ITEQ INC, 10-K, 1997-03-13

ITEQ INC
10-K, 1997-03-13
INDUSTRIAL & COMMERCIAL FANS & BLOWERS & AIR PURIFING EQUIP

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

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FORM 10-K

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

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 1-10668

ITEQ, INC.
(Exact name of registrant as specified in its charter)

<TABLE>
<C> <C>
DELAWARE 47-1667001
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
</TABLE>

2727 ALLEN PARKWAY, SUITE 760, HOUSTON, TEXAS 77019
(Address of principal executive offices) (zip code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 713-285-2700

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

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

None

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

<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
<C> <C>
Common Stock, $.001 par value Nasdaq National Market
</TABLE>

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].

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

Aggregate market value of the voting stock held by nonaffiliates of the
registrant as of March 6, 1997 was $56,289,031. As of March 6, 1997, there were
11,601,346 shares of the registrant's Common Stock, $.001 par value,
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE. Certain portions of the registrant's
definitive Proxy Statement for the 1997 Annual Meeting of Shareholders ("Proxy
Statement") are incorporated in Part III by reference.

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<PAGE> 2

TABLE OF CONTENTS

PART I

<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 5
Item 3. Legal Proceedings........................................... 6
Item 4. Submission of Matters to a Vote of Security Holders......... 6

PART II

Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters......................................... 6
Item 6. Selected Financial Data..................................... 7
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 8
Item 8. Financial Statements and Supplementary Data................. 12
Item 9. Disagreements on Accounting and Financial Disclosure........ 12

PART III

Item 10. Directors and Executive Officers of the Registrant.......... 12
Item 11. Executive Compensation...................................... 12
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 12
Item 13. Certain Relationships and Related Transactions.............. 12

PART IV

Item 14. Financial Statements and Financial Statement Schedule,
Exhibits and Reports on Form 8-K............................ 13
</TABLE>

i
<PAGE> 3

PART I
ITEM 1. BUSINESS

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.

The Company was incorporated in Delaware in 1990 under the name Air-Cure
Environmental, Inc. The Company changed its name in 1993 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.

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 Industries, Inc. ("Allied") acquisition, the
Company began to increase its focus on the process equipment business.
Consistent with this focus, in November 1996 the Company completed the
acquisition of Ohmstede, Inc. ("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 mini Waste treatment, foundry,
scrubbers, heat exchangers smelter
Ceilcote Air Pollution 1992 Wet scrubbers, tower internals, Microelectronics, chemical
Control, Inc. FRP fans processing, waste treatment,
food processing
VIC Environmental Systems, 1994 Carbon adsorption systems Pharmaceutical, rubber
Inc.
Amerex Industries, Inc. 1994 Fabric filters, wet and dry Steel, cement and lime,
scrubbers, heat exchangers refining, foundry
Allied Industries, Inc.(2) 1995 Air separation equipment, Petrochemical, plastics,
reactors, blenders, stacks, towers refining
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.

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Pending Acquisition. In March 1997, the Company entered into a letter of
intent to purchase Exell, Inc. and an affiliated partnership (collectively,
"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 million. The transaction is presently scheduled to close by June 1997,
but remains subject to completion of a definitive agreement and to the
satisfaction of customary contractual conditions and regulatory approvals;
accordingly, there can be no assurance that the transaction will be consummated.

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>
NINE
FISCAL YEAR FISCAL YEAR MONTHS
ENDED ENDED ENDED YEAR ENDED DECEMBER 31,
MARCH 31, MARCH 31, DECEMBER 31, -----------------------------
1992 1993 1993 1994 1995 1996(1)
----------- ----------- ------------ ------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Filtration equipment.............. $7,026 $12,790 $27,859 $44,713 $ 74,511 $ 64,331
Heat exchangers and other process
equipment....................... -- -- -- 17,113 38,653 46,473
------ ------- ------- ------- -------- --------
$7,026 $12,790 $27,859 $61,826 $113,164 $110,804
====== ======= ======= ======= ======== ========
</TABLE>

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

(1) Ohmstede was acquired effective November 1, 1996 in a transaction accounted
for as a purchase. Includes the reported revenues of Ohmstede for the
two-month period subsequent to acquisition.

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

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direction in the void between the outer shell of the units and the tube bundles.
In the 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, adsorption 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 expansions 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 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

3
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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 certain circumstances, in situations
where it is not the low bidder. A significant portion of the Company's annual
revenues represents repeat business from its 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.

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 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.

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BACKLOG

At December 31, 1996, the Company's backlog was $56.7 million, compared
with $28.1 million at December 31, 1995. Such backlog consisted of written
orders or commitments believed to be firm and, with respect to 1996, includes
backlog attributable to Ohmstede. 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 December 31, 1996 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.

ITEM 2. PROPERTIES

The Company leases 4,768 square feet in Houston, Texas for its corporate
offices. The lease expires June 30, 2001.

Allied leases a 17.2 acre facility in Houston which has 185,000 square feet
of manufacturing space, 30,000 square feet of warehouse space, 30,000 square
feet of office space, and 55,000 square feet of other facilities. The initial
term of the lease expires in February 1999, subject to renewal at Allied's
option for five additional years. The facility is adjacent to the Houston ship
channel and has ready access to road, rail and water transportation.

Ohmstede's operations are conducted from plants and related office space
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 and related office space. As
of December 31, 1996, the net book value of the land and the buildings and
improvements was $0.7 million and $4.4 million, respectively.

Amerex is located in Woodstock, Georgia, where it leases 10,400 square feet
of office and warehouse space, which lease expires June 30, 1999. Amerex leases
an additional 8,200 square feet of office space in Woodstock under two separate
leases of 5,200 square feet and 3,000 square feet, which leases expire September
30, 2001 and June 30, 2000, respectively. Amerex also has an 1,156 square foot
sales office in Denver, Colorado under a lease which expires November 14, 1997.

Ceilcote Air Pollution Control's North American operations maintain office
facilities in three principal locations and lease a 26,000 square foot
manufacturing facility and a 7,500 square foot storage facility in La Grange,
Ohio. The principal North American operations are located in office and
laboratory space aggregating 11,016 square feet in Strongsville, Ohio under a
lease that expires in January 2010. The lease of the La Grange facility expires
March 31, 1999.

Ceilcote Air Pollution Control's European operations are located in 5,542
square feet of office space in Biebesheim, Germany. The lease of the office
space expires in June 1997, and the lease of the manufacturing space expires in
June 1997.

Ceilcote Air Pollution Control's Far East leases office and manufacturing
space in Singapore. The lease expires May 31, 1998.

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ITEM 3. LEGAL PROCEEDINGS

Certain of the Company's subsidiaries are parties to legal proceedings in
the ordinary course of business. While the outcome of lawsuits or other
proceedings cannot be predicted with certainty, management does not expect these
matters to have a material adverse effect on the financial condition or results
of operations of the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the
fourth quarter of 1996.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS

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

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1995
First Quarter............................................. 3 3/8 2 3/16
Second Quarter............................................ 2 15/16 2
Third Quarter............................................. 4 3/4 2 5/16
Fourth Quarter............................................ 4 3/8 3 1/4

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
</TABLE>

On March 11, 1997, the last reported sale price for the Common Stock, as
quoted by the Nasdaq National Market, was $7.125 per share. As of the same date,
there were approximately 160 holders of record of the Common Stock, and the
Company estimates that there are over 2,000 beneficial owners of Common Stock.

In November 1996, the Company issued Senior Subordinated Notes
("Subordinated Notes") to two institutional lenders in an aggregate amount of
$15 million which mature November 18, 2003. As additional consideration, the
Subordinated Note holders received warrants to purchase an aggregate of
1,760,000 shares of the Company's common stock at $5.10 per share, subject to
adjustment. The warrants were issued in a private placement in reliance on
Section 4(2) of the Securities Act of 1933, as amended. The warrants may be
exercised at any time prior to expiration on November 18, 2003.

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.

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ITEM 6. SELECTED 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. Historical 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," and the Consolidated Financial Statements and notes
thereto.

<TABLE>
<CAPTION>
FISCAL FISCAL NINE YEAR ENDED DECEMBER 31,
YEAR YEAR MONTHS ------------------------------------
ENDED ENDED ENDED 1994 1995
MARCH 31, MARCH 31, DECEMBER 31, AS AS
1992 1993 1993 RESTATED(1) RESTATED(1) 1996
--------- --------- ------------ ----------- ----------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Revenue........................... $7,026 $12,790 $27,859 $61,826 $113,164 $110,804
Cost of revenues(2)............... 5,339 9,821 20,725 49,135 93,262 88,949(3)
------ ------- ------- ------- -------- --------
Gross profit...................... 1,687 2,969 7,134 12,691 19,902 21,855
Selling, general and
administrative expenses......... 1,645 3,843 5,677 8,926 11,645 11,977
Sales commissions................. -- -- -- 1,327 2,477 2,755
Depreciation and amortization..... 123 363 688 845 1,009 1,146
Merger costs, restructuring
charges and other nonrecurring
costs........................... -- -- -- -- 1,335 3,704
------ ------- ------- ------- -------- --------
Operating profit(loss)............ (81) (1,237) 769 1,593 3,436 2,273
Interest expense, net............. (48) (15) (192) (888) (1,502) (2,660)
Other income...................... 164 31 128 112 326 305
------ ------- ------- ------- -------- --------
Earnings (loss) before provision
(benefit) for income taxes...... 35 (1,221) 705 817 2,260 (82)
Provision (benefit) for income
taxes........................... 14 (396) 234 338 1,500 4
------ ------- ------- ------- -------- --------
Net earnings (loss)............... $ 21 $ (825) $ 471 $ 479 $ 760 $ (86)
====== ======= ======= ======= ======== ========
Net earnings (loss) per common
share........................... $ .01 $ (.22) $ .08 $ .04 $ .07 $ (.01)
====== ======= ======= ======= ======== ========
Weighted average common and common
equivalent shares outstanding... 2,991 3,763 5,928 10,891 11,552 11,481
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------
1994 1995
MARCH 31, MARCH 31, AS AS
1992 1993 1993 RESTATED(1) RESTATED(1) 1996
--------- --------- ------- ----------- ----------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital....................... $3,382 $ 4,038 $ 4,197 $ 7,964 $17,834 $ 29,851
Total assets.......................... 7,344 26,585 25,887 52,800 70,844 136,388
Short-term borrowings and current
maturities.......................... 1,694 1,569 981 2,468 3,347 6,012
Long-term obligations and other, less
current maturities.................. 4 2,129 983 8,305 18,028 67,141
Stockholders' equity.................. 5,404 14,540 14,627 21,474 21,403 23,253
</TABLE>

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

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

(2) Includes depreciation and amortization of $668, $622, and $1,574 for the
years ended December 31, 1994, 1995 and 1996, respectively.

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

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

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.

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 method 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 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.

RESULTS OF OPERATIONS

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.

8
<PAGE> 11

In 1996, the Company's sales to the petrochemical and refining industries
increased due to the acquisition of Ohmstede, which had sales to these
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

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.

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

9
<PAGE> 12

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 20.5%, respectively. Filtration equipment margins
improved to 22.8% in 1995 compared with 21.9% in 1994. Processing 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.

10
<PAGE> 13

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 December 31, 1996 the Company's cash position was $6.3 million compared
with $2.2 million at December 31, 1995. Typically, the Company maintains cash
levels of $2 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 at year
end. Working capital at December 31, 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. Cash provided by operations in 1996 was $8.1 million. During 1995, the
Company's operating activities used $6 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 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 recently acquired Ohmstede operations. 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 $25.4 million was outstanding at December
31, 1996). 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 1,760,000 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

11
<PAGE> 14

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 December 31, 1996, the Company was in compliance
with the provisions of its loan agreements.

Except with respect to the funding of the $10.4 million cash purchase price
for the proposed acquisition of Exell which will require additional equity or
debt financing, 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 will be available when required or whether such financing can be
obtained on terms acceptable to the Company.

INFORMATION REGARDING FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K includes forward looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Although the Company believes that its
expectations are based on reasonable assumptions, it can give no assurance that
such expectations will be achieved. Important factors that could cause actual
results to differ materially from those in the forward looking statements
herein.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required hereunder is included in this report as set forth
in the "Index to Financial Statements" on page F-1.

ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item regarding directors is set forth in
the Proxy Statement under the caption entitled "Election of Directors" and is
incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is set forth in the Proxy Statement
under the caption "Compensation of Directors and Executive Officers" and is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is set forth in the Proxy Statement
under the captions "Election of Directors" and "Compensation of Directors and
Executive Officers" and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is set forth in the Proxy Statement
under the caption "Certain Transactions" and is incorporated herein by
reference.

12
<PAGE> 15

PART IV

ITEM 14. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE, EXHIBITS AND
REPORTS ON FORM 8-K

(A)(1) AND (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

See "Index to Financial Statements" set forth on page F-1.

(A)(3) EXHIBITS

13
<PAGE> 16
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S> <C>
4.11 -- Warrant Agreement, dated April 24, 1996, between the
Registrant and Sanders Morris Mundy, Inc. (Filed as an
exhibit to Form 10-Q for the quarter ended September 30,
1996 and incorporated herein by reference).
4.12 -- Warrant Agreement, dated December 1992, between Registrant
and Pennsylvania Merchant Group, Ltd. (Filed as an exhibit
to Form 10-K for fiscal year ending March 31, 1993 and
incorporated herein by reference).
10.1 -- Agreement and Plan of Merger dated September 19, 1996, among
the Registrant, Air-Cure Acquisition, Inc. and Ohmstede,
Inc. (Filed as an exhibit to Form 10-Q for the quarter ended
September 30, 1996 and incorporated herein by reference).
10.2 -- Agreement and Plan of Merger dated October 13, 1995, among
the Registrant, Air-Cure Acquisition Corporation, Allied
Industries, Inc., Mark E. Johnson and Pierre S. Melcher.
(Filed as an exhibit to Post-Effective Amendment No. 1 to
Form S-4 Registration Statement (No. 33-92308) and
incorporated herein by reference). BP>
10.3 -- Agreement and Plan of Merger dated April 28, 1994, among the
Registrant., VIC Acquisition Corporation, VIC Environmental
Systems, Inc. and Ronald E. Lewis. (Filed as an exhibit to
Post-Effective Amendment No. 1 to Form S-1 Registration
Statement (No. 33-69524) and incorporated herein by
reference).
10.4 -- Agreement and Plan of Merger dated April 5, 1994, among the
Registrant, Air-Cure Acquisition Corporation, Amerex, Inc.,
Amerex Industries, Inc. and certain other parties. (Filed as
an exhibit to Post-Effective Amendment No. 1 to Form S-1
Registration Statement (No. 33-69524) and incorporated
herein by reference).
10.5 -- Employment Agreement dated March 1, 1996, between the
Registrant and Lawrance W. McAfee. (Filed as an exhibit to
Form 10-Q for the quarter ended September 30, 1996 and
incorporated herein by reference).
10.6 -- Employment Agreement dated December 29, 1995, between the
Registrant and Mark E. Johnson. (Filed as an exhibit to Form
10-K for the year ended December 31, 1995 and incorporated
herein by reference).
10.7 -- Employment Agreement dated December 29, 1995, between the
Registrant and Pierre S. Melcher. (Filed as an exhibit to
Form 10-K for the year ended December 31, 1995 and
incorporated herein by reference).
10.8 -- Employment Agreement dated March 1, 1995, between the
Registrant and John P. Fitzpatrick. (Filed as an exhibit to
Form 10-K for the year ended December 31, 1994 and
incorporated herein by reference).
10.9 -- Employment Agreement dated December 17, 1992, between the
Registrant and Michael P. Lawlor. (Filed as an exhibit to
Form 10-K for the fiscal year ended March 31, 1993 and
incorporated herein by reference).
10.10 -- Employees Stock Purchase Plan, as amended, dated December
15, 1994. (Filed as an exhibit to Form 10-K for year ended
December 31, 1994 and incorporated herein by reference).
10.11 -- Director Stock Option Plan, as amended. (Plan filed as an
exhibit to Proxy Statement for Annual Meeting of
Stockholders hold on June 29, 1995, and amendment filed as
an exhibit to Form 10-Q for the quarter ended June 30, 1996
both of which are incorporated herein by reference).
10.12 -- Amended and Restated 1990 Stock Option Plan, as amended,
dated June 29, 1995. (Filed as an exhibit to Proxy Statement
for Annual Meeting of Stockholders held on June 29, 1995 and
incorporated herein by reference).
10.13 -- Form of Stock Option Agreement. (Filed as an exhibit to Form
10-K for the fiscal year ended March 31, 1993 and
incorporated herein by reference).
</TABLE>

14
<PAGE> 17
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S> <C>
10.14 -- Lease Agreement dated May 25, 1994, between Halligan and
Labbe Enterprises, L.L.C. and Amerex Industries, Inc. (Filed
as an exhibit to Form 10-K for the year ended December 31,
1994 and incorporated herein by reference).
10.15 -- License and Technical Assistance Agreement dated August 28,
1991, between Interel Environmental Technologies, Inc. and
Heinrich Luhr Staubtechnik GmbH & Co. (Filed as an exhibit
to Form S-1 (No. 33-44205) and incorporated herein by
reference).
*23.1 -- Consent of Arthur Andersen LLP.
*23.2 -- Consent of KPMG Peat Marwick LLP.
*23.3 -- Letter of Arthur Andersen LLP regarding change in
accounting.
</TABLE>

- ---------------
* Filed herewith.

(B) REPORTS ON FORM 8-K

The Company filed a Report on Form 8-K on December 5, 1996 reporting the
acquisition of Ohmstede, Inc.

15
<PAGE> 18

ITEQ, INC. AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
------
<S> <C>
Reports of Independent Public Accountants................... F-2,3
Consolidated Balance Sheets -- December 31, 1995 and
December 31, 1996......................................... F-4
Consolidated Statements of Operations -- Years ended
December 31, 1994, 1995 and 1996.......................... F-5
Consolidated Statements of Stockholders' Equity -- Years
ended December 31, 1994, 1995 and 1996.................... F-6
Consolidated Statements of Cash Flows -- Years ended
December 31, 1994, 1995 and 1996.......................... F-7
Notes to Consolidated Financial Statements.................. F-8
</TABLE>

F-1
<PAGE> 19

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-2
<PAGE> 20

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-3
<PAGE> 21

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 obligations................. 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-4
<PAGE> 22

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-5
<PAGE> 23

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-6
<PAGE> 24

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-7
<PAGE> 25

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-8
<PAGE> 26

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

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
the first-in, first-out (FIFO) method for purchased parts. Inventory consists of
the following:

<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-9
<PAGE> 27

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 modifies the life and/or the carrying amount of an acquisition
intangible if an 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.

F-10
<PAGE> 28

ITEQ, INC. AND SUBSIDIARIES

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

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-11
<PAGE> 29

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 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.

Air-Cure 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-12
<PAGE> 30

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 non-recurring 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 $5.9 million is being amortized

F-13
<PAGE> 31

ITEQ, INC. AND SUBSIDIARIES

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

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 to 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.

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.

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>

F-14
<PAGE> 32

ITEQ, INC. AND SUBSIDIARIES

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

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>

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

F-15
<PAGE> 33

ITEQ, INC. AND SUBSIDIARIES

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

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.

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.

F-16
<PAGE> 34

ITEQ, INC. AND SUBSIDIARIES

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

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.

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.

F-17
<PAGE> 35

ITEQ, INC. AND SUBSIDIARIES

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

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.

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.

F-18
<PAGE> 36

ITEQ, INC. AND SUBSIDIARIES

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

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>

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>

F-19
<PAGE> 37

ITEQ, INC. AND SUBSIDIARIES

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

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.

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 10% and 11%, respectively.

Financial data by geographical area is as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1994 1995
AS RESTATED AS 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 revenue 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-20
<PAGE> 38

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 13th day of
March, 1997.

ITEQ, INC.
(Registrant)

By /s/ MARK E. JOHNSON
-----------------------------------
(Mark E. Johnson)
Chairman of the Board, President
and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of registrant and in
the capacities indicated and on the 13th day of March, 1997.

<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>

/s/ MARK E. JOHNSON Director, Chairman of the Board, President
- ----------------------------------------------------- and Chief Executive Officer (Principal
(Mark E. Johnson) Executive Officer)

/s/ LAWRANCE W. MCAFEE Director, Executive Vice President, Chief
- ----------------------------------------------------- Financial Officer and Secretary (Principal
(Lawrance W. McAfee) Financial Officer and Principal Accounting
Officer)

/s/ PIERRE S. MELCHER Director and Senior Vice President
- -----------------------------------------------------
(Pierre S. Melcher)

/s/ THOMAS N. AMONETT Director
- -----------------------------------------------------
(Thomas N. Amonett)

/s/ T. WILLIAM PORTER Director
- -----------------------------------------------------
(T. William Porter)

Director
- -----------------------------------------------------
(James L. Rainey)

Director
- -----------------------------------------------------
(James A. Read)
</TABLE>
<PAGE> 39

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S> <C>
3.1 -- Certificate of Incorporation of Registrant, as amended
(Filed as an exhibit to Form 10-Q for the quarter ended June
30, 1995 and incorporated herein by reference).
3.2 -- Certificate of Amendment to Certificate of Incorporation of
Registrant (Filed as an exhibit to Form 8-K dated March 7,
1997 and incorporated herein by reference).
3.3 -- Bylaws of the Registrant, as amended (Filed as an exhibit to
Form 10-Q for the quarter ended September 30, 1995 and
incorporated herein by reference).
4.1 -- See Exhibits 3.1 and 3.3 for provisions of the Certificate
of Incorporation and Bylaws of the Registrant defining the
rights of holders of Common Stock.
4.2 -- Amended and Restated Credit Agreement dated November 18,
1996, among the Registrant, Bank of America National Trust
and Savings Association, as Agent, The First National Bank
of Boston, as Co-Agent and certain other financial
institutions. (Filed as an exhibit to Form 8-K dated
December 5, 1996 and incorporated herein by reference).
4.3 -- Subordination Agreement among the Registrant and various
financial institutions (the "Senior Lenders"), including
Bank of America National Trust and Savings Association, as
Agent, and The First National Bank of Boston, as Co-Agent.
(Filed as an exhibit to Form 8-K dated December 5, 1996 and
incorporated herein by reference).
4.4 -- Subordinated Note and Purchase Agreement dated November 18,
1996, among the Registrant, International Mezzanine Capital,
B.V. ("Mezzanine") and First Commerce Corporation ("First
Commerce"). (Filed as an exhibit to Form 8-K dated December
5, 1996 and incorporated herein by reference).
4.5 -- Senior Subordinated Note due November 18, 2003, between the
Registrant and Mezzanine, dated November 18, 1996. (Filed as
an exhibit to Form 8-K dated December 5, 1996 and
incorporated herein by reference).
4.6 -- Senior Subordinated Note due November 18, 2003, between the
Registrant and First Commerce, dated November 18, 1996.
(Filed as an exhibit to Form 8-K dated December 5, 1996 and
incorporated herein by reference).
4.7 -- Guaranty dated November 18, 1996, executed by the Registrant
in favor of Mezzanine and First Commerce. (Filed as an
exhibit to Form 8-K dated December 5, 1996 and incorporated
herein by reference).
4.8 -- Warrant Agreement, dated November 18, 1996, between the
Registrant and Mezzanine. (Filed as an exhibit to Form 8-K
dated December 5, 1996 and incorporated herein by
reference).
4.9 -- Warrant Agreement dated November 18, 1996, between the
Registrant and First Commerce. (Filed as an exhibit to Form
8-K dated December 5, 1996 and incorporated herein by
reference).
4.10 -- Registration Rights Agreement dated November 18, 1996, among
the Registrant, Mezzanine, and First Commerce. (Filed as an
exhibit to Form 8-K dated December 5, 1996 and incorporated
herein by reference).
4.11 -- Warrant Agreement, dated April 24, 1996, between the
Registrant and Sanders Morris Mundy, Inc. (Filed as an
exhibit to Form 10-Q for the quarter ended September 30,
1996 and incorporated herein by reference).
4.12 -- Warrant Agreement, dated December 1992, between Registrant
and Pennsylvania Merchant Group, Ltd. (Filed as an exhibit
to Form 10-K for fiscal year ending March 31, 1993 and
incorporated herein by reference).
10.1 -- Agreement and Plan of Merger dated September 19, 1996, among
the Registrant, Air-Cure Acquisition, Inc. and Ohmstede,
Inc. (Filed as an exhibit to Form 10-Q for the quarter ended
September 30, 1996 and incorporated herein by reference).
</TABLE>
<PAGE> 40
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S> <C>
10.2 -- Agreement and Plan of Merger dated October 13, 1995, among
the Registrant, Air-Cure Acquisition Corporation, Allied
Industries, Inc., Mark E. Johnson and Pierre S. Melcher.
(Filed as an exhibit to Post-Effective Amendment No. 1 to
Form S-4 Registration Statement (No. 33-92308) and
incorporated herein by reference).
10.3 -- Agreement and Plan of Merger dated April 28, 1994, among the
Registrant., VIC Acquisition Corporation, VIC Environmental
Systems, Inc. and Ronald E. Lewis. (Filed as an exhibit to
Post-Effective Amendment No. 1 to Form S-1 Registration
Statement (No. 33-69524) and incorporated herein by
reference).
10.4 -- Agreement and Plan of Merger dated April 5, 1994, among the
Registrant, Air-Cure Acquisition Corporation, Amerex, Inc.,
Amerex Industries, Inc. and certain other parties. (Filed as
an exhibit to Post-Effective Amendment No. 1 to Form S-1
Registration Statement (No. 33-69524) and incorporated
herein by reference).
10.5 -- Employment Agreement dated March 1, 1996, between the
Registrant and Lawrance W. McAfee. (Filed as an exhibit to
Form 10-Q for the quarter ended September 30, 1996 and
incorporated herein by reference).
10.6 -- Employment Agreement dated December 29, 1995, between the
Registrant and Mark E. Johnson. (Filed as an exhibit to Form
10-K for the year ended December 31, 1995 and incorporated
herein by reference).
10.7 -- Employment Agreement dated December 29, 1995, between the
Registrant and Pierre S. Melcher. (Filed as an exhibit to
Form 10-K for the year ended December 31, 1995 and
incorporated herein by reference).
10.8 -- Employment Agreement dated March 1, 1995, between the
Registrant and John P. Fitzpatrick. (Filed as an exhibit to
Form 10-K for the year ended December 31, 1994 and
incorporated herein by reference).
10.9 -- Employment Agreement dated December 17, 1992, between the
Registrant and Michael P. Lawlor. (Filed as an exhibit to
Form 10-K for the fiscal year ended March 31, 1993 and
incorporated herein by reference).
10.10 -- Employees Stock Purchase Plan, as amended, dated December
15, 1994. (Filed as an exhibit to Form 10-K for year ended
December 31, 1994 and incorporated herein by reference).
10.11 -- Director Stock Option Plan, as amended. (Plan filed as an
exhibit to Proxy Statement for Annual Meeting of
Stockholders hold on June 29, 1995, and amendment filed as
an exhibit to Form 10-Q for the quarter ended June 30, 1996
both of which are incorporated herein by reference).
10.12 -- Amended and Restated 1990 Stock Option Plan, as amended,
dated June 29, 1995. (Filed as an exhibit to Proxy Statement
for Annual Meeting of Stockholders held on June 29, 1995 and
incorporated herein by reference).
10.13 -- Form of Stock Option Agreement. (Filed as an exhibit to Form
10-K for the fiscal year ended March 31, 1993 and
incorporated herein by reference).
10.14 -- Lease Agreement dated May 25, 1994, between Halligan and
Labbe Enterprises, L.L.C. and Amerex Industries, Inc. (Filed
as an exhibit to Form 10-K for the year ended December 31,
1994 and incorporated herein by reference).
10.15 -- License and Technical Assistance Agreement dated August 28,
1991, between Interel Environmental Technologies, Inc. and
Heinrich Luhr Staubtechnik GmbH & Co. (Filed as an exhibit
to Form S-1 (No. 33-44205) and incorporated herein by
reference).
*23.1 -- Consent of Arthur Andersen LLP.
*23.2 -- Consent of KPMG Peat Marwick LLP.
*23.3 -- Letter of Arthur Andersen LLP regarding change in
accounting.
</TABLE>

- ---------------
* Filed herewith.

<PAGE> 1

EXHIBIT 23.1

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

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

As independent public accountants, we hereby consent to the incorporation
of our report dated February 24, 1997 related to the consolidated financial
statements of ITEQ, Inc. and subsidiaries included in this Form 10-K, into
ITEQ's previously filed Registration Statement File no. 333-09051 on Form S-8.

ARTHUR ANDERSEN LLP

Houston, TX
March 10, 1997

<PAGE> 1

EXHIBIT 23.2

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

The Board of Directors
Allied Industries, Inc.

We hereby consent to the use of our report for the year ended December 31,
1994 included in this Form 10-K.

KPMG PEAT MARWICK LLP

Houston, TX
March 10, 1997

<PAGE> 1

EXHIBIT 23.3
Air-Cure Technologies, Inc.
2727 Allen Parkway, Suite 760
Houston, Texas 77019

Re: Form 10-K Report for the year ended December 31, 1996

Gentlemen:

This letter is written to meet the requirements of Regulation S-K calling
for a letter from a registrant's independent accountants whenever there has been
a change in accounting principle or practice.

ITEQ, Inc. (the Company) changed its method of estimating the percentage of
completion for recognizing revenues and profits at its Allied Industries, Inc.
subsidiary (Allied) from being based on when the liability for the cost of the
material was legally incurred to a method based on when the material is placed
into production. Management of the Company believes this change better reflects
the economics of the earnings process of Allied. Allied represented
approximately 5.6% and 25% of the Company's consolidated assets and revenues as
of and for the year ended December 31, 1996, respectively. Materials are a large
portion of Allied's total cost of sales. Previously, Allied recognized
percentage of completion revenue and profits related to materials based on when
they incurred the liability for such materials, which precedes the date
materials are received and placed into production. Recognition of percentage of
completion revenues and profits based on when the materials are received and
placed into production (the new method) better reflects Allied's economic
performance under its customer contracts and delivery of value to such customers
than the prior method. No change was made to the method for estimating
percentage of completion revenues and profits related to labor and overhead
costs, which continue to be recognized when incurred.

A complete coordinated set of financial and reporting standards for
determining the preferability of accounting principles among acceptable
alternative principles has not been established by the accounting profession.
Thus, we cannot make an objective determination of whether the change in
accounting described in the preceding paragraph is to a preferable method.
However, we have reviewed the pertinent factors, including those related to
financial reporting, in this particular case on a subjective basis, and our
opinion stated below is based on our determination made in this manner.

We are of the opinion that the Company's change in method of accounting is
to an acceptable alternative method of accounting, which, based upon the reasons
stated for the change and our discussions with you, is also preferable under the
circumstances in this particular case. In arriving at this opinion, we have
relied on the business judgment and business planning of your management.

Very truly yours,

ARTHUR ANDERSEN LLP

Houston, Texas
February 24, 1997

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 6,475
<SECURITIES> 0
<RECEIVABLES> 34,774
<ALLOWANCES> 544
<INVENTORY> 10,649
<CURRENT-ASSETS> 74,904
<PP&E> 16,398
<DEPRECIATION> 2,737
<TOTAL-ASSETS> 136,388
<CURRENT-LIABILITIES> 45,053
<BONDS> 0
0
0
<COMMON> 11
<OTHER-SE> 23,242
<TOTAL-LIABILITY-AND-EQUITY> 136,388
<SALES> 110,804
<TOTAL-REVENUES> 110,804
<CGS> 88,949
<TOTAL-COSTS> 108,531
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,660
<INCOME-PRETAX> (82)
<INCOME-TAX> 4
<INCOME-CONTINUING> (86)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (86)
<EPS-PRIMARY> (0.01)
<EPS-DILUTED> (0.01)

</TABLE>