gross profits during the three months ended March
31, 1996, and (ii) a decrease in gross profits of $1.8 million at certain of the
Company's other operations.

Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses increased by $2.2
million from $2.6 million to $4.8 million, which was attributable to the
Ohmstede acquisition. Ohmstede's SG&A expense for the three months ended March
31, 1997 was $2.5 million, which was partially offset by a $0.2 million
reduction in SG&A expense related to the sale of ACI and Pipkorn.

Sales Commissions

Sales commissions represent commissions paid to third party sales
representatives or distributors. The commissions vary from period to period with
the projects and products sold and the arrangement between the Company and the
sales representative.

Depreciation and Amortization

Depreciation and amortization expense (excluding amounts included in cost
of revenues) for the three months ended March 31, 1997 increased $0.3 million to
$0.5 million. The increase was as a result of the Ohmstede acquisition.

Interest Expense

Interest expense for the three months ended March 31, 1997 and 1996 was
$1.8 million and $0.4 million, respectively. The borrowings required to finance
the Ohmstede acquisition, which aggregated $56.1 million, caused the increase in
interest expense.

Income Taxes

The effective rate for the three months ended March 31, 1997 and 1996 was
41% and 39%, respectively.

Other

As planned when acquired, Ohmstede has initiated foreign sales, which
typically have longer production times and more units per order in production
and shipment than Ohmstede's historical

13
<PAGE> 14

domestic business. Accordingly, such sales were recognized under the
percentage-of-completion revenue recognition method, resulting in revenues and
gross margin of $3.6 million and $0.7 million, respectively, during the three
months ended March 31, 1997. Also, at March 31, 1997, Ohmstede had more jobs
substantially complete but not shipped than in prior periods, which under the
Company's completed contract policy resulted in revenues and gross margin of
$2.0 million and $0.6 million, respectively, during the three months ended March
31, 1997.

In March 1997, a vessel at the Company's Allied subsidiary was damaged by a
subcontractor during the final stages of completion. The Company has entered
into a second contract with the customer to construct a replacement vessel. The
direct cost of the original and replacement vessels will be recovered from the
customer. The Company expects to recover additional amounts from either the
subcontractor or from insurance proceeds, which have not been recognized in the
accompanying financial statements.

1996 COMPARED WITH 1995

Revenues

Revenues for the year ended December 31, 1996 declined $2.4 million, or 2%,
to $110.8 million from $113.2 million for the year ended December 31, 1995. This
decrease resulted primarily from a decrease in total sales of filtration systems
in 1996 compared with 1995 due to the commencement and completion of an $11.8
million order in 1995 which was not replaced in full by other orders in 1996,
and to a $10.9 million decrease in process equipment sales, excluding sales by
Ohmstede. Such aggregate decrease was partially offset by a $17.0 million
revenue increase resulting from the operations of Ohmstede for the two months
following its acquisition.

In 1996, the Company's sales to the petrochemical and refining industries
increased due to the acquisition of Ohmstede, which had sales to these two
industries only. The Company's sales to the microelectronics and the cement and
lime industries also increased during 1996.

Gross Profits

Although revenues declined in 1996 as compared with 1995, gross profits
increased by $2.0 million to $21.9 million. The gross margin also improved to
19.7% in 1996 from 17.6% in 1995. These improvements were primarily the result
of increased sales of higher margin wet scrubbers and fans and the addition of
Ohmstede, which contributed $3.6 million in gross profits, at a 20.9% gross
margin, for the two month period subsequent to its acquisition.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the years ended December
31, 1996 and 1995 were relatively unchanged at $12.0 million and $11.6 million,
respectively.

Sales Commissions

Sales commissions represent commissions paid to third party sales
representatives or distributors. The commissions vary with the project and
products sold and the arrangement between the Company and the sales
representative.

Depreciation and Amortization

Depreciation and amortization expense (excluding amounts included in cost
of revenues) for the year ended December 31, 1996 increased $0.1 million to $1.1
million. The increase was primarily as a result of the Ohmstede acquisition.

Merger Costs, Restructuring Charges and Other Nonrecurring Expenses

14
<PAGE> 15

chief executive officer who was replaced in March 1996, and (ii) the cost of
implementing new management's plan to reduce the Company's overall cost
structure including employee severance, lease and other contract buyouts,
inventory and other asset impairments, losses related to termination of
unprofitable business lines, excess machinery disposal and other related costs.

During 1995, the Company recorded a nonrecurring charge of approximately
$1.1 million for acquisition costs related to the Allied acquisition, which is
more fully described in Note 2 to the Consolidated Financial Statements. In
addition, operational consolidation during 1995, and unrelated litigation
settlement costs, resulted in a one-time charge of $0.2 million.

Interest Expense

Interest expense for the years ended December 31, 1996 and 1995 was $2.7
million and $1.5 million, respectively. The borrowings required to finance the
Ohmstede acquisition, which aggregated $56.1 million, accounted for 75% of the
increase. The Company's average interest rate on borrowings for 1996 and 1995
was 9.6% and 8.7%, respectively. As further described in Note 5 to the
Consolidated Financial Statements, the interest rate charged to the Company by
its lenders increases or decreases based on the Company's leverage ratio. As a
result of the Ohmstede acquisition, the Company's leverage increased, resulting
in higher average interest rates.

Income Taxes

The decrease in income tax expense in 1996 resulted from both a decrease in
1996 pre-tax earnings and increased 1995 tax expense resulting from the 1995
acquisition of Allied, as more fully described in Notes 2 and 7 to the
Consolidated Financial Statements. The earnings decrease accounted for
approximately $0.8 million in reduced federal and state tax expenses. The
acquisition of Allied in 1995 resulted in additional 1995 tax expense of
approximately $0.5 million. The majority of the 1995 tax expense increase was
attributable to deferred tax expense incurred when Allied was converted from an
S corporation to a C corporation.

1995 COMPARED WITH 1994

Revenues

Revenues for the year ended December 31, 1995 increased $51.4 million to
$113.2 million, or 83%, from revenues of $61.8 million for the year ended
December 31, 1994. Filtration equipment revenues increased approximately $29.8
million in 1995, partially as the result of an $11.8 million filtration system
job, as well as the inclusion of Amerex and VIC operations in 1995 for the full
year as compared to the seven months of Amerex and VIC operations included in
1994 following their acquisition. Process equipment revenues in 1995 increased
by $21.6 million to $38.7 million. In addition to 1995 sales of process
equipment being unusually high compared to prior years, the increase was also
attributable to 1994 revenues including only the eleven months of Allied
revenues subsequent to its inception.

During 1995, the Company experienced growth in sales to a number of
industry groups, including the steel, chemical, petrochemical, cement, air
separation and microelectronics industries. Petrochemical industry sales
increased both internationally and domestically primarily because of increased
marketing efforts. Similarly, revenue growth from process equipment sales to the
air separation industry reflected the Company's increased marketing to customers
within that industry. The Company's revenues were also positively impacted by
the growth in the Company's filtration sales to the microelectronics industry.
Sales to the utility industry decreased in 1995 from 1994.

Gross Profits

Gross profits for the years ended December 31, 1995 and 1994 were $19.9
million and $12.7 million, respectively. The corresponding gross margins for the
periods were 17.6% and 20.6%, respectively. Filtration equipment margins
improved to 22.8% in 1995 compared with 21.9% in 1994. Processing

15
<PAGE> 16

equipment margins in 1995 were 8% compared with 17.0% in 1994. This decrease
resulted from competitive bidding on several large orders performed at reduced
margins and from losses on several jobs. The job losses related principally to
products and services that the Company discontinued, as reflected in the
Company's restructuring charge taken in 1996, which is more fully described in
Note 3 to the Consolidated Financial Statements.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the years ended December
31, 1995 and 1994 were $11.6 million and $8.9 million, respectively. The
increase is related primarily to the inclusion of the operations of Allied,
Amerex and VIC, which were acquired in 1994, for a full twelve months in 1995
compared with eleven months for Allied and seven months for both Amerex and VIC
in 1994.

Sales Commissions

Depreciation and Amortization

Depreciation and amortization expense (excluding amounts included in cost
of revenues) was $1.0 million and $0.8 million for the years ended December 31,
1995 and 1994, respectively. The increase was primarily a result of the
acquisitions of Amerex and VIC in May 1994. Depreciation and amortization
expense for Amerex and VIC was $0.3 million and $0.2 million for the twelve
months ended December 31, 1995 and the seven months ended December 31, 1994,
respectively.

Merger Costs, Restructuring Charges and Other Nonrecurring Expenses

Interest Expense

Interest expense in 1995 was $1.5 million compared to $0.9 million in 1994.
The corresponding average interest rates were 8.7% and 9.3% in 1995 and 1994,
respectively. The expense increase reflects the additional borrowings required
to finance the Amerex, VIC and Allied acquisitions.

Income Taxes

The increase in income tax expense for 1995 compared to 1994 resulted from
higher pre-tax earnings and the Allied acquisition in 1995, as more fully
described previously and in Notes 2 and 7 to the Consolidated Financial
Statements. The majority of the 1995 tax expense increase was attributable to
deferred tax expense incurred when Allied was converted from an S corporation to
a C corporation.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 1997 the Company's cash position was $1.8 million compared
with $6.3 million at December 31, 1996. Typically, the Company maintains cash
levels of $1 million to $3 million for general corporate purposes, with any
additional amounts being used to reduce borrowings under the Company's line of
credit. The cash level at December 31, 1996 resulted from large customer
payments received at year end. Working capital at March 31, 1997 was $23.0
million compared to $29.9 million at December 31, 1996, which decrease resulted
from the difference in cash position. Working capital at December 31,

16
<PAGE> 17

1996 increased to $29.9 million from $17.8 million at December 31, 1995,
primarily as a result of the Ohmstede acquisition.

The Company's existing capital resources consist of cash balances, cash
provided by its operating activities and funds available under its line of
credit. The Company's operating activities provided $4.5 million in cash during
the three months ended March 31, 1997. Cash provided by operations in 1996 was
$8.1 million. During 1995, the Company's operating activities used $6.0 million
in cash, while 1994 provided $2.3 million in cash. During 1996, cash provided by
operating activities was approximately $14.1 million greater as compared to
1995, partially as a result of the Company's program to reduce the amount of
accounts receivable, increase progress billings and reduce inventory levels.

The Company's cash requirements consist of its general working capital
needs, capital expenditures, obligations under its leases and promissory notes,
and capital required for future acquisitions. The Company's general working
capital requirements consist of salary costs and related overhead and the
purchase price of materials and components, and may also include subcontract
costs incurred prior to the receipt of corresponding progress payments under the
contract with respect to which such costs are incurred. Management anticipates
that the Company will make capital expenditures of approximately $2.4 million in
1997 as compared to $1.0 million in 1996. The increase in capital expenditures
relates primarily to the ownership of the Ohmstede operations for all of 1997 as
compared to two months during 1996. The capital expenditures at Ohmstede relate
primarily to planned equipment upgrades and replacement. Excluding payments
under the Company's revolving line of credit, principal payments made under
promissory notes totaled approximately $2.5 million for the year ended 1996.
Approximately $6.0 million and $7.3 million in principal will be payable during
1997 and 1998, respectively.

In November 1996, the Company amended its principal credit agreement to
increase its maximum borrowings in conjunction with the Ohmstede acquisition.
The financing consisted of a $35 million term loan and a $38 million revolving
line of credit facility (under which $17.0 million was outstanding at March 31,
1997). In addition to the bank financing, in November 1996, the Company issued
Senior Subordinated Notes ("Subordinated Notes") to two institutional lenders in
an aggregate amount of $15 million. The Subordinated Notes mature November 18,
2003 and bear interest at 12% through December 31, 1997, which rate increases by
0.5% per year for each year the Subordinated Notes remain outstanding. As
additional consideration, the Subordinated Note holders received warrants to
purchase an aggregate of 1.8 million shares of the Company's common stock at
$5.10 per share, subject to adjustment. The warrants may be exercised at any
time prior to expiration on November 18, 2003. The $2.3 million warrant value
was reflected as equity and as debt discount that is being amortized as
additional interest expense over the seven year life of the Subordinated Notes.

The Company's principal credit facility and the Subordinated Notes require
the Company to maintain certain levels of working capital and stockholders'
equity and contain other restrictive covenants. Such instruments also limit the
ability of the Company to incur additional indebtedness and to make acquisitions
and certain investments. At March 31, 1997, the Company was in compliance with
the provisions of its debt agreements.

Except with respect to the funding of any future acquisitions, management
believes that funds available under its credit facilities, together with cash
generated from operations, will be sufficient to meet the Company's anticipated
cash requirements for 1997. Management further believes that the Company could
obtain additional capital to make acquisitions primarily through either
issuances of common or preferred stock, or debt or lease financing, although no
assurance can be given with respect to whether such financing would be available
when required or whether such financing can be obtained on terms acceptable to
the Company.

17
<PAGE> 18

BUSINESS

GENERAL

BUSINESS STRATEGY

The Company aspires to be a leading provider of manufactured equipment,
engineered systems and services used in each of the niche industrial markets in
which it operates and to expand its markets through acquisitions of
complementary product and service lines. ITEQ has experienced rapid growth since
its inception in 1990 through a combination of strategic acquisitions and
internal growth.

- Well managed, typically privately-held, domestic companies serving niche
industrial markets.

- Large defensible share of their respective markets, involving proven
technologies.

- Provide complementary products and services which afford cross-selling
opportunities or are direct competitors.

- Significant installed product bases and long operating histories.

- Potential for significant expansion into international markets.

- Predictable cash flow and earnings potential.

- Potential for internal synergies and economies of scale.

ITEQ has made seven acquisitions to date, including the acquisition of
Ohmstede in November 1996, which contributed approximately $100.2 million to the
Company's pro forma 1996 revenues of $193.9 million. The Company continually
screens potential acquisition candidates, and ITEQ believes that further

18
<PAGE> 19

acquisitions are likely in future periods, although no assurance can be given
that any additional acquisitions will be completed.

ACQUISITION HISTORY AND PROSPECTS

Completed Acquisitions. Since its inception in 1990, the Company has
experienced substantial growth through acquisitions. The Company's business was
originally focused on the highly regulated air pollution control industry.
However, in 1995, with the Allied acquisition, the Company began to increase its
focus on the process equipment business. Consistent with this focus, in 1996 the
Company completed the acquisition of Ohmstede and sold Air-Cure, Inc. The
following table sets forth certain information concerning the businesses which
had been acquired by ITEQ through December 31, 1996.

<TABLE>
<CAPTION>
DATE PRINCIPAL
ACQUIRED COMPANY ACQUIRED PRODUCTS INDUSTRY SERVED
- ------------------------- -------- ------------------------- -------------------------
<S> <C> <C> <C>
Air-Cure, Inc.(1) 1990 Fabric filters Electric utilities, coal
Interel, Inc. 1991 Dry scrubbers, packed and Waste treatment, foundry,
mini scrubbers, heat smelter
exchangers
Ceilcote Air Pollution 1992 Wet scrubbers, tower Microelectronics,
Control, Inc. internals, FRP fans chemical processing,
waste treatment, food
processing
VIC Environmental 1994 Carbon adsorption systems Pharmaceutical, rubber
Systems, Inc.
Amerex Industries, Inc. 1994 Fabric filters, wet and Steel, cement and lime,
dry scrubbers, heat refining, foundry
exchangers
Allied Industries, 1995 Air separation equipment, Petrochemical, plastics,
Inc.(2) reactors, blenders, refining
stacks, towers and
columns, pressure vessels
Ohmstede, Inc. 1996 Heat exchangers Petrochemical, refining
</TABLE>

- ---------------
(1) Divested in November 1996.

(2) Accounted for as a pooling-of-interests; all other acquisitions accounted
for as purchases.

Pending Acquisition. In April 1997, the Company entered into an agreement
to purchase Exell for a cash purchase price of approximately $10.4 million,
subject to certain adjustments. Exell is a manufacturer of shell and tube heat
exchangers and a principal competitor of the Company's heat exchanger
manufacturing operation. For its fiscal year ended September 30, 1996, Exell
reported revenues of $25.0 million. The transaction is presently scheduled to
close by June 1997, but remains subject to the satisfaction of customary
contractual conditions and regulatory approvals; accordingly, there can be no

19
<PAGE> 20

assurance that the transaction will be consummated and if it is not consummated,
that the prevailing market prices for the Company's common stock will not be
adversely affected. Assuming consummation of the purchase of Exell, the Company
expects to fund such purchase through use of a portion of the proceeds of the
Offering. See "Use of Proceeds."

PRODUCTS AND SERVICES

The following table sets forth, for the periods indicated, the contribution
to the Company's revenues from its significant classes of products and services:

<TABLE>
<CAPTION>
THREE
FISCAL YEAR FISCAL YEAR NINE MONTHS PRO FORMA MONTHS
ENDED ENDED ENDED YEAR ENDED DECEMBER 31, YEAR ENDED ENDED
MARCH 31, MARCH 31, DECEMBER 31, ------------------------------ DECEMBER 31, MARCH 31,
1992 1993 1993 1994 1995 1996(1) 1996(1) 1997
----------- ----------- ------------ -------- -------- -------- ------------ ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Filtration equipment.... $7,026 $12,790 $27,859 $ 44,713 $ 74,511 $ 66,007 $ 64,331 $13,636
Heat exchangers and
other process
equipment............. -- -- -- 17,113 38,653 44,797 129,597 34,858
------ ------- ------- -------- -------- -------- -------- -------
$7,026 $12,790 $27,859 $ 61,826 $113,164 $110,804 $193,928 $48,494
====== ======= ======= ======== ======== ======== ======== =======
</TABLE>

- ---------------
(1) Ohmstede was acquired effective November 1, 1996 in a transaction accounted
for as a purchase. The "Year Ended December 31, 1996" includes the reported
revenues of Ohmstede for the period subsequent to acquisition, and the "Pro
Forma Year Ended December 31, 1996" includes the revenues of Ohmstede for
the full year on a combined basis.

For information with respect to the Company's financial data by geographic
location, see Note 10 to the Consolidated Financial Statements.

Filtration. Filtration products are marketed by the Company under the
Amerex, VIC Environmental Systems, Ceilcote Air Pollution Control, Interel,
Tellerette(R) and IWS tradenames to engineering and construction firms and
directly to end-users for environmental and general industrial applications.
Such systems operate by filtering air or gas through many large filter bags
("baghouses") that capture ambient particulate matter or by venting a
particulate-laden air stream through an aerosol spray which captures the
particulates ("scrubbers"). Baghouses and scrubbers are custom designed systems
which may be of substantial scale and incorporate a variety of products
manufactured by the Company. These include wet scrubbers, dry scrubbers, axial
and centrifugal fiberglass reinforced plastic fans, heat exchangers, ductwork,
aeration towers (strippers), scrubber packing, tower internals, air washers,
carbon adsorption systems, quenches, cooling and condensing towers, mist
eliminators and pneumatic conveying systems. Such products are sold as
components to other systems fabricators or incorporated into complete systems
designed and constructed by the Company.

Heat Exchangers. The Company's line of custom-built shell and tube heat
exchangers are marketed under the well-established Ohmstede name primarily to
the petrochemical and refining industries in the Gulf Coast area. ITEQ intends
to pursue increased sales of new heat exchangers by marketing its products
throughout the United States and internationally by capitalizing on its existing
distribution network and customer relationships. The Company has a substantial
installed base of heat exchangers, since Ohmstede units were marketed for more
than 40 years by the family-owned business acquired by the Company in November
1996. Aftermarket services are provided both in the field and on Company
premises and may consist of a variety of services ranging from minor field
repair and maintenance to de-coking (i.e., the removal of fouling from tubes) or
complete unit reconstruction.

Shell and tube heat exchangers are used in a variety of temperature
control, heating and cooling, and other plant operation applications and are
integrated into a variety of industrial processes that allow heat to be
transferred from one fluid or gas involved in the process to another. Usually
the fluid being cooled runs through a series of tubes in the heat exchanger,
while the cooling fluid flows simultaneously in the opposite direction in the
void between the outer shell of the units and the tube bundles. In the

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<PAGE> 21

petrochemical and power industries, this type of exchanger is used as feedwater
heaters and surface condensers for plant operations.

Process Equipment. The Company designs and manufactures custom process and
containment equipment, which are marketed under the Allied Industries name,
primarily to the refining, petrochemical and plastics industries. ITEQ intends
to pursue increased sales of process equipment by cross-selling to Ohmstede's
customers. It emphasizes the engineering and fabrication of large-diameter
vessels, thin-walled aluminum vessels, cryogenic application vessels, and
vessels requiring careful handling for applications in which cleanliness and
corrosion resistance are vital to product purity. The Company has particular
expertise in the fabrication of welded structures and vessels made of aluminum,
stainless steel and such exotic metals as hastelloy, incoloy, and clad composite
metals. Process and containment equipment is used in applications where fluid
flow, heat transfer and mass transfer are employed in continuous batch processes
to convert crude oil, natural gas and coal into fuel, lubricants, petrochemicals
and specialty products, and in the air separation industry to separate component
gases from air using cryogenic, absorption and membrane technologies.

SALES AND MARKETING

The Company's products are marketed primarily through approximately 75
commission-based, independent representative organizations, each operating in an
exclusive territory and serving engineering firms and specialized industrial
customers located in that territory. In addition to sales activities at Company
offices, ITEQ also maintains sales offices in Denver, Pittsburgh and Ontario,
Canada, from which its own marketing support personnel assist the representative
organizations and, in those geographic areas not served by representative
organizations, make direct marketing calls on potential customers. Inquiries
from potential customers are referred to Company engineering personnel for any
necessary product or system design and for job cost estimation and preparation
of price quotations or bid packages for submission to the prospective customer.
The interval between customer inquiry and confirmation of an order or contract
execution varies substantially. In general, orders are filled for components and
small systems on a purchase order basis at fixed prices on normal 30-day trade
terms, and larger, more complex systems involving long lead times are filled on
a contract basis. Though contract terms are subject to considerable variation,
contracts normally provide for progress payments, price adjustment provisions
during periods when metal goods prices are subject to volatility and, except for
sales from certain foreign subsidiaries, are either dollar denominated or
payable in currencies with fixed exchange rates against the dollar. As a result,
working capital, raw material pricing, and currency translation risks are not
significant to the Company. Substantially all contracts for products to be
exported for sale are secured by letters of credit drawn on major commercial
banks. In certain instances, particularly in the performance of aftermarket heat
exchanger services, work may be undertaken on a time and materials basis on
normal 30-day credit terms.

Consistent with emerging industry trends, the Company has also entered into
formal "corporate alliances" with certain of its customers, under which the
Company has been designated a preferred vendor for various products. The Company
intends to continue to pursue additional strategic alliances or other corporate
partnering arrangements. In addition, the Company will continue its emphasis on
aftermarket sales and services in an effort to offset the cyclical nature of
industry capital spending.

MARKET CONDITIONS AND COMPETITION

Market Conditions. The industrial equipment markets in which ITEQ operates
are mature. Worldwide capital expenditures for hydrocarbon processing equipment
and air filtration equipment have averaged about $40 billion per year in recent
years, with approximately 30% attributable to domestic spending. Although the
Company's products and services are utilized in a number of industrial
applications, a majority of its recent annual revenues has been attributable to
the petrochemical and refining industries. A significant portion of ITEQ's
revenues from those markets is attributable to plant expansion and upgrades,
maintenance and the construction of new industrial capacity abroad. In an effort
to minimize the effects of cyclical capital spending, ITEQ intends increasingly
to emphasize greater

21
<PAGE> 22

market penetration in aftermarkets and diversification into less competitive
international markets and other less cyclical domestic markets by capitalizing
on its broad range of product lines with potential customers and through
extension of its "corporate alliance" program into other industries. See " --
Significant Customers." In addition, the Company seeks to carry minimal
inventories of raw materials and components and maintain a reasonable balance
between the manufacture and purchase of product components and subassemblies.
Since virtually all the Company's revenues are attributable to products and
systems manufactured to customer specifications, it carries almost no finished
goods inventory and purchases raw materials, components and subassemblies only
on a job specific, often "just in time" basis. During the year ended December
31, 1996, certain components and subassemblies were purchased from numerous
subcontractors, typically under fixed price arrangements. Should the need arise,
the Company believes that any subcontractor can be replaced without significant
disruption to its business.

Competition. All the markets in which the Company competes in North
America are highly fragmented, and most competitors in these niche markets are
relatively small, privately-held businesses. In North American markets,
competition is based on several competitive factors, including reputation,
manufacturing capabilities, availability of plant capacity, price, performance
and dependability. In foreign markets, competition varies widely. In some
international markets, price competition is more intense than that prevailing in
North America while in others, where prior relationships and product quality
receive more customer emphasis than do marginal pricing differentials, price
competition is less intensive. As a result of innovative design solutions,
quality of product workmanship and dependability of "on time" performance,
ITEQ's product and services are sold, in some circumstances, in situations where
it is not the low bidder. Although the Company does not typically maintain
supply or service contracts with its customers, a significant portion of the
Company's annual revenues represents repeat business from the same customers.

With increasing frequency, the Company is asked by end-users to submit
proposals or bids for entire filtration systems, thus bypassing engineering and
construction firms in the procurement process. When awarded such jobs, the
Company designs the entire system, purchases certain "off-the-shelf" or
fabricated components from vendors or subcontractors, and manufactures those
portions of the system for which it has particular expertise. The partially
completed system is then delivered to the customer's site for final assembly and
installation by field construction personnel who may be subcontractors for or
supervised by the Company.

MANUFACTURING FACILITIES

The Company operates seven manufacturing facilities, all located in the
United States, which range in size from less than 10,000 square feet to
approximately 185,000 square feet of manufacturing and related space, or an
aggregate of approximately 608,600 square feet. Of this total, about 211,000
square feet of manufacturing and related space is located in leased premises
under leases expiring at various dates through 2004. The Company believes its
facilities are suitable for their present and intended purposes and more than
adequate for its current level of operations.

ENVIRONMENTAL MATTERS

ITEQ is subject to numerous federal, state, local and foreign laws and
regulations relating to the storage, handling, emission and discharge of
materials into the environment, including the Comprehensive Environmental
Response Compensation and Liability Act ("CERCLA"), the Clean Water Act, the
Clean Air Act (including the 1990 Amendments) ("CAA") and the Resource
Conservation and Recovery Act ("RCRA"). Each of these statutes allows the
imposition of substantial civil and criminal penalties, as well as permit
revocation, for violations of the requirements. Although the Company's
operations may involve environmental management issues typically associated with
manufacturing operations, the Company believes that it is in material compliance
with all environmental laws. The Company has no current plans for substantial
capital expenditures in this area. It is not a party to any threatened or
pending legal proceedings or administrative actions relating to the environment.
It is

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<PAGE> 23

possible that future developments, such as changes in existing laws, regulations
or enforcement practices under environmental laws, could lead to material costs
of environmental compliance and cleanup by the Company.

SIGNIFICANT CUSTOMERS

Historically, the Company's principal customers have been international
refining and petrochemical processors, steel producers, foundries, mining and
waste treatment concerns. Recently, ITEQ's customer base has been expanded to
include steel mini-mills and microelectronics manufacturers. The Company is a
designated preferred vendor for various products under its formal "corporate
alliance" program with certain of its customers, including Amoco Corporation,
Bechtel Group, Chevron Corporation, Lyondell-Citgo, Dow Chemical, E. I. Du Pont,
Olin Corporation and Hoechst Celanese. The Company intends to continue its focus
on entering into additional strategic alliances or other corporate partnering
arrangements. Due to the contractual nature of the Company's operations, it is
anticipated that significant portions of future consolidated revenues may be
attributable to a limited number of customers in any particular year, although
it is likely that the particular customers may vary from year to year.

BACKLOG

At December 31, 1996, the Company's backlog was $56.7 million (which
includes backlog attributable to Ohmstede), compared with $28.1 million at
December 31, 1995. At March 31, 1997, the Company's backlog was $68.9 million.
Such backlog consisted of written orders or commitments believed to be firm.
Contracts for products and services are occasionally varied or modified by
mutual consent and in certain instances may be cancelable by the customer on
short notice without substantial penalty. As a result, the Company's backlog as
of any particular date may not be indicative of the Company's actual operating
results for any subsequent fiscal period. It is, however, anticipated that
substantially all of the orders and commitments included in backlog at March 31,
1997 will be completed within the next twelve months.

EMPLOYEES

At December 31, 1996, the Company employed approximately 1,000 full-time
personnel, including approximately 180 unionized employees at four domestic
manufacturing facilities who are subject to collective bargaining agreements.
The Company considers its relations with its employees to be good.

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<PAGE> 24

MANAGEMENT

DIRECTORS AND EXECUTIVE OFFICERS

The directors and executive officers of the Company are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Mark E. Johnson........................ 46 Director, chairman of the board, president and chief
executive officer
Lawrance W. McAfee..................... 42 Director, executive vice president, chief financial
officer and secretary
Pierre S. Melcher...................... 37 Director, senior vice president and treasurer
Thomas N. Amonett...................... 52 Director
T. William Porter...................... 55 Director
James L. Rainey, Jr.................... 66 Director
James A. Read.......................... 46 Director
</TABLE>

Mark E. Johnson. Mr. Johnson has been a director of the Company since
December 1995 and chairman of the board, president and chief executive officer
since March 1996. From February 1994 until December 1995, Mr. Johnson was a
shareholder, director and president of Allied Industries, Inc. ("Allied"), a
wholly-owned subsidiary of the Company since December 1995. Prior to that time,
Mr. Johnson was a private investor and was a shareholder and served as chairman
of the board, chief executive officer and president of Semco, Inc. ("Semco"), a
manufacturer of pneumatic conveyancing equipment, and of Stillbrooke
Corporation, a cemetery and funeral home holding company. From 1982 to 1986, Mr.
Johnson served as a partner of KPMG Peat Marwick LLP.

Lawrance W. McAfee. Mr. McAfee has been a director of the Company since
December 1995 and executive vice president and chief financial officer since
January 1993 and secretary since May 1993. From 1991 until the time he joined
the Company in 1993, Mr. McAfee served as a director and chief financial officer
of Waste Processor Industries, Inc., an environmental services company. Prior to
that time, Mr. McAfee served as senior vice president and chief financial
officer of Stillbrooke Corporation from 1989 to 1991. From 1982 to 1989, Mr.
McAfee served as vice president and chief financial officer of U.S. Home
Corporation, a residential builder, developer and financial services company.

Pierre S. Melcher. Mr. Melcher has been a director of the Company since
March 1996 and senior vice president and treasurer since April 1996. From
February 1994 until December 1995, Mr. Melcher was a shareholder and served as
director and senior vice president of Allied. Prior to that time, Mr. Melcher
pursued private investments and was a shareholder and served as a director and
senior vice president of Semco. From 1988 to 1991, Mr. Melcher served as an
investment banker with Texas Commerce Bank.

Thomas N. Amonett. Mr. Amonett has been a director of the Company since
April 1996. Mr. Amonett has served as acting chief executive officer of
Weatherford Enterra, Inc., an energy services company, since July 1996, and a
director since May 1974. From July 1992 to December 1995, he served as president
and a director of Reunion Resources Company (previously known as Buttes Gas and
Oil Company), a Houston-based oil and gas exploration, development and
production company. From 1986 to 1992, he was of counsel with the law firm of
Fulbright & Jaworski L.L.P. Mr. Amonett also currently serves as a director of
American Residential Services, Inc., a residential services company, and of
PetroCorp Incorporated, an oil and gas producer.

T. William Porter. Mr. Porter has served as a director of the Company
since December 1995. Since 1981, Mr. Porter has been a partner of Porter &
Hedges, L.L.P., a Houston-based law firm and the Company's principal outside
legal counsel. Mr. Porter also serves on the board of Gundle/SLT Environmental,
Inc., a manufacturer and supplier of lining systems used in waste and industrial
containment systems.

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<PAGE> 25

James L. Rainey. Mr. Rainey has served as a director of the Company since
October 1993. He is an independent business consultant. From May 1986 through
April 1991, he served as president and chief executive officer of Farmland
Industries, Inc., the largest domestic agricultural supply cooperative. Prior to
that time, he spent over 20 years with Kerr-McGee Corporation, including serving
as president of Kerr-McGee Chemical Corporation. Mr. Rainey also serves on the
boards of Jacobs Engineering Group, Inc., The Wirthlin Group and Biomat, Inc.

James A. Read. Mr. Read has served as a director of the Company since
January 1997. Since 1988, Mr. Read has served as a managing director of
Mezzanine Management Limited, an independent private debt and equity fund
management and advisory company. Mr. Read also serves on the boards of directors
of Core Laboratories N.V., JJI Lighting Group, Inc. and Western Sky Industries,
Inc. in the United States and British Printing Co. Limited, Page One
Communications Limited, Wellington Holding plc, CF Holdings Ltd. and CB Holdings
SA in Europe.

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<PAGE> 26

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of April 14, 1997, as adjusted to
reflect the sale of the shares offered hereby by (i) each person known by the
Company to be the beneficial owner of more than 5% of the Company's Common
Stock, (ii) each of the Company's directors, (iii) all directors and officers as
a group, and (iv) each Selling Stockholder.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
SHARES BENEFICIALLY OWNED AFTER
OWNED PRIOR TO OFFERING NUMBER OF OFFERING(1)
------------------------ SHARES BEING --------------------
NAME NUMBER(2) PERCENT OFFERED NUMBER(2) PERCENT
---- ----------- --------- ------------ --------- -------
<S> <C> <C> <C> <C> <C>
Mark E. Johnson(3).............. 1,668,062 14.1% 300,000 1,368,062 8.4%
2727 Allen Parkway, Suite 760
Houston, Texas 77019
Pierre S. Melcher(4)............ 2,019,034 17.0% 400,000 1,619,034 10.0%
2727 Allen Parkway, Suite 760
Houston, Texas 77019
International Mezzanine Capital,
B.V.(5)....................... 1,525,333 11.6% -- 1,525,333 9.4%
Manfield House
376-379 Strand
London WCZR-OLR
United Kingdom
Thomas N. Amonett............... 12,000 * -- 12,000 *
Lawrance W. McAfee.............. 228,000 1.8% -- 228,000 1.4%
T. William Porter............... 15,000 * -- 15,000 *
James L. Rainey, Jr. ........... 30,000 * -- 30,000 *
James A. Read................... 5,000 * -- 5,000 *
OTHER SELLING STOCKHOLDER:
Pennsylvania Merchant Group
Ltd. ......................... 50,000 * 50,000 -- --
All directors and executive
officers as a group (8
persons)(6)................... 4,023,091 33.5% 3,373,091 20.4%
</TABLE>

- ---------------

* Less than 1% of outstanding shares.

(1) Adjusted to reflect the sale of shares of Common Stock offered hereby,
assuming the Underwriters' over-allotment option is not exercised.

(2) Includes shares underlying outstanding stock options, as follows: Mr.
Amonett - 12,000; Mr. McAfee - 213,750; Mr. Porter - 15,000; Mr. Rainey -
30,000; and Mr. Read - 5,000.

(3) Mark E. Johnson is a director of the Company and currently serves as its
chairman of the board, president and chief executive officer. Mr. Johnson
previously served as director, president and chief executive officer of
Allied Industries, Inc., a wholly-owned subsidiary of the Company. See
"Management."

(4) Pierre S. Melcher is a director of the Company and currently serves as its
senior vice president and treasurer. Mr. Melcher previously served as
director and senior vice president of Allied Industries, Inc., a
wholly-owned subsidiary of the Company. See "Management."

(5) Consists of Common Stock which may be acquired upon exercise of outstanding
warrants. The board of directors of International Mezzanine Capital, B.V.
("IMC") has investment and voting power with respect to the shares
attributable to IMC; the members of the board of directors are Kipp Koester,
Steve Weber, Hamish Mair, Franz Horhager, Tom Abbott, Charlie Symington,
Muneef Othman and Ian Cotterill. Such persons disclaim beneficial ownership
of the shares attributable to IMC.

(6) Includes all shares referred to in note (2) above.

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<PAGE> 27

DESCRIPTION OF CAPITAL STOCK

The Company's Certificate of Incorporation, as amended (the "Certificate of
Incorporation"), provides for authorized capital stock of 31,000,000 shares,
consisting of 30,000,000 shares of Common Stock, par value $.001 per share, and
1,000,000 shares of preferred stock, par value $.01 per share ("Preferred
Stock"). The following summary description of the capital stock of the Company
is a summary, does not purport to be complete or to give effect to applicable
statutory or common law, is subject in all respects to the applicable provisions
of the Certificate of Incorporation, and the information is qualified in its
entirety by this reference.

COMMON STOCK

Holders of Common Stock are entitled to one vote per share in the election
of directors and on all other matters on which stockholders are entitled or
permitted to vote. Holders of Common Stock are not entitled to cumulative voting
rights. Therefore, subject to the voting rights that may be granted to holders
of Preferred Stock, pursuant to the Company's Bylaws (the "Bylaws") holders of a
plurality of the shares of Common Stock present in person or represented by
proxy at the meeting and entitled to vote can elect all of the directors of the
Company. Subject to the terms of any outstanding series of Preferred Stock, the
holders of Common Stock are entitled to dividends in such amounts and at such
times as may be declared by the Company's board of directors out of funds
legally available therefor. The Common Stock is not subject to any calls or
assessments. Upon liquidation or dissolution, holders of Common Stock are
entitled to share ratably in all net assets available for distribution to
stockholders after payment of any liquidation preferences to holders of
Preferred Stock. Holders of Common Stock have no redemption, conversion or
preemptive rights.

PREFERRED STOCK

Shares of Preferred Stock may be issued without stockholder approval. The
board of directors is authorized to issue up to 1,000,000 shares of Preferred
Stock in one or more series and to determine, with respect to any series of
Preferred Stock, the terms and rights of such series, including, without
limitations (i) the number of shares and the name of the series, (ii) the rate
and times at which dividends will be payable on the shares of the series, and
the status of such dividends as cumulative or non-cumulative and as
participating or non-participating, (iii) the prices, times and terms, if any,
at or upon which shares of the series will be subject to redemption, (iv) the
rights, if any, to convert such shares into, or to exchange such shares for,
shares of any other class of stock of the Company, (v) the terms of the sinking
fund or redemption or purchase account, if any, to be provided for shares of the
series, (vi) the rights and preferences, if any, of shares of the series upon
any liquidation, dissolution or winding up of the affairs of, or upon any
distribution of the assets of, the Company, (vii) the limitations, if any,
applicable while the series is outstanding, on the payment of dividends or
making of distributions on, or the acquisition of, the Common Stock or any other
class of stock which does not rank senior to the shares of the series, and
(viii) the voting rights, if any, to be provided for shares of the series. The
Company has no current plans for issuance of any shares of Preferred Stock. Any
issuance of shares of Preferred Stock may adversely affect the voting powers or
rights of the holders of Common Stock.

WARRANTS

The Company has issued warrants to purchase an aggregate of 1,983,675
shares of Common Stock, of which warrants to purchase an aggregate of 1,760,000
are exercisable at a price of $5.10 per share and expire in November 2003 (the
"Financing Warrants"), warrants to purchase 140,000 shares of Common Stock are
exercisable at a price of $4.42 per share and expire in September 1997 (the
"Advisor Warrants"), warrants to purchase 33,675 shares of Common Stock are
exercisable at a price of $4.72 per share and expire in April 1998, and warrants
to purchase 50,000 shares of Common Stock are exercisable at a price of $4.80
per share and expire in December 1997. The 50,000 shares offered herein by
Pennsylvania Merchant Group Ltd. represent the shares of Common Stock underlying
the 50,000 warrants that expire in December 1997. See "Selling Stockholders."
The exercise price and, if

27
<PAGE> 28

applicable, the number of shares underlying these warrants are subject to
adjustment upon, among other things, the declaration or payment of certain
dividends on the Common Stock (subject to certain exceptions) and stock splits,
combinations and reclassifications of shares. In addition, the exercise price of
the Financing Warrants is subject to adjustment upon the issuance of additional
shares of Common Stock (including the grant of options) and the issuance of
securities convertible into Common Stock, subject to certain exceptions, at
certain price levels. In the case of certain extraordinary transactions
including, without limitation, a merger or consolidation in which the Company is
not the surviving entity, or a sale of all or substantially all of the assets of
the Company, all of the above warrants become exercisable for the number of
shares of stock, securities, or other property which the Common Stock issuable
upon exercise of such warrants would have been entitled upon such transactions,
together with any necessary adjustments.

CERTAIN ANTI-TAKEOVER PROVISIONS

The Certificate of Incorporation and the Bylaws contain certain provisions
that could make more difficult the acquisition of the Company by means of a
tender or exchange offer, a proxy contest or otherwise. The description of such
provisions set forth below is intended only as a summary and is qualified in its
entirety by reference to the pertinent sections of the Certificate of
Incorporation and the Bylaws and of the Delaware General Corporation Law (the
"DGCL").

Preferred Stock. Although the board of directors has no intention at the
present time of doing so, it could issue a series of Preferred Stock that could,
depending on the terms of such series, impede the completion of a merger, tender
offer or other takeover attempt. The board of directors will make any
determination to issue such shares based on its judgment as to the best
interests of the Company and its stockholders. The board of directors, in so
acting, could issue Preferred Stock having terms that could discourage an
acquisition attempt through which an acquiror may be otherwise able to change
the composition of the board of directors, including a tender or exchange offer
or other transaction that some, or a majority, of the Company's stockholders
might believe to be in their best interests or in which stockholders might
receive a premium for their stock over the then-market price of such stock.

Special Meetings. The Bylaws provide that special meetings of stockholders
can be called by the directors or by any officer instructed by the directors to
call the special meeting of stockholders. The business permitted to be conducted
at any special meeting of stockholders is limited to the business brought before
the meeting pursuant to the notice of meeting given by the Company. This
provision would prevent non-director stockholders of the Company from forcing
stockholder consideration of a proposal by calling a special meeting of
stockholders before the time the board believes such consideration to be
appropriate.

Anti-Takeover Legislation. As a Delaware corporation, the Company is
subject to Section 203 of the DGCL ("Section 203"). In general, Section 203
prohibits the Company from engaging in a "business combination" (as defined
therein) with an "interested stockholder" (defined generally as a person owning
15% or more of a corporation's outstanding voting stock) for three years
following the time such person became an interested stockholder unless (i)
before such person became an interested stockholder, the board of the
corporation approved the transaction in which the interested stockholder became
an interested stockholder or approved the business combination; (ii) upon
consummation of the transaction that resulted in the stockholder becoming an
interested stockholder, the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced (excluding stock held by directors who are also officers of the
corporation and by employee stock plans that do not provide employees with the
rights to determine confidentially whether shares held subject to the plan will
be tendered in a tender or exchange offer); or (iii) following the transaction
in which such person became an interested stockholder, the business combination
was approved by the board of the corporation and authorized at a meeting of the
stockholders by the affirmative vote of the holders of two-thirds of the
outstanding voting stock of the corporation not owned by the interested
stockholder. Under Section 203, the restrictions described above also do not
apply to certain business combinations proposed by an interested stockholder
following the announcement or notification of one of

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<PAGE> 29

certain extraordinary transactions involving the corporation and a person who
had not been an interested stockholder during the previous three years or who
became an interested stockholder with the approval of a majority of the
corporation's directors, if such extraordinary transaction is approved or not
opposed by a majority of the directors who were directors prior to any person
becoming an interested stockholder during the previous three years or were
recommended for election or elected to succeed such directors by a majority of
such directors.

LIMITATION ON DIRECTORS' LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS

The Certificate of Incorporation contains a provision that eliminates, to
the extent currently allowed under Section 102(b)(7) of the DGCL, the personal
monetary liability of a director to the Company and its stockholders for breach
of his fiduciary duty of care as a director. If a director were to breach the
duty of care in performing his duties as a director, neither the Company nor its
stockholders could recover monetary damages from the director, and the only
course of action available to the Company's stockholders would be equitable
remedies, such as an action to enjoin or rescind a transaction involving a
breach of the fiduciary duty of care. To the extent certain claims against
directors are limited to equitable remedies, this provision of the Certificate
of Incorporation may reduce the likelihood of derivative litigation and may
discourage stockholders or management from initiating litigation against
directors for breach of their duty of care. Additionally, equitable remedies may
not be effective in many situations. If a stockholder's only remedy is to enjoin
the completion of a transaction or an event authorized by the board of
directors, the remedy would be ineffective if the stockholder does not become
aware of a transaction or event until after it has been completed. In such a
situation, such stockholder would have no effective remedy against the
directors. Liability for monetary damages remains for (i) any breach of the duty
of loyalty to the Company or its stockholders, (ii) acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law, (iii) payment of an improper dividend or improper repurchase or redemption
of the Company's stock under Section 174 of the DGCL or (iv) any transaction
from which the director derived an improper personal benefit. The Certificate of
Incorporation further provides that if Section 102(b)(7) of the DGCL is amended
or supplemented to allow further elimination or limitation of the liability of
directors, then the liability of the Company's directors shall be limited to the
fullest extent permitted by the amended DGCL.

The DGCL permits a corporation to indemnify certain persons, including
officers and directors, who are (or are threatened to be made) parties to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (other than an action by or in the
right of the corporation), by reason of their being officers or directors of the
corporation. The indemnity may include expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by an indemnified officer or director, provided he acted in good faith and in a
manner he reasonably believed to be in or not opposed to the corporation's best
interests and, in the case of criminal proceedings, provided he had no
reasonable cause to believe that his conduct was unlawful. The Certificate of
Incorporation provides indemnification for the Company's directors and officers
to the fullest extent allowed pursuant to the foregoing provisions of the DGCL.

The DGCL further permits a corporation to indemnify certain persons,
including officers and directors, who are (or are threatened to be made) parties
to any threatened, pending or completed action or suit by or in the right of the
corporation to procure a judgment in its favor by reason of their being officers
or directors of the corporation. The indemnity may include expenses (including
attorneys' fees) actually and reasonably incurred by the indemnified officer or
director, provided he acted in good faith and in a manner he reasonably believed
to be in, or not opposed to, the corporation's best interests. However, no such
person will be indemnified as to matters for which he is found to be liable for
negligence or misconduct in the performance of his duty to the corporation
unless, and only to the extent that, indemnification is ordered by a court. The
Certificate of Incorporation provides indemnification of the Company's directors
and officers to the fullest extent allowed pursuant to the foregoing provisions
of the DGCL.

Delaware corporations also are authorized to obtain insurance to protect
officers and directors from certain liabilities, including liabilities against
which the corporation cannot indemnify its directors and

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<PAGE> 30

officers. The foregoing indemnification provisions are not exclusive of any
other right to indemnity to which a director or officer may be entitled under
any bylaw, agreement, vote of stockholders or disinterested directors or
otherwise.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Common Stock is Harris Trust and
Savings Bank, New York, New York.

30
<PAGE> 31

CERTAIN UNITED STATES FEDERAL TAX CONSEQUENCES
TO NON-UNITED STATES HOLDERS

The following is a general discussion of certain United States Federal tax
consequences of the acquisition, ownership, and disposition of Common Stock by a
holder that, for United States Federal income tax purposes, is not a "United
States person" (as defined below) (a "Non-United States Holder"). This
discussion is based upon the Company's review and analysis of the United States
Federal tax law now in effect, which is subject to change, possibly
retroactively. This discussion does not consider any specific facts or
circumstances that may apply to a particular Non-United States Holder.
Prospective investors are urged to consult their tax advisors regarding the
United States Federal tax consequences of acquiring, holding, and disposing of
Common Stock, as well as any tax consequences that may arise under the laws of
any foreign, state, local, or other taxing jurisdiction.

For purposes of this discussion, a "United States person" means (i) a
citizen or resident of the United States, (ii) a corporation, partnership, or
other entity created or organized in the United States or under the laws of the
United States or of any political subdivision thereof, (iii) an estate whose
income is includible in gross income for United States Federal income tax
purposes regardless of its source, or (iv) a trust whose administration is
subject to the primary supervision of a United States court and which has one or
more United States fiduciaries who have the authority to control all substantial
decisions of the trust.

DIVIDENDS

Dividends paid to a Non-United States Holder will generally be subject to
withholding of United States Federal income tax at the rate of 30% unless the
dividend is effectively connected with the conduct of a trade or business within
the United States by the Non-United States Holder, in which case the dividend
will be subject to the United States Federal income tax imposed on net income on
the same basis that applies to United States persons generally (and, with
respect to corporate holders and under certain circumstances, the branch profits
tax). Non-United States Holders should consult any applicable income tax
treaties that may provide for a lower rate of withholding or other rules
different from those described above. A Non-United States Holder may be required
to satisfy certain certification requirements in order to claim treaty benefits
or otherwise claim a reduction of or exemption from withholding under the
foregoing rules.

GAIN ON DISPOSITION

A Non-United States Holder will generally not be subject to United States
Federal income tax on gain recognized on a sale or other disposition of Common
Stock unless (i) the gain is effectively connected with the conduct of a trade
or business within the United States by the Non-United States Holder or (ii) in
the case of a Non-United States Holder who is a nonresident alien individual and
holds the Common Stock as a capital asset, such holder is present in the United
States for 183 or more days in the taxable year and certain other requirements
are met. Gain that is effectively connected with the conduct of a trade or
business within the United States by the Non-United States Holder will be
subject to the United States Federal income tax imposed on net income on the
same basis that applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits tax) but
will not be subject to withholding. Non-United States Holders should consult
applicable treaties that may provide for different rules.

FEDERAL ESTATE TAXES

Common Stock owned or treated as owned by an individual who is not a
citizen or resident (as specially defined for United States Federal estate tax
purposes) of the United States on the date of death will be included in such
individual's estate for United States Federal estate tax purposes, unless an
applicable estate tax treaty provides otherwise.

31
<PAGE> 32

INFORMATION REPORTING AND BACKUP WITHHOLDING

The Company must report annually to the United States Internal Revenue
Service and to each Non-United States Holder the amount of dividends paid to,
and the tax withheld with respect to, such holder, regardless of whether any tax
has been actually withheld. This information may also be made available to the
tax authorities of a country in which the Non-United States Holder resides.

Under temporary United States Treasury regulations, United States
information requirements and backup withholding tax will generally not apply to
dividends paid on the Common Stock to a Non-United States Holder at an address
outside the United States. Payments by a United States office of a broker of the
proceeds of a sale of the Common Stock is subject to both backup withholding at
a rate of 31% and information reporting unless the holder certifies its
Non-United States Holder status under penalties of perjury or otherwise
establishes an exemption. Information reporting requirements (but not backup
withholding) will also apply to payments of the proceeds of sales of the Common
Stock by foreign offices of United States brokers, or foreign brokers with
certain types of relationships to the United States, unless the broker has
documentary evidence in its records that the holder is a Non-United States
Holder and certain other conditions are met, or the holder otherwise establishes
an exemption.

Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be refunded or credited against the Non-United
States Holder's United States Federal income tax liability, provided that
certain required information is furnished to the United States Internal Revenue
Service by the Non-United States Holder.

These information reporting and backup withholding rules are under review
by the United States Treasury and their application to the Common Stock could be
changed by future regulations. The United States Internal Revenue Service has
recently issued proposed Treasury regulations concerning these rules which are
presently proposed to be effective for payments made after December 31, 1997.
Prospective investors should consult their tax advisors concerning the potential
adoption of such proposed Treasury regulations and the potential effect on their
ownership and disposition of the Common Stock.

32
<PAGE> 33

UNDERWRITING

The Underwriters named below, for whom Deutsche Morgan Grenfell Inc.,
EVEREN Securities, Inc. and Sanders Morris Mundy are acting as representatives
(the "Representatives"), have severally agreed, subject to the terms and
conditions contained in the Underwriting Agreement (the form of which is filed
as an exhibit to the Company's Registration Statement, of which this Prospectus
is a part), to purchase from the Company and the Selling Stockholders the
respective number of shares of Common Stock indicated below opposite their
respective names. The Underwriters are committed to purchase all of the shares,
if they purchase any.

<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
---- ---------
<S> <C>
Deutsche Morgan Grenfell Inc................................ 1,520,000
EVEREN Securities, Inc...................................... 1,515,000
Sanders Morris Mundy........................................ 1,515,000
PaineWebber Incorporated.................................... 125,000
Robert W. Baird & Co. Incorporated.......................... 75,000
Cleary Gull Reiland & McDevitt Inc.......................... 75,000
Harris Webb & Garrison, Inc................................. 75,000
Legg Mason Wood Walker Incorporated......................... 75,000
Raymond James & Associates, Inc............................. 75,000
---------
Total............................................. 5,050,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions.

The Representatives have advised the Company that the Underwriters propose
initially to offer the Common Stock to the public on the terms set forth on the
cover page of this Prospectus. The Underwriters may allow to selected dealers
(who may include the Underwriters) a concession of not more than $0.26 per
share. After the Offering, the price, the concession and the reallowance and
other selling terms may be changed by the Representatives. The Common Stock is
offered subject to receipt and acceptance by the Underwriters, and to certain
other conditions, including the right to reject orders in whole or in part. The
Underwriters do not intend to sell any of the shares of Common Stock offered
hereby to accounts for which they exercise discretionary authority.

In connection with the Offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Common Stock. Specifically, the Underwriters may overallot the Offering,
creating a syndicate short position. Underwriters may bid for and purchase
shares of Common Stock in the open market to cover syndicate short positions. In
addition, the Underwriters may bid for and purchase shares of Common Stock in
the open market to stabilize the price of the Common Stock. These activities may
stabilize or maintain the market price of the Common Stock above independent
market levels. The Underwriters are not required to engage in these activities
and may end these activities at any time.

The Company has granted an option to the Underwriters to purchase up to a
maximum of 757,500 additional shares of Common Stock to cover over-allotments,
if any, at the public offering price, less the underwriting discount set forth
on the cover page of this Prospectus. Such option may be exercised at any time
until 30 days after the date of the Underwriting Agreement. To the extent the
Underwriters exercise this option, each of the Underwriters will be committed,
subject to certain conditions, to purchase such additional shares in
approximately the same proportion as set forth in the above table. The
Underwriters may purchase such shares only to cover over-allotments made in
connection with the Offering.

Each Underwriter has represented and agreed that: (i) it has not offered or
sold and prior to the date six months after the date of issue of the Common
Stock will not offer or sell any Common Stock to persons in the United Kingdom
except to persons whose ordinary activities involve them in acquiring,

33
<PAGE> 34

holding, managing or disposing of investments (as principal or agent) for the
purposes of their businesses or otherwise in circumstances which have not
resulted and will not result in an offer to the public in the United Kingdom
within the meaning of the Public Offers of Securities Regulations 1995; (ii) it
has complied and will comply with all applicable provisions of the Financial
Services Act 1986 with respect to anything done by it in relation to the Common
Stock in, from or otherwise involving the United Kingdom; and (iii) it has only
issued or passed on and will only issue or pass on in the United Kingdom any
document received by it in connection with the issue of the Common Stock to a
person who is of a kind described in Article 11(3) of the Financial Services Act
1986 (Investment Advertisements) (Exemptions) Order 1996 or is a person to whom
such document may otherwise lawfully be issued or passed on.

In connection with the Offering, the Selling Stockholders have agreed not
to, directly or indirectly, offer, sell or otherwise dispose of any shares of
Common Stock for a period of 180 days after the date of this Prospectus, without
the prior written consent of Deutsche Morgan Grenfell Inc. In addition, the
Company and its directors and officers have agreed not to, directly or
indirectly, offer, sell or otherwise dispose of any shares of Common Stock for a
period of 120 days after the date of this Prospectus, without the prior written
consent of Deutsche Morgan Grenfell Inc., except for the issuance of shares
pursuant to the exercise of stock options granted under the Company's stock
option plans and except for the issuance of shares in business acquisitions.
Furthermore, the holders of the Financing Warrants and the holder of the Advisor
Warrants and the warrants to purchase 33,675 shares of Common Stock exercisable
at a price of $4.72 per share have agreed not to, directly or indirectly, offer,
sell or otherwise dispose of any shares of Common Stock for a period of 120 days
after the date of this Prospectus, without the prior written consent of Deutsche
Morgan Grenfell Inc.

The Underwriting Agreement provides that the Company and the Selling
Stockholders will indemnify the several Underwriters against certain liabilities
including civil liabilities under the Securities Act or will contribute to
payments the Underwriters may be required to make in respect thereof. In
addition, the Underwriting Agreement provides that the Company will reimburse
Deutsche Morgan Grenfell Inc. for its itemized, reasonable out-of-pocket
expenses incurred in connection with the Offering not to exceed $200,000.

Sanders Morris Mundy has in the past provided, and may in the future
provide, investment banking services to the Company.

LEGAL MATTERS

Certain legal matters in connection with the Commons Stock offered hereby
are being passed upon for the Company by Porter & Hedges, L.L.P. T. William
Porter, a partner of the firm Porter & Hedges, L.L.P., the Company's principal
outside legal counsel, is a director of the Company. Certain legal matters
relating to this Offering will be passed upon for the Underwriters by Andrews &
Kurth L.L.P.

EXPERTS

The audited financial statements of the Company included in this Prospectus
have been audited by Arthur Andersen LLP and KPMG Peat Marwick LLP, independent
auditors, as stated in their reports appearing herein, and have been so included
in reliance upon such reports given upon the authority of those firms as experts
in accounting and auditing.

The audited financial statements of Ohmstede incorporated by reference into
this Prospectus have been audited by Arthur Andersen LLP, Melton & Melton and
KPMG Peat Marwick LLP, independent auditors, as stated in their reports
appearing in Form 8-K/A dated February 3, 1997, and have been so incorporated by
reference in reliance upon such reports given upon the authority of those firms
as experts in accounting and auditing.

34
<PAGE> 35

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports and other
information may be inspected and copied or obtained by mail upon the payment of
the Commission's prescribed rates at the public reference facilities maintained
by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the following Regional Offices of the Commission:
CitiCorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661;
and Seven World Trade Center, New York, New York 10048. Copies of such material
can also be obtained at prescribed rates from the Public Reference Section of
the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. In addition,
the Company is required to file electronic versions of these documents with the
Commission through the Commission's Electronic Data Gathering, Analysis and
Retrieval (EDGAR) system. The Commission maintains a World Wide Web site at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission. The Common Stock is listed on the Nasdaq National Market, and
reports, proxy statements and other information filed by ITEQ can be inspected
at the offices of the National Association of Securities Dealers, Inc., 1735 K
Street, Washington, D.C.

The Company has filed with the Commission a registration statement on Form
S-2 (together with all amendments, supplements and exhibits thereto, the
"Registration Statement") under the Securities Act of 1933, as amended (the
"Securities Act"), with respect to the shares of Common Stock to be offered
hereby. This Prospectus does not contain all of the information set forth in the
Registration Statement, certain parts of which are omitted in accordance with
the rules and regulations of the Commission. The Registration Statement and any
amendments thereto, including exhibits filed as a part thereof, are available
for inspection and copying as set forth above. Statements contained in this
Prospectus as to the contents of any contract or other document referred to
herein are not necessarily complete, and reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
such statement being qualified in all respects by such reference.

INCORPORATION OF DOCUMENTS BY REFERENCE

The Company hereby incorporates by reference in this Prospectus the
Company's (i) Annual Report on Form 10-K for the fiscal year ended December 31,
1996, as amended by Form 10-K/A dated May 2, 1997, (ii) Form 8-K/A dated
February 3, 1997, (iii) Form 8-K dated March 7, 1997, and (iv) Form 10-Q dated
April 30, 1997, as amended by Form 10-Q/A dated May 6, 1997, all of which have
been filed with the Commission pursuant to the Exchange Act.

The Company will provide without charge to each person to whom a copy of
this Prospectus is delivered, upon written or oral request, a copy of any or all
of the documents incorporated by reference as a part of the Registration
Statement, other than exhibits to such documents. Requests should be directed to
Lawrance W. McAfee, executive vice president and chief financial officer, ITEQ,
Inc., 2727 Allen Parkway, Suite 760, Houston, Texas 77019, telephone number
(713) 285-2700.

35
<PAGE> 36

ITEQ, INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Unaudited Pro Forma Combined Financial Information.......... F-2
Unaudited Pro Forma Combined Statement of Operations........ F-3
Notes to Unaudited Pro Forma Combined Statement of
Operations................................................ F-4
Consolidated Balance Sheets as of December 31, 1996 and
March 31, 1997 (unaudited)................................ F-5
Consolidated Statements of Operations for the three months
ended March 31, 1996
(unaudited) and 1997 (unaudited).......................... F-6
Consolidated Statements of Cash Flows for the three months
ended March 31, 1996
(unaudited) and 1997 (unaudited).......................... F-7
Notes to Consolidated Financial Statements (unaudited)...... F-8
Reports of Independent Public Accountants................... F-11,12
Consolidated Balance Sheets -- December 31, 1995 and
December 31, 1996......................................... F-13
Consolidated Statements of Operations -- Years ended
December 31, 1994, 1995 and 1996.......................... F-14
Consolidated Statements of Stockholders' Equity -- Years
ended December 31, 1994, 1995 and 1996.................... F-15
Consolidated Statements of Cash Flows -- Years ended
December 31, 1994, 1995 and 1996.......................... F-16
Notes to Consolidated Financial Statements.................. F-17
</TABLE>

F-1
<PAGE> 37

ITEQ, INC.

UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION

The following unaudited pro forma combined statement of operations gives
effect to the acquisition (the "Acquisition") by ITEQ, Inc. (the "Company") of
Ohmstede, Inc. ("Ohmstede") on November 20, 1996, which for accounting purposes
was effective November 1, 1996. The unaudited pro forma combined statement of
operations presented was prepared utilizing the historical audited financial
statements of the Company and the unaudited financial statements of Ohmstede,
respectively. The Company accounted for the Acquisition using the purchase
method of accounting. The allocation of the purchase price to the assets
acquired and liabilities assumed is based on estimates of fair market values.
The unaudited pro forma combined statement of operations for the year ended
December 31, 1996 assumes the Acquisition occurred on January 1, 1996. The
results of Ohmstede are included in the Company's historical results for the
three months ended March 31, 1997, and therefore pro forma financial data for
this period is not included. The pro forma combined statement of operations may
not be indicative of the Company's results of operations that would have
occurred had the Acquisition been completed at the beginning of the period
presented, nor do such statements purport to indicate the Company's financial
condition or results of operations at any future date or for any future period.

Other than savings attributable to compensation and benefits for certain
positions of Ohmstede which were required to be eliminated pursuant to the
purchase agreement and which have been eliminated since the Acquisition, no
expected benefits and/or cost reductions anticipated by the Company, corporate
allocations, additional costs from association with a public company or
additional revenues related to selling Ohmstede products through the Company's
international marketing network have been reflected in this unaudited pro forma
combined statement of operations. Also, the following unaudited pro forma
combined statement of operations does not include the effect of the Offering.

F-2
<PAGE> 38

ITEQ, INC. AND SUBSIDIARIES

UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEAR ENDED DECEMBER 31, 1996

<TABLE>
<CAPTION>
HISTORICAL
-------------------------
OHMSTEDE
FOR TEN
MONTHS
ENDED PRO FORMA
OCTOBER 31, ACQUISITION
COMPANY 1996 ADJUSTMENTS PRO FORMA
-------- ----------- ----------- ---------
(AUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues.............................. $110,804(a) $ 83,124(b) -- $193,928
Cost of revenues(h)................... 88,949(g) 63,794 -- 152,743
-------- ----------- --------- --------
Gross profit..................... 21,855 19,330 -- 41,185
Selling, general and administrative
expenses............................ 11,977 9,964 $ (541)(c) 21,400
Sales commissions..................... 2,755 337 -- 3,092
Depreciation and amortization......... 1,146 144 828(d) 2,118
Restructuring charges and other
nonrecurring costs.................. 3,704(g) -- -- 3,704
-------- ----------- --------- --------
Operating profit................. 2,273 8,885 (287) 10,871
-------- ----------- --------- --------
Other income (expense):
Interest expense, net............... (2,660) (301) (4,890)(e) (7,851)
Other income........................ 305 284 -- 589
-------- ----------- --------- --------
Total other expense......... (2,355) (17) (4,890) (7,262)
-------- ----------- --------- --------
Earnings (loss) before provision for
income taxes........................ (82) 8,868 (5,177) 3,609
Provision for income taxes............ 4 444 908(f) 1,356
-------- ----------- --------- --------
NET EARNINGS (LOSS)......... $ (86) $ 8,424 $ (6,085) $ 2,253
======== =========== ========= ========
Net earnings (loss) per common
share............................ $ (.01) $ .19
======== ========
Weighted average number of common
and common equivalent shares
outstanding...................... 11,481 11,604
======== ========
</TABLE>

See Notes to Unaudited Pro Forma Combined Statement of Operations on the
following page.

F-3
<PAGE> 39

ITEQ, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
(IN THOUSANDS)

a) Includes revenues of $17.0 million from the operations of Ohmstede for
the two month period following the date of acquisition.

b) Reflects revenues of $83.2 million from the operations of Ohmstede for
the ten month period ended October 31, 1996, and prior to its acquisition by the
Company.

c) Represents estimated savings attributable to salaries, bonuses and
benefits for positions at Ohmstede that have been eliminated. No anticipated
cost reductions, corporate allocations from ITEQ, Inc., or additional costs
related to association with a public company have been included in this
adjustment.

d) Reflects the additional amortization related to the intangible assets
and the excess of costs over the net assets acquired.

e) Reflects the increase in interest expense related to the additional debt
borrowed for the Ohmstede acquisition and the amortization of both the debt
financing costs and the subordinated debt discount, net of historical interest
expense savings from the paydown of Ohmstede debt related to the transaction.

f) Reflects pro forma income tax expense based on the expected effective
tax rate of the Company (38%) related to the net pro forma adjustments and
conversion of Ohmstede's federal income tax status from an S Corporation to a C
Corporation.

g) During 1996, the Company incurred a restructuring charge of $4.4
million, of which $3.7 million and $0.7 million were recorded as restructuring
charges and cost of revenues, respectively. The charge included (i) a provision
for the contractually required severance obligations to the former president and
chief executive officer who was replaced in March 1996, and (ii) the cost of
implementing new management's plan to reduce the Company's overall cost
structure including employee severance, lease and other contract buyouts,
inventory and other asset impairments, losses related to termination of
unprofitable business lines, excess machinery disposal and other related costs.

h) Includes depreciation and amortization of $719, $855 and $1,574 for the
historical Company, historical Ohmstede and pro forma financial information,
respectively.

F-4
<PAGE> 40

ITEQ, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

ASSETS

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1996 1997
------------ -----------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............... $ 6,331 $ 1,759
Restricted cash......................... 144 155
Due on contracts and other receivables,
net................................... 34,230 33,261
Costs and estimated earnings in excess
of billings on uncompleted
contracts............................. 20,690 23,759
Inventories............................. 10,649 6,268
Prepaid expenses, deposits and other
assets................................ 881 1,106
Deferred tax asset...................... 1,979 1,166
-------- --------
Total Current Assets.......... 74,904 67,474
-------- --------
Property and Equipment, net............. 13,661 13,775
Other Assets, net....................... 47,823 47,045
-------- --------
TOTAL ASSETS............................ $136,388 $128,294
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Accounts payable........................ $ 14,568 $ 13,550
Accrued liabilities:
Job costs............................. 8,171 9,004
Warranties............................ 353 343
Compensation.......................... 5,067 4,927
Other................................. 4,260 2,978
Billings in excess of costs and
estimated earnings on uncompleted
contracts............................. 958 952
Progress billings....................... 5,137 6,496
Current maturities of long-term debt.... 6,012 6,012
Income taxes payable.................... 527 506
-------- --------
Total Current Liabilities..... 45,053 44,768
LONG-TERM LIABILITIES:
Borrowings under line of credit......... 25,400 17,000
Other long-term obligations, less
current maturities.................... 29,029 27,548
Subordinated notes...................... 12,712 12,796
Deferred tax liability.................. 941 941
-------- --------
Total Liabilities............. 113,135 103,053
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 1,000
shares authorized, no shares issued or
outstanding........................... -- --
Common stock, $.001 par value; 30,000
shares authorized, 11,510 and 11,838
shares issued and outstanding at
December 31, 1996 and March 31, 1997,
respectively.......................... 11 12
Additional paid-in capital.............. 23,161 24,400
Retained earnings (deficit)............. (44) 1,129
Translation adjustment.................. 125 (300)
-------- --------
Total Stockholders' Equity.... 23,253 25,241
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY................................ $136,388 $128,294
======== ========
</TABLE>

See Notes to Consolidated Financial Statements

F-5
<PAGE> 41

ITEQ, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1996
AS
RESTATED 1997
-------- -------
<S> <C> <C>
Revenues.................................................... $ 22,129 $48,494
Cost of revenues............................................ 17,430 38,870
-------- -------
Gross profit.............................................. 4,699 9,624
Selling, general and administrative expenses................ 2,647 4,807
Sales commissions........................................... 1,047 645
Depreciation and amortization............................... 245 481
Merger costs, restructuring charges and other nonrecurring
costs..................................................... 3,500 --
-------- -------
Operating profit....................................... (2,740) 3,691
-------- -------
Other income (expense):
Interest expense, net.................................. (385) (1,807)
Other income........................................... 18 102
-------- -------
Total other expense............................... (367) (1,705)
-------- -------
Earnings (loss) before provision for income taxes........... (3,107) 1,986
Provision (benefit) for income taxes........................ (1,210) 813
-------- -------
Net earnings (loss).................................... ($ 1,897) $ 1,173
======== =======
Net earnings (loss) per common share........................ ($ 0.17) $ 0.10
======== =======
Weighted average common and common equivalent shares
outstanding............................................... 11,462 12,272
======== =======
</TABLE>

See Notes to Consolidated Financial Statements

F-6
<PAGE> 42

ITEQ, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1996 AND 1997
(IN THOUSANDS)
(UNAUDITED)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1996
AS RESTATED 1997
----------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)......................................... $(1,897) $ 1,173
Adjustments to reconcile net earnings (loss) to net cash
provided (used) by operating activities:
Non Cash Interest......................................... -- 218
Depreciation and amortization............................. 376 730
Provision (benefit) for income taxes...................... (115) 813
Changes in assets and liabilities:
Restricted cash........................................ (156) (27)
Due on contracts and other receivables................. 6,909 780
Inventories............................................ 453 4,359
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. (858) (3,523)
Prepaid expenses, deposits and other assets............ (397) (225)
Refundable income taxes................................ (1,210)
Accounts payable and accrued liabilities............... (5,377) (1,144)
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. 42 46
Progress Billings...................................... -- 1,359
Income taxes payable................................... -- (21)
Other.................................................. 4 (20)
------- -------
Net cash provided (used) by operating
activities...................................... (2,226) 4,518
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......................... (44) (490)
------- -------
Net cash used by investing activities............. (44) (490)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term obligations........................... (4) (9,881)
Net borrowings under line of credit......................... 102 --
Proceeds from exercise of stock options..................... 43 1,240
------- -------
Net cash provided (used) by financing
activities...................................... 141 (8,641)
------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... (16) 41
------- -------
Net decrease in cash and cash equivalents................... (2,145) (4,572)
Cash and cash equivalents, beginning of period.............. 2,216 6,331
------- -------
Cash and cash equivalents, end of period.................... $ 71 $ 1,759
======= =======
</TABLE>

See Notes to Consolidated Financial Statements

F-7
<PAGE> 43

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 -- BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been
prepared in accordance with regulation S-X pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although management believes that the
disclosures are adequate to make the information presented not misleading.

In the opinion of management, the unaudited financial statements contain
all adjustments, consisting of only normal recurring adjustments, necessary to
present fairly the financial position as of March 31, 1997, the results of
operations for the three months ended March 31, 1996 and 1997, and the cash
flows for the three months ended March 31, 1996 and 1997.

During the fourth quarter of 1996, effective January 1, 1996, the Company
estimated percentage-of-completion for the materials portion of its long-term
contracts at its Allied Industries, Inc. subsidiary, based on when purchased
material was placed into production, whereas previously, such estimates were
based on when the liability for the cost of the material was legally incurred.
The new method of applying the percentage-of-completion accounting principle was
adopted to better reflect the economics of Allied's revenue and profit earnings
process. Financial statements of prior years and interim periods have been
restated to apply the revised method retroactively. The effect of the accounting
change on previously reported March 31, 1996 net earnings is as follows (in
thousands):

<TABLE>
<CAPTION>
INCREASE (DECREASE)
-------------------
MARCH 31,
1996
-------------------
<S> <C>
Net earnings (loss)......................................... $12
Net earnings (loss) per common share........................ --
</TABLE>

NOTE 2 -- DUE ON CONTRACTS AND OTHER RECEIVABLES

At December 31, 1996 and March 31, 1997, due on contracts and other
receivables consist of (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1996 1997
------------ ---------
<S> <C> <C>
Billings on completed contracts and contracts in progress... $34,273 $33,232
Retained contract receivables............................... 544 628
Other miscellaneous receivables............................. 125 134
Allowance for doubtful accounts............................. (712) (733)
------- -------
$34,230 $33,261
======= =======
</TABLE>

NOTE 3 -- INVENTORIES

Inventories consist of costs for which no related revenue has been
recognized. Inventories include materials used in the manufacturing process,
purchased parts and equipment held for resale and are valued at the lower of
cost or market. Cost is determined by the average cost method for materials and

F-8
<PAGE> 44

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

the first-in, first-out (FIFO) method for purchased parts. At December 31, 1996
and March 31, 1997, inventories consist of the following (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1996 1997
------------ ---------
<S> <C> <C>
Raw Materials............................................... $ 3,514 $ 3,524
Work in Progress............................................ 7,135 2,744
------- -------
Total....................................................... $10,649 $ 6,268
======= =======
</TABLE>

NOTE 4 -- OTHER ASSETS

At December 31, 1996 and March 31, 1997, other assets consist of the
following items (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1996 1997
------------ ---------
<S> <C> <C>
Excess of costs over net assets acquired, net of
accumulated amortization, of $1,789 and $1,995 at
December 31, 1996 and March 31, 1997, respectively...... $32,941 $32,449
Licenses, trademarks and tradenames, net of accumulated
amortization of $878 and $1,050 at December 31, 1996 and
March 31, 1997, respectively............................ 11,880 11,708
Debt issuance costs, net of accumulated amortization of
$45 and $179 at December 31, 1996 and March 31, 1997,
respectively............................................ 2,957 2,843
Other..................................................... 45 45
------- -------
Other Assets, net....................................... $47,823 $47,045
======= =======
</TABLE>

NOTE 5 -- BUSINESS ACQUISITIONS

In March 1997, the Company entered into a letter of intent to purchase
Exell, Inc. and an affiliated partnership (collectively, "Exell") for a combined
cash purchase price of approximately $10.4 million, subject to reduction for
certain adjustments. A definitive purchase agreement was entered into in April
1997. Exell is a manufacturer of shell and tube heat exchangers and a competitor
of the Company's Ohmstede heat exchanger manufacturing operation. For its fiscal
year ended September 30, 1996, Exell reported revenues of $25.0 million. The
transaction, if consummated, will be accounted for using the purchase method of
accounting and is presently scheduled to close by June 30, 1997, but remains
subject to the satisfaction of customary contractual conditions and certain
regulatory approvals, and there can be no assurance that the transaction will be
consummated.

NOTE 6 -- RESTRUCTURING COSTS

A restructuring charge of $4.2 million was taken during the three months
ended March 31, 1996, of which $3.5 million and $0.7 million were recorded as
restructuring charges and cost of revenues, respectively. The charge included
(i) a provision for the contractually required severance obligations to the
former president and chief executive officer who was replaced in March 1996, and
(ii) the cost of implementing new management's plan to reduce the Company's
overall cost structure including employee severance, lease and other contract
buyouts, inventory and other asset impairments, losses related to termination of
unprofitable product lines, excess machinery disposal and other related costs.

F-9
<PAGE> 45

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)

NOTE 7 -- RECENT DEVELOPMENTS

As planned when acquired, Ohmstede has initiated foreign sales, which
typically have longer production times and more units per order in production
and shipment than Ohmstede's historical domestic business. Accordingly, such
sales were recognized under the percentage-of-completion revenue recognition
method, resulting in revenues and gross margin of $3.6 million and $0.7 million,
respectively, during the three months ended March 31, 1997. Also, at March 31,
1997, Ohmstede had more jobs substantially complete but not shipped than in
prior periods, which under the Company's completed contract policy resulted in
revenues and gross margin of $2.0 million and $0.6 million, respectively, during
the three months ended March 31, 1997.

In March 1997, a vessel at the Company's Allied subsidiary was damaged by a
subcontractor during the final stages of completion. The Company entered into a
second contract with the customer to construct a replacement vessel. The direct
cost of the original and replacement vessels will be recovered from the
customer. The Company expects to recover additional amounts from either the
subcontractor or from insurance proceeds, which have not been recognized in the
accompanying financial statements.

The Company has filed a registration statement on Form S-2 to register for
sale 5.1 million shares of common stock (4.3 million from the Company and 0.8
million from certain selling stockholders). The primary use of the offering
proceeds to the Company will be to reduce debt incurred in acquisitions and for
potential future acquisitions. Subsequent to March 31, 1997 the Company incurred
$0.1 million in expenses to date in conjunction with the offering which will be
capitalized and recorded as a reduction of offering proceeds.

F-10
<PAGE> 46

ITEQ, INC. AND SUBSIDIARIES

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of
ITEQ, Inc.:

We have audited the accompanying consolidated balance sheets of ITEQ, Inc.
(a Delaware corporation, formerly Air-Cure Technologies, Inc.) and subsidiaries
as of December 31, 1995 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1996. We did not audit the financial statements of
Allied Industries, Inc., a company acquired during 1995 in a transaction
accounted for as a pooling of interests, as discussed in Note 2, for the period
from January 28, 1994 to December 31, 1994. The statement of operations and cash
flows for Allied Industries, Inc. is included in the 1994 consolidated
statements of operations and cash flows of ITEQ, Inc. and reflects total
revenues of 28% of the consolidated total. These statements were audited by
other auditors whose report has been furnished to us, and our opinion, insofar
as it relates to amounts included for Allied Industries, Inc., is based solely
upon the report of other auditors. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.

In our opinion, based on our audit and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of ITEQ, Inc. and subsidiaries as of
December 31, 1995 and 1996, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.

As explained in Note 1 to the consolidated financial statements, the
Company has given retroactive effect to the change in accounting for
percentage-of-completion on long-term contracts.

Arthur Andersen LLP

Houston, Texas
February 24, 1997

F-11
<PAGE> 47

ITEQ, INC. AND SUBSIDIARIES

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

The Board of Directors
Allied Industries, Inc.:

We have audited the balance sheet of Allied Industries, Inc. (the Company)
as of December 31, 1994, and the related statements of operations, retained
earnings and cash flows for the period from January 28, 1994 (date of inception)
to December 31, 1994 (not presented separately herein). These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Allied Industries, Inc. as
of December 31, 1994, and the results of its operations and its cash flows for
the period from January 28, 1994 (date of inception) to December 31, 1994 in
conformity with generally accepted accounting principles.

As explained in Note 1 to the financial statements, the Company has given
retroactive effect to the change in accounting for percentage of completion on
long-term contracts.

KPMG Peat Marwick LLP

Houston, Texas
March 31, 1995, except as to Note 1 which
is as of February 24, 1997

F-12
<PAGE> 48

ITEQ, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1995 AND 1996
(IN THOUSANDS)

<TABLE>
<CAPTION>
DECEMBER 31,
1995
AS RESTATED DECEMBER 31,
(NOTE 1) 1996
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................... $ 2,216 $ 6,331
Restricted cash............................................. 83 144
Due on contracts and other receivables including retainages
of $1,279 and $544 at December 31, 1995 and 1996,
respectively, net......................................... 22,926 34,230
Costs and estimated earnings in excess of billings on
uncompleted contracts..................................... 18,067 20,690
Inventories................................................. 3,944 10,649
Refundable income taxes..................................... 832 --
Prepaid expenses, deposits and other assets................. 502 881
Deferred tax asset.......................................... 240 1,979
------- --------
Total Current Assets............................... 48,810 74,904
PROPERTY AND EQUIPMENT, NET................................. 5,392 13,661
OTHER ASSETS, NET........................................... 16,642 47,823
------- --------
TOTAL ASSETS....................................... $70,844 $136,388
======= ========

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
Accounts payable............................................ $11,799 $ 14,568
Accrued liabilities
Job costs................................................. 10,854 8,171
Warranties................................................ 419 353
Compensation.............................................. 2,358 5,067
Other..................................................... 1,260 4,260
Billings in excess of costs and estimated earnings on
uncompleted contracts..................................... 815 958
Progress billings........................................... -- 5,137
Current maturities of long-term debt........................ 3,347 6,012
Income taxes payable........................................ 124 527
------- --------
Total Current Liabilities.......................... 30,976 45,053
LONG-TERM LIABILITIES
Borrowings under line of credit............................. 11,499 25,400
Other long-term obligations, less current maturities........ 6,709 29,029
Subordinated notes.......................................... -- 12,712
Deferred tax liability...................................... 257 941
------- --------
Total Liabilities.................................. 49,441 113,135
------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 1,000 shares authorized, no
shares issued or outstanding.............................. -- --
Common stock, $.001 par value; 30,000 shares authorized,
11,453 and 11,510 shares issued and outstanding at
December 31, 1995 and 1996, respectively.................. 11 11
Additional paid-in capital.................................. 20,901 23,161
Retained earnings (deficit)................................. 42 (44)
Translation adjustment...................................... 449 125
------- --------
Total Stockholders' Equity......................... 21,403 23,253
------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $70,844 $136,388
======= ========
</TABLE>

See Notes to Consolidated Financial Statements

F-13
<PAGE> 49

ITEQ, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
1994 1995
AS AS
RESTATED RESTATED
(NOTE 1) (NOTE 1) 1996
-------- -------- --------
<S> <C> <C> <C>
Revenues................................................... $61,826 $113,164 $110,804
Cost of revenues........................................... 49,135 93,262 88,949
------- -------- --------
Gross profit............................................. 12,691 19,902 21,855
Selling, general and administrative expenses............... 8,926 11,645 11,977
Sales commissions.......................................... 1,327 2,477 2,755
Depreciation and amortization.............................. 845 1,009 1,146
Merger costs, restructuring charges and other nonrecurring
costs.................................................... -- 1,335 3,704
------- -------- --------
Operating profit......................................... 1,593 3,436 2,273
------- -------- --------
Other income (expense):
Interest expense, net.................................... (888) (1,502) (2,660)
Other income............................................. 112 326 305
------- -------- --------
Total other expense.............................. (776) (1,176) (2,355)
------- -------- --------
Earnings (loss) before provision for income taxes.......... 817 2,260 (82)
Provision for income taxes................................. 338 1,500 4
------- -------- --------
Net earnings (loss).............................. $ 479 $ 760 $ (86)
======= ======== ========
Net earnings (loss) per common share....................... $ 0.04 $ 0.07 $ (0.01)
======= ======== ========
Weighted average common and common equivalent shares
outstanding.............................................. 10,891 11,552 11,481
======= ======== ========
</TABLE>

See Notes to Consolidated Financial Statements

F-14
<PAGE> 50

ITEQ, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED TOTAL
--------------- PAID-IN EARNINGS TRANSLATION STOCKHOLDERS'
SHARES AMOUNT CAPITAL (DEFICIT) ADJUSTMENT EQUITY
------ ------ ---------- --------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1993.................... 5,906 $ 6 $14,577 $ 236 $(192) $14,627
Stock issued for business combinations........ 1,390 1 5,167 -- -- 5,168
Stock issued for the employee stock purchase
plan........................................ 2 -- 2 -- -- 2
Costs related to issuance of stock............ -- -- (76) -- -- (76)
Change in foreign currency translation
adjustment.................................. -- -- -- -- 335 335
Equity transactions of pooled company......... 4,140 4 935 -- -- 939
Net earnings.................................. -- -- -- 479 -- 479
------ --- ------- ------- ----- -------
BALANCE, DECEMBER 31, 1994 As Restated (Note
1).......................................... 11,438 11 20,605 715 143 21,474
Stock issued for the employee stock purchase
plan........................................ 15 -- 46 -- -- 46
Stock issued for the exercise of stock
options..................................... -- -- 1 -- -- 1
Costs related to issuance of stock............ -- -- (14) -- -- (14)
Compensation expense in connection with non-
qualified stock option grants............... -- -- 13 -- -- 13
Change in foreign currency translation
adjustment.................................. -- -- -- -- 306 306
Equity transactions of pooled company......... -- -- 250 (1,433) -- (1,183)
Net earnings.................................. -- -- -- 760 -- 760
------ --- ------- ------- ----- -------
BALANCE, DECEMBER 31, 1995 As Restated (Note
1).......................................... 11,453 11 20,901 42 449 21,403
Stock issued for the employee stock purchase
plan........................................ 15 -- 44 -- -- 44
Stock issued for the exercise of stock
options..................................... 42 -- 134 -- -- 134
Warrants issued to Subordinated Lenders, net
of issuance costs........................... -- -- 2,082 -- -- 2,082
Change in foreign currency translation
adjustment.................................. -- -- -- -- (324) (324)
Net loss...................................... -- -- -- (86) -- (86)
------ --- ------- ------- ----- -------
BALANCE, DECEMBER 31, 1996.................... 11,510 $11 $23,161 $ (44) $ 125 $23,253
====== === ======= ======= ===== =======
</TABLE>

See Notes to Consolidated Financial Statements

F-15
<PAGE> 51

ITEQ, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995, AND 1996
(IN THOUSANDS)

<TABLE>
<CAPTION>
1994 1995
AS AS
RESTATED RESTATED
(NOTE 1) (NOTE 1) 1996
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)....................................... $ 479 $ 760 $ (86)
Adjustments to reconcile net earnings (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization........................... 1,513 1,631 1,865
Provision (benefit) for deferred income taxes........... (444) 118 (156)
Gain on sale of investment in subsidiary................ -- -- (160)
Non-cash interest....................................... -- -- 302
Changes in assets and liabilities, net of effects of
businesses acquired:
Restricted cash....................................... (293) 552 (61)
Due on contracts and other receivables, net........... (26) (7,537) 6,944
Inventories........................................... 616 (664) 2,863
Costs and estimated earnings in excess of billings on
uncompleted contracts.............................. 153 (9,937) (3,409)
Prepaid expenses, deposits and other assets........... (20) (122) (390)
Accounts payable and accrued liabilities.............. 479 11,988 (3,176)
Billings in excess of costs and estimated earnings on
uncompleted contracts.............................. (296) (2,695) 184
Progress billings..................................... -- -- 4,128
Income taxes payable.................................. 147 (26) 21
Other................................................. (6) (27) (817)
-------- ------- --------
Net cash provided (used) by operating activities... 2,302 (5,959) 8,052
-------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for acquired businesses, net of cash acquired... (2,087) -- (52,786)
Purchases of property and equipment....................... (657) (932) (991)
Proceeds from sale of investment in subsidiary............ -- -- 1,000
-------- ------- --------
Net cash used by investing activities.............. (2,744) (932) (52,777)
-------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term obligations....................... 3,000 10,000 27,499
Proceeds from subordinated debt & warrants................ -- -- 15,000
Payments of long-term obligations......................... (11,247) (9,279) (2,499)
Net borrowings under line of credit....................... 8,906 8,117 11,977
Debt issuance costs....................................... -- -- (3,002)
Capital contributions from (distributions to) shareholders
of pooled company....................................... 939 (1,433) --
Proceeds from exercise of stock options................... 2 47 178
Costs relating to issuance of warrants and stock.......... (75) -- (206)
-------- ------- --------
Net cash provided by financing activities.......... 1,525 7,452 48,947
-------- ------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... 72 114 (107)
-------- ------- --------
Net increase in cash and cash equivalents................... 1,155 675 4,115
Cash and cash equivalents, beginning of period.............. 386 1,541 2,216
-------- ------- --------
Cash and cash equivalents, end of period.................... $ 1,541 $ 2,216 $ 6,331
======== ======= ========
Supplemental disclosure of cash flow information:
Cash paid for interest.................................... $ 729 $ 569 $ 1,718
======== ======= ========
Cash paid for income taxes................................ $ 546 $ 2,168 $ 126
======== ======= ========
Supplemental schedule of non-cash investing & financing
activities:
Financing of non-compete agreements....................... -- -- $ 500
======== ======= ========
Net business assets disposed through Company financing or
non-cash consideration.................................. -- -- $ 950
======== ======= ========
</TABLE>

See Notes to Consolidated Financial Statements

F-16
<PAGE> 52

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ITEQ, Inc. (formerly Air-Cure Technologies, Inc.) and its subsidiaries (the
"Company") is a provider of manufactured equipment, engineered systems and
services used in the processing, treatment and movement of gases and liquids. It
is a domestic manufacturer of shell and tube heat exchangers, principally for
petrochemical and refining applications, and a producer of baghouses, scrubbers,
fans and other filtration systems and components for environmental and general
industrial applications. ITEQ also manufactures specialized process equipment,
such as reactors, blenders, stacks, towers, columns and pressure vessels,
principally for the refining, petrochemical and plastics industries. The Company
has operations in the United States, Canada, Germany and Singapore.

A summary of the Company's significant accounting policies consistently
applied in the preparation of the accompanying consolidated financial statements
follows.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of ITEQ, Inc.
and its wholly-owned subsidiaries. Significant intercompany balances and
transactions have been eliminated. The consolidated financial statements have
also been restated to reflect the merger with Allied Industries, Inc. ("Allied")
on December 28, 1995, which was accounted for as a pooling-of-interests. (See
Note 2).

REVENUE RECOGNITION

"Costs and estimated earnings in excess of billings on uncompleted
contracts" represents revenues recognized in excess of amounts billed. Such
revenues are expected to be billed and collected within one year. "Billings in
excess of costs and estimated earnings on uncompleted contracts" represents
billings in excess of revenues recognized.

F-17
<PAGE> 53

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Beginning in 1996, the Company estimated percentage-of-completion for the
materials portion of its long-term contracts at Allied based on when the
material was placed into production, whereas previously such estimates were
based on when the liability for the cost of the material was legally incurred.
The new method of applying the percentage-of-completion accounting principle was
adopted to better reflect the economics of Allied's revenue and profit earnings
process, and financial statements of prior years have been restated to apply the
revised method retroactively. The effect of the accounting change on previously
reported 1994 and 1995 results and net earnings of 1996 is as follows:

<TABLE>
<CAPTION>
INCREASE (DECREASE)
------------------------
1994 1995 1996
---- ------- -----
<S> <C> <C> <C>
Net earnings (loss)......................................... $94 $(1,608) $ 321
Net earnings (loss) per common share........................ -- $ (.14) $ .03
</TABLE>

The balances of retained earnings at December 31, 1994 and 1995 have been
increased (reduced) by $94 and $(1,514), respectively, for the effect (net of
income taxes) of applying retroactively the revised method of accounting. The
change in method had no effect on periods prior to 1994, since Allied is
included in the Company's historical financial statements beginning January 28,
1994, the date of inception of Allied.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid temporary investments including
those with an original maturity of three months or less to be cash equivalents.
Cash and cash equivalents consist primarily of interest bearing accounts.

RESTRICTED CASH

From time to time, the Company pledges cash to financial institutions as
security for bonds.

ACCOUNTS RECEIVABLE

The allowance for doubtful accounts totaled $195 and $712 at December 31,
1995 and 1996, respectively. All retainages as of December 31, 1996 are expected
to be collected by December 31, 1997.

INVENTORIES

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
Raw Materials............................................ $3,529 $ 3,514
Work in Progress......................................... -- 7,135
Other.................................................... 415 --
------ -------
Total.......................................... $3,944 $10,649
====== =======
</TABLE>

F-18
<PAGE> 54

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, including costs to ready assets
for use. Depreciation and amortization of property and equipment are computed on
the straight-line method over the estimated useful lives of the assets as
follows:

<TABLE>
<CAPTION>
USEFUL LIVES
------------
<S> <C>
Furniture and Fixtures...................................... 3 to 15 Years
Machinery and Equipment..................................... 7 to 15 Years
Patterns and Molds.......................................... 5 Years
Transportation Equipment.................................... 3 Years
Buildings and Improvements.................................. 7 to 39 Years
Leasehold Improvements...................................... Life of the lease
</TABLE>

At December 31, 1995 and 1996, Property and Equipment was comprised of the
following items:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
Land.................................... $ -- $ 700
Furniture and fixtures.................. 427 668
Machinery and equipment................. 6,341 9,176
Patterns and molds...................... 625 602
Transportation equipment................ 186 540
Buildings and improvements.............. -- 4,382
Leasehold improvements.................. 252 330
------- --------
7,831 16,398
Less accumulated depreciation and
amortization....................... (2,439) (2,737)
------- --------
Net property and equipment.... $ 5,392 $ 13,661
======= ========
</TABLE>

Repair and maintenance costs are expensed as incurred while major renewals
and betterments are capitalized. The cost of assets retired or otherwise
disposed of and the related accumulated depreciation are eliminated from the
accounts in the year of disposal. Gains and losses resulting from property
disposals are included in "Other income."

Under the provisions of Statement of Financial Accounting Standards (SFAS)
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," the Company reviews certain long-lived assets for
impairment whenever events indicate that the carrying amount of an asset may not
be recoverable and recognizes an impairment loss under certain circumstances in
the amount by which the carrying value exceeds the fair value of the asset. The
Company's adoption of SFAS No. 121 had no material effect on the Company's
results of operations or financial position.

AMORTIZATION OF INTANGIBLES

The excess of cost over net assets acquired and licenses, trademarks and
tradenames are amortized on a straight-line basis over periods ranging from five
to forty years. The Company maintains separate financial records for each of its
acquired entities and performs periodic strategic and long-range planning for
each entity. This enables the Company to monitor each entity's historical and
expected performance in the context of the value assigned to acquisition
intangibles and to the amortization period applied to each intangible asset. The
Company assesses the recoverability of its goodwill whenever adverse events or
changes in circumstances or business climate indicate that expected future cash
flows (undiscounted and without interest charges) for individual business units
may not be sufficient to support recorded goodwill. The Company modifies the
life and/or the carrying amount of an acquisition intangible if an

F-19
<PAGE> 55

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

impairment is identified. Amortization expense was $0.7 million, $0.8 million
and $0.8 million for the years ended December 31, 1994, 1995 and 1996,
respectively.

At December 31, 1995 and 1996, other assets was comprised of the following
items:

<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
Excess costs over net assets acquired, net of accumulated
amortization, of $1,370 and $1,789 at December 31, 1995
and 1996, respectively................................... $12,191 $32,941
Licenses, trademarks and tradenames, net of accumulated
amortization of $600 and $878 at December 31, 1995 and
1996, respectively....................................... 4,400 11,880
Debt issuance costs, net of accumulated amortization of $45
at December 31, 1996..................................... -- 2,957
Other...................................................... 51 45
------- -------
Net Other Assets................................. $16,642 $47,823
======= =======
</TABLE>

INCOME TAXES

The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 requires deferred taxes to be
provided based on temporary differences between the book and tax basis of assets
and liabilities using presently enacted tax rates.

NET EARNINGS (LOSS) PER COMMON SHARE

Primary and fully diluted earnings per share are computed based upon the
weighted average number of common and dilutive common equivalent shares
outstanding. The dilutive effect of common equivalent shares is calculated
through the use of the Treasury Stock Method. Common Stock equivalents consist
of stock options and warrants.

TRANSLATION ADJUSTMENT

The financial activity of the Company's non-U.S. operations located in
Canada, Germany and Singapore are translated into U.S. dollars in accordance
with SFAS No. 52, "Foreign Currency Translation." Net assets of non-U.S.
operations whose "functional" currencies are other than the U.S. dollar are
translated at year end rates of exchange. Income and expense items are
translated at the average exchange rate for the year.

USE OF ESTIMATES

The presentation of the 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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

FAIR VALUES

The carrying amounts of cash, accounts receivable, accounts payable and
accrued liabilities are reasonable estimates of their fair values due to the
short maturities of these instruments. The fair value of long-term obligations
is estimated based on ITEQ's current financing agreement and approximates
carrying value.

F-20
<PAGE> 56

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

CONCENTRATION OF CREDIT RISK

Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and accounts
receivable. The Company maintains its cash with various financial institutions.
Accounts receivable at any given time are concentrated in a number of primarily
domestic customers. An allowance for doubtful accounts has been provided for
estimated losses. To mitigate credit risk the Company may require customers to
make advance payments. At December 31, 1996, the Company had collected
approximately $2,018 in such advance payments which are included in progress
billings.

RECLASSIFICATIONS

Certain reclassifications have been made to the prior years' consolidated
financial statements to conform with the December 31, 1996 presentation.

NOTE 2 -- BUSINESS COMBINATIONS

OHMSTEDE

On November 20, 1996 (effective November 1, 1996), the Company purchased
all the outstanding stock (excluding certain assets and liabilities) of
Ohmstede, Inc. ("Ohmstede") for approximately $52.9 million in cash. Assets not
purchased included the majority of receivables due from and a 99 percent equity
investment in C&D Robotics ("C&D"), a partnership formerly consolidated by
Ohmstede; a federal tax deposit made by the owners; and the cash surrender value
of life insurance policies for certain owners. Additionally, the former owners
received approximately $0.6 million in dividends just prior to the transaction,
as set forth in the agreement with the Company. As the Company continues to rent
operating space to C&D, rental fees charged to C&D are included in the financial
statements.

The Company paid $52 million for Ohmstede's stock and $0.9 million for
related acquisition costs. The acquisition has been accounted for using the
purchase method of accounting, and, accordingly, the purchase price has been
allocated to the assets purchased and the liabilities assumed based upon the
estimated fair values at the date of the acquisition, as follows:

<TABLE>
<S> <C>
Working capital............................................. $14,800
Property and equipment...................................... 8,453
Intangibles................................................. 7,500
Excess of costs over net assets acquired.................... 21,914
Imputed interest expense.................................... 257
-------
Total purchase price.............................. $52,924
=======
</TABLE>

The following unaudited pro forma consolidated results of operations assume
that the purchase occurred on January 1, 1995 and include merger costs,
restructuring charges, and other non-recurring expenses:

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
<S> <C> <C>
Revenues................................................. $201,917 $193,928
Net earnings............................................. $ 699 $ 2,253
Net earnings per share................................... $ .06 $ .19
</TABLE>

F-21
<PAGE> 57

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

ALLIED

On December 28, 1995, the Company issued 4,140 shares of its common stock
in exchange for all of the outstanding common stock of Allied. The merger has
been accounted for as a pooling-of-interests and, accordingly, the Company's
consolidated financial statements have been restated to include the accounts and
operations of Allied effective January 28, 1994, the date of inception of
Allied.

Effective January 1, 1995, Allied was granted S Corporation tax status.
Accordingly, Allied did not pay U.S. Federal income taxes during 1995. Allied
was included in the Company's income tax return effective December 28, 1995,
and, therefore, a deferred tax liability and corresponding charge to income tax
expense of approximately $0.5 million, or $.04 per share, was recorded upon
closing to reflect Allied's net taxable temporary differences.

Revenues, net earnings and related per share amounts of the merged entities
are presented in the following table. The table includes unaudited pro forma net
earnings and per share amounts reflecting the elimination of the nonrecurring
merger costs and pro forma adjustments to present income taxes on the basis on
which they will be reported in future periods.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1994 1995
AS RESTATED AS RESTATED
(NOTE 1) (NOTE 1)
----------- -----------
<S> <C> <C>
Net revenues:
ITEQ..................................................... $44,713 $ 74,457
Allied................................................... 17,113 38,707
------- --------
Total............................................ $61,826 $113,164
======= ========
Net earnings:
ITEQ..................................................... $ (298) $ 1,557
Allied................................................... 777 (797)
------- --------
Net earnings, as reported........................ 479 760
Pro forma adjustments:
Allied merger costs, net of tax.......................... -- 973
Allied Subchapter S status............................... -- (321)
Allied deferred tax liability............................ -- 491
Interest on convertible debt............................. -- 12
------- --------
Pro forma net earnings........................... $ 479 $ 1,915
======= ========
Net earnings per common share:
As reported.............................................. $ .04 $ .07
Pro forma................................................ $ .04 $ .17
</TABLE>

The "Allied merger costs, net of tax" balance of $973 related to $1.1
million in nonrecurring merger costs, the majority of which was non-deductible.

AMEREX

On May 25, 1994, Amerex, Inc. and Amerex Industries, Inc. (collectively
"Amerex") were merged into a subsidiary of the Company. In the merger, the
stockholders of Amerex received $4 million and 1,256 shares of Common Stock with
a fair market value of $3.69 per share at the acquisition date. The excess of
the total acquisition costs over the fair value of the net assets acquired in
the amount of

F-22
<PAGE> 58

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

$5.9 million is being amortized on a straight-line basis over 25 years. Amerex
produces and markets filtration, gas cleaning and heat recovery equipment.

The accounts of Amerex have been included in the accompanying financial
statements for the period from the date of acquisition through December 31,
1996. This acquisition has been accounted for as a purchase with the purchase
price allocated to the assets acquired and liabilities assumed based upon their
estimated fair market values.

NOTE 3 -- MERGER COSTS, RESTRUCTURING CHARGES AND OTHER NONRECURRING COSTS

During 1996, the Company incurred a restructuring charge of $4.4 million,
of which $3.7 million and $0.7 million were recorded as restructuring charges
and cost of revenues, respectively. The charge included (i) a provision for the
contractually required severance obligations to the former president and chief
executive officer who was replaced in March 1996, and (ii) the cost of
implementing new management's plan to reduce the Company's overall cost
structure including employee severance, lease and other contract buyouts,
inventory and other asset impairments, losses related to termination of
unprofitable product lines, excess machinery disposal and other related costs.

The following table summarizes the major components of the restructuring
charge:

<TABLE>
<S> <C>
Termination pay and benefits........................ $1,300
Discontinued product lines.......................... 1,656
Office relocation and consolidation................. 564
Legal............................................... 242
Other............................................... 642
------
$4,404
======
</TABLE>

When the Company committed to its restructuring plan during the first
quarter, it made the decision to terminate 15 employees, including the former
president and chief executive officer. By December 31, 1996, all 15 employees
had been terminated. Approximately $0.9 million in severance pay and benefits,
unpaid as of December 31, 1996, was paid during the first quarter of fiscal
1997. Substantially all of the terminated employees were either in management
positions or were professionals including engineers and accountants.

During the fourth quarter of fiscal 1995, the Interel and VIC subsidiaries
were reorganized and combined. The reorganization of these operations and costs
of settling a lawsuit resulted in a one-time charge of approximately $0.2
million. In the fourth quarter of 1995, the Company recorded a nonrecurring
charge of approximately $1.1 million for acquisition costs related to the Allied
merger, which is more fully described in Note 2 to the financial statements.

NOTE 4 -- CONTRACTS IN PROGRESS

The Company obtains substantially all of its contracts through competitive
bids. The Company's prerequisites for billing on contracts vary with individual
contract terms. The Company sometimes has bonds or letters of credit as
collateral on accounts receivable, and generally all amounts are due in the
month following performance under contract except for retainages that are
collected upon completion of the contract. The Company has lien rights on
certain contracts.

F-23
<PAGE> 59

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Costs incurred to date, estimated earnings and the related progress
billings to date on contracts in progress are as follows:

<TABLE>
<CAPTION>
1995
AS RESTATED
(NOTE 1) 1996
----------- --------
<S> <C> <C>
Costs incurred to date...................................... $ 49,137 $ 53,037
Estimated earnings.......................................... 14,801 17,701
-------- --------
Revenue recognized.......................................... 63,938 70,738
Progress billings to date................................... (48,867) (51,961)
Costs incurred for which no revenues were recognized to
date...................................................... 2,181 955
-------- --------
$ 17,252 $ 19,732
======== ========
</TABLE>

The preceding is included in the accompanying consolidated balance sheets
as follows:

<TABLE>
<CAPTION>
1995
AS RESTATED
(NOTE 1) 1996
----------- -------
<S> <C> <C>
Costs and estimated earnings in excess of billings on
uncompleted contracts..................................... $18,067 $20,690
Billings in excess of costs and estimated earnings on
uncompleted contracts..................................... (815) (958)
------- -------
$17,252 $19,732
======= =======
</TABLE>

NOTE 5 -- LONG-TERM OBLIGATIONS

Long-term obligations include the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1995 1996
------- -------
<S> <C> <C>
Secured term loan note ("term loan"), maturing October 31,
2001; due in quarterly installments of $1,500 commencing
January 31, 1997 and increasing to $1,813 after the first
four payments, with interest (December 31, 1996 -- 8.6%)
fluctuating with the Offshore Rate or Base Rate defined
below..................................................... $10,000 $35,000
Secured note maturing November 18, 2001, under a revolving
credit facility ("line of credit") totaling $38,000 with
interest (December 31, 1996 -- 8.9%) fluctuating with the
Offshore Rate or Base Rate defined below.................. 11,499 25,400
Unsecured senior subordinated notes maturing November 18,
2003, bearing interest at 12% through 1997 increasing 0.5%
per year through maturity................................. -- 15,000
Less debt discount related to issuance of detachable
warrants in conjunction with senior subordinated notes.... -- (2,288)
Other....................................................... 56 41
------- -------
21,555 73,153
Less current maturities..................................... (3,347) (6,012)
------- -------
Long-term obligations, net of current maturities............ $18,208 $67,141
======= =======
</TABLE>

F-24
<PAGE> 60

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Scheduled maturities of long-term obligations are as follows:

<TABLE>
<S> <C>
1997........................................................ $ 6,012
1998........................................................ 7,262
1999........................................................ 7,262
2000........................................................ 7,255
2001........................................................ 32,650
Thereafter.................................................. 12,712
-------
$73,153
=======
</TABLE>

On November 18, 1996, the Company revised its financing agreement to, among
other things, increase its credit facilities with participating financial
institutions ("Lenders"), including Bank of America National Trust and Savings
Association ("BoA"), as agent for the Lenders. The financing consists of a $35
million term loan and a $38 million revolving line of credit facility. The term
loan currently bears interest at the BoA Offshore Rate ("Offshore Rate"), as
defined by BoA, plus a spread, and the line of credit bears interest at the
Offshore Rate or the Base Rate plus spreads. The spread can range from 2% to 3%
above the Offshore Rate and from 0.25% to 1.25% above the Base Rate. The spread
increases or decreases based on the Company's leverage ratio. Substantially all
of the assets of the Company serve as collateral.

In addition to the bank financing, on November 18, 1996, the Company
entered into two Senior Subordinated Notes ("Subordinated Notes") with
International Mezzanine Capital, B.V. and First Commerce Capital, (collectively,
the "Subordinated Note Holders"), for $13 million and $2 million, respectively.
The Subordinated Notes, which mature November 18, 2003, bear interest at 12%
through December 31, 1997 and increase by 0.5% per year for each year they
remain unpaid. As further consideration, the Subordinated Note Holders received
warrants to purchase an aggregate of 1,760 shares of the Company's Common Stock
at $5.10 per share, subject to adjustment. The warrants may be exercised at any
time or from time to time until they expire on November 18, 2003. The warrants
were valued at approximately $2.3 million, which was reflected as equity and as
a debt discount at the date of their issuance, and will be amortized as
additional interest expense over the seven-year life of the Subordinated Notes.

The debt obligations require the Company to maintain certain levels of
working capital and stockholders' equity and contain other provisions, some of
which restrict expenditures for the purchase of the Company's stock, for capital
expenditures and for payment of dividends. Such agreements also limit, subject
to the Lenders' and Subordinated Note Holders' consent, the creation, incurrence
or assumption of indebtedness (as defined by the agreements) and acquisitions
and investments. At December 31, 1996, the Company was in compliance with the
provisions of its debt agreements.

F-25
<PAGE> 61

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

NOTE 6 -- LEASE COMMITMENTS

The Company and its subsidiaries are obligated under various leases for
office and manufacturing facilities and certain machinery, equipment and
fixtures. Certain leases have renewal or escalation clauses or both. The
following is a schedule of minimum rental commitments under all non-cancellable
leases which expire at various dates:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- ------------------------
<S> <C> <C>
1997........................................................... $ 924
1998........................................................... 795
1999........................................................... 667
2000........................................................... 599
2001........................................................... 571
Thereafter..................................................... 1,579
------
$5,135
======
</TABLE>

The leases provide for payment of maintenance and other expenses by the
Company. Rent expense was $1.1 million, $1.2 million, and $1.2 million for the
years ended December 31, 1994, 1995 and 1996, respectively.

NOTE 7 -- INCOME TAXES

Provision for income taxes consists of the following:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Current:
Federal............................... $ 644 $ 1,069 $ --
State................................. 105 201 --
Foreign............................... 33 112 160
------- ------- -------
782 1,382 160
------- ------- -------
Deferred:
Federal............................... 119 99 (419)
State................................. 6 19 (74)
Foreign............................... (569) -- 337
------- ------- -------
(444) 118 (156)
------- ------- -------
Provision for income taxes.............. $ 338 $ 1,500 $ 4
======= ======= =======
</TABLE>

The earnings before taxes relating to foreign operations totaled
approximately $0.1 million and $1.4 million for the years ended December 31,
1995 and 1996, respectively. The loss before taxes relating to foreign
operations totaled approximately $1.3 million for the year ended December 31,
1994.

F-26
<PAGE> 62

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The tax effects of the financial reporting and income tax reporting basis
differences which give rise to the deferred income tax asset and liability are
as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
------- -------
<S> <C> <C>
Net current deferred income tax assets:
Compensation recognition.............. $ -- $ 382
Accruals and reserves................. 439 1,056
Tax benefit carryforwards............. -- 825
Contract accounting................... (213) (316)
Other................................. 14 32
------- -------
$ 240 $ 1,979
======= =======
Net non-current deferred income tax
liabilities:
Tax benefit carryforwards............. $ 524 $ 208
Property and equipment................ (444) (692)
Intangible assets..................... (197) (313)
Other................................. 6 2
Valuation allowance................... (146) (146)
------- -------
$ (257) $ (941)
======= =======
</TABLE>

The valuation allowance relates to deferred tax assets established under
SFAS No. 109 for losses incurred in foreign subsidiaries. These losses will be
carried forward to future years for utilization and are not expected to expire.

As of December 31, 1995 and 1996, the Company had regular U.S. and foreign
net operating loss carryforwards for tax reporting purposes totaling
approximately $1.3 million and $2.6 million, respectively. The majority of the
foreign net operating loss carryforwards do not have an expiration date.

Differences between the Company's effective income tax rate and the
statutory federal income tax rate are as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1994 1995 1996
----- ------- -----
<S> <C> <C> <C>
Tax provision at the federal statutory income tax rate..... $277 $ 768 $(28)
Differences in foreign versus U.S. tax rates............... (79) 7 9
State income taxes, net of federal benefit................. 46 178 (74)
Amortization of intangible assets.......................... 70 104 84
Non-deductible acquisition costs........................... -- 234 --
S Corporation income....................................... -- (202) --
Conversion from S-Corporation.............................. -- 491 --
Valuation allowance........................................ -- (137) --
Other...................................................... 24 57 13
---- ------ ----
Total Tax Provision.............................. $338 $1,500 $ 4
==== ====== ====
</TABLE>

During 1995, the valuation allowance was reduced by $137 in order to
properly recognize the portion of the Company's deferred tax asset which was
more likely than not to be realized.

F-27
<PAGE> 63

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

NOTE 8 -- STOCK WARRANTS AND OPTIONS

STOCK WARRANTS

Following is a summary of the warrants outstanding at December 31, 1996:

<TABLE>
<CAPTION>
STOCK EXERCISE
OUTSTANDING ISSUABLE PRICE
DATE AND UPON PER EXPIRATION
DESCRIPTION ISSUED EXERCISABLE EXERCISE SHARE DATE
----------- ------ ----------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
Financial advisor:
Warrants.................... 6/92 100 140 $4.42 6/97
Warrants.................... 4/96 34 34 $4.72 4/98
Underwriter warrants.......... 12/92 50 50 $4.80 12/97
Subordinated debt warrants.... 11/96 1,760 1,760 $5.10 11/03
----- -----
Total............... 1,944 1,984
===== =====
</TABLE>

No warrants have been exercised. The exercise price of the subordinated
debt warrants and the financial advisor warrants issued in June of 1992 are
subject to adjustment.

STOCK OPTIONS

On October 1, 1990, the Company's Board of Directors approved an Employee
Stock Option Plan (the "Plan") which was subsequently amended and which provides
for the issuance of up to 10% of the Company's outstanding shares of Common
Stock shares but initially not less than 1,250 shares of Common Stock (subject
to anti-dilution provisions). Options granted expire in five to ten years, and
the option price, which must be at least the fair market value of the Company's
stock at the date of grant can be paid in cash or in shares of the Company's
Common Stock. Options may not be transferred by the optionee other than by will
or the laws of descent and distribution.

The Company's Board of Directors approved the Directors' Stock Option Plan
on May 19, 1993, which provides for the issuance of up to 200 shares of Common
Stock (subject to anti-dilution provisions). The plan currently provides that
each outside director will be granted an option to purchase 10 shares of Common
Stock at the fair market value of the Common Stock at the date of grant at each
time the director is elected, re-elected or appointed to the Board of Directors.
Options granted under this plan expire after ten years, and the option price
must be paid in cash. Options may not be transferred by the optionee other than
by will or the laws of descent and distribution.

The Company accounts for these plans under APB Opinion No. 25, under which
no compensation cost has been recognized. Had compensation cost for these plans
been determined consistent with SFAS No. 123 "Accounting for Stock-Based
Compensation", the Company's net earnings (loss) and net earnings (loss) per
common share would have been reduced to the following pro forma amounts:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------
1995 1996
----- ----
<S> <C> <C>
Net earnings (loss):
As reported............................................... $ 760 $(86)
Pro forma................................................. 730 (199)
Net earnings (loss) per common share:.......................
As reported............................................... .07 (.01)
Pro forma................................................. .06 (.02)
</TABLE>

F-28
<PAGE> 64

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of the pro forma cost to be expected in future years. The
fair value of each option grant is estimated on the date of the grant using the
Black-Scholes option-pricing model with the following assumptions:

<TABLE>
<CAPTION>
1995 GRANTS 1996 GRANTS
--------------- -----------------
<S> <C> <C>
Expected dividend yield....................... 0% 0%
Expected stock price volatility............... 39.74% - 45.09% 42.88% - 44.85%
Risk free interest rate....................... 5.43% - 6.48% 5.38% - 6.93%
Expected life of options...................... 5 to 10 years 4.25 - 10 years
</TABLE>

A summary of the status of the Company's two stock option plans at December
31, 1995 and 1996 and changes during the years then ended is presented in the
table below.

<TABLE>
<CAPTION>
1995 1996
------------------- -------------------
WTD AVG WTD AVG
SHARES EX PRICE SHARES EX PRICE
------ --------- ------ ---------
<S> <C> <C> <C> <C>
Outstanding at beginning of year............ 751 $ 4.00 953 $ 3.63
Granted..................................... 249 2.50 385 3.66
Exercised................................... -- (3.38) (42) (3.15)
Forfeited................................... (47) (3.52) (201) (3.42)
Expired..................................... -- -- -- --
----- ------ ----- ------
Outstanding at end of year.................. 953 $ 3.63 1,095 $ 3.70
===== ====== ===== ======
Exercisable at end of year.................. 474 $ 3.96 681 $ 3.88
===== ====== ===== ======
Weighted average fair value of options
granted................................... $1.19 $1.78
===== =====
</TABLE>

The options outstanding at December 31, 1996 have exercise prices between
$2.44 and $4.75 and a weighted average remaining contractual life of 4.44 years.

The Company maintains an Employee Stock Purchase Plan whereby all employees
are eligible for participation after ninety days of service. Under this plan,
employees may purchase stock at 90% of the current market price of the stock.
During the years ended December 31, 1995 and December 31, 1996, 15 and 15
shares, respectively, were issued under the plan.

NOTE 9 -- COMMITMENTS AND CONTINGENCIES

The Company is party to certain legal proceedings which are considered by
management to be customary and incidental to its business. In the opinion of
management, after consulting with legal counsel, the ultimate disposition of
these lawsuits will not have a material adverse effect on the Company's
financial position or results of operations.

F-29
<PAGE> 65

ITEQ, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

NOTE 10 -- MAJOR CUSTOMERS AND FOREIGN OPERATIONS

Due to the nature of the Company's business, contracts are generally
nonrecurring. For the year ended December 31, 1996, no single customer accounted
for 10% of revenues. For the years ended December 31, 1994 and 1995, a single
customer accounted for revenues of 11% and 10%, respectively.

Financial data by geographical area is as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1995
1994 AS
AS RESTATED RESTATED
(NOTE 1) (NOTE 1) 1996
------------ -------- -----------
<S> <C> <C> <C>
Revenue:
North America................................. $56,764 $101,546 $ 96,024
Europe........................................ 1,913 6,974 8,866
Asia.......................................... 3,149 4,644 5,914
------- -------- --------
Total................................. $61,826 $113,164 $110,804
======= ======== ========
Operating profit (loss):
North America................................. $ 2,558 $ 2,640 1,237
Europe........................................ (1,140) 404 620
Asia.......................................... 175 392 416
------- -------- --------
Total................................. $ 1,593 $ 3,436 $ 2,273
======= ======== ========
Identifiable assets:
North America................................. $47,916 $ 63,983 $128,915
Europe........................................ 3,214 4,276 5,633
Asia.......................................... 1,670 2,585 1,840
------- -------- --------
Total................................. $52,800 $ 70,844 $136,388
======= ======== ========
</TABLE>

Including exports, international sales accounted for approximately 23% of
total revenues in 1996.

NOTE 11 -- SUBSEQUENT EVENT (UNAUDITED)

The Company is in the process of filing a registration statement on Form
S-2 to register for sale 5.1 million shares of common stock (4.3 million from
the Company and 0.8 million from certain selling stockholders). The primary use
of the offering proceeds to the Company will be to reduce debt incurred in the
aforementioned acquisitions and for potential future acquisitions.

F-30
<PAGE> 66

- ---------------------------------------------------------
- ---------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER
INDIVIDUAL HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE
OFFERING COVERED BY THIS PROSPECTUS.
IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN
OFFER TO SELL, OR A SOLICITATION OF
AN OFFER TO BUY, THE COMMON STOCK IN
ANY JURISDICTION WHERE, OR TO ANY
PERSON TO WHOM, IT IS UNLAWFUL TO
MAKE SUCH OFFER OR SOLICITATION.
NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE AN IMPLICATION
THAT THERE HAS NOT BEEN ANY CHANGE IN
THE FACTS SET FORTH IN THIS
PROSPECTUS OR IN THE AFFAIRS OF THE
COMPANY SINCE THE DATE HEREOF.

- -------------------------------------

TABLE OF CONTENTS

Prospectus Summary.................... 3
Risk Factors.......................... 6
Recent Developments................... 8
Use of Proceeds....................... 8
Price Range of Common Stock........... 9
Dividend Policy....................... 9
Capitalization........................ 10
Selected Historical and Pro Forma
Combined Financial Data............. 11
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 12
Business.............................. 18
Management............................ 24
Principal and Selling Stockholders.... 26
Description of Capital Stock.......... 27
Certain United States Federal Tax
Consequences to Non-United States
Holders............................. 31
Underwriting.......................... 33
Legal Matters......................... 34
Experts............................... 34
Available Information................. 35
Incorporation of Documents by
Reference........................... 35
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>

-------------------------------------
[I T E Q LOGO]

5,050,000 SHARES

COMMON STOCK

DEUTSCHE MORGAN GRENFELL

EVEREN SECURITIES, INC.

SANDERS MORRIS MUNDY

PROSPECTUS

MAY 20, 1997