Itek Engineering

In September of 1989, Mr Al Tanton, President of Itek Engineering, West Royalty, PEI,

reflected on the events of the last twelve months. He had successfully secured a
manufacturing license from Elge Heat Exchangers of Sweden and distribution rights from
Naval valves of Finland and ISS Heat Meters of Denmark. Al was pleased with the joint
venture relationship with each company and the quality of the products, but now he faced
decisions about the future operations of his company.

Company Background

Itek Engineering was founded in 1988 to manufacture, distribute and service some of the
key components of district heating systems. The founder, Mr Al Tanton, had been a
consultant to contractors, engineers and other clients in the fields of metallurgy, welding
and design of quality control systems for the manufacturing of pressure vessels. In recent
years, he had been active consulting on district heating projects because the construction
of a district heating system involved specialized welding and the use of pressure vessels.
This case was prepared by Professor Timothy Carroll of the University of Prince Edward Island for the Atlantic
Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective
management. Some elements of this case have been disguised.

Copyright 0 1991, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for
educational purposes, but all such reproductions must acknowledge the copyright. This permission does not include
publication.

This work led him to be in contact with a number of district heating component suppliers
including Elge, Naval and ISS. The idea of becoming a distributor for each had been
discussed, but never really progressed until Elge began to experience difficulties with its
North American manufacturer.

The units that were being assembled by this manufacturer were not passing inspection by
the PEI Department of Labour which administered the Boiler and Pressure Vessels Act.
Elge hired Al as a consultant to go in and act as a troubleshooter on the failed inspections.
Al supervised the welding and assembly of the heat exchangers on their behalf and his
work was eventually completed.

Elge officials were impressed with Al's expertise and knowledge of district heating
systems and welding. They also knew that Al's consulting activities provided a lot of
contacts that could prove to be useful as they entered the North American market.

Elge calculated that it was less expensive to license sub-assembly in Canada than to
establish their own operation. Mr Tanton informed Elge that he was interested in the
opportunity, but did not have the financial resources to start up a manufacturing facility
for heat exchangers. Consequently, Elge offered financial support in the form of
collateral and payment terms. This, combined with local government assistance
programs, led to the establishment of Itek Engineering.
Naval and ISS immediately initiated discussions with Itek regarding distributorship
arrangements. Agreements with each company were finalized in the summer of 1989, for
distribution of all products and the assembly of Elge heat exchangers.

The manufacturing operations of Itek were based on specialization. An illustration of this

was the fact that Itek did not plan to hire local journeyman welders who were trained in
the conventional way. According to Al, a journeyman welder was too independent and
creative to follow the precise quality control requirements of an Elge heat exchanger. He
planned to hire a technician who would operate a computerized welding machine.

District Heating Systems

In its simplest terms, district heating was the provision of heat from a central source and
then distributed to a number of buildings. This was quite different from the conventional
North American heating system where each building had its own heating unit. In Europe,
district heating was available as a commercial service, much like a power utility, and
anyone within the geographic limits (usually 3 Ian) could be connected to a central
heating source.

District heating with steam had been used in North America in the past. In the European
district heating system, water had been used as the heat distribution medium over the last
40 years. The use of water provided greater economy in overall fuel use and water was
the only practical medium for transmitting heat over long distances.

The water was heated in a central boiler and distributed by underground insulated pipe to
various heat consumers. The distribution was a dosed two-pipe system where hot water
was pumped out to consumers and the cooled water was returned to the boiler plant for
reheating.

There were three major elements in any hot water district heating system. They were:

1. Heat consumer's equipment which consisted of whatever heat distribution system

they already had for the building such as radiators, convectors or forced air. The only
change was the replacement of their existing boiler with a heat exchanger like the one
produced by Elge.

2. Distribution system consisting of pumps, meters, valves and insulated pipework

system.

3. A central heat system that could be fired from off or any other fuel. In PEI, wood
chips were used as fuel.

The first installation in North America of a state-of-the-art district heating system using
water was the installation at the University of Prince Edward Island (UPEI) in 1985.
Some of the benefits for UPEI included the elimination of maintenance costs for several
burners and boilers, reduced fire insurance premiums, alternative uses for space where
burners were located and the elimination of liabilities regarding above or underground
fuel storage tanks. In addition, air pollution was reduced because it is much easier to
control emission from one central unit than a number of smaller units.

The total capital cost in 1985 of the UPEI system was approximately $1,500,000. Half of
this cost was for the installation of a wood chip fired boiler unit and the other half
included the components and installation of the district heating system. Approximately
half of the district heating capital costs were devoted to the specialized insulated pipe and
its installation. This pipe was purchased from I.C. Moore of Denmark. The remaining
$375,000 (approximately) was paid to cover the cost of the items to be sold by Itek
Engineering including heat exchangers, control valves and heat and flow meters.

According to one analysis done by the PEI Energy Corporation, the energy savings to
UPEI as a result of the district heating system, were approximately $110,000 per year
since 1985. The savings came from the increased efficiency of distributing heat with
water and the lower cost fuel. As the price of oil increased, the savings from the system
increased.

The Market

The energy crisis of the mid-seventies marked the beginning of sustained interest in
North America in alternative energy sources and systems. District heating with steam was
designed in North America when energy was considered to be limitless, therefore, little
consideration was given to thermal efficiency. The European concept of using water and
heating a number of buildings from the same source had continued to attract interest
because of its economic and environmental advantages.

The typical prospects for district heating systems in North America included both public
and private sector institutions, although public institutions seemed to be leading the way
The typical prospect usually invested in district heating when new construction was
involved or when existing systems had become unworkable. Consulting engineers were
usually involved in recommending district heating. A good example were the Canadian
prison facilities which were outdated and in need of repair, therefore Public Works
Canada was considering the district heating system alternative.

Al Tanton had worked on the UPEI system as well as other Island systems that had been
installed for buildings in the Charlottetown area. He knew there was a growing interest in
district heating in North America because of the number of orders and inquiries he was
receiving from consulting engineers.

When Itek first started operations in 1989, it had firm orders for fifty-seven Elge heat
exchangers at a value of $230,000. In addition, $90,000 worth of heat meters and Naval
valves were being ordered. This was to fill one order from Public Works Canada for
installation at the Springhill Minimum Security Prison in Springhill, Nova Scotia. Public
Works Canada indicated that the Springhill project was a pilot project. If district heating
proved successful there, they planned to begin converting all prison facilities across
Canada to district heating over the next five to ten years.

The City of Minneapolis, Minnesota had already started a major district heating retrofit.
They indicated that they had installed plate type heat exchangers and they were now
leaking. They had seen Elge heat exchangers in Sweden which did not leak. They
indicated they would place orders with Itek as soon as Itek received their ASME-U1
certification.

In addition, Itek had received inquiries from a number of U.S. based consulting
engineering firms who were involved in heating projects in Chicago, Detroit, Newark,
Boston, Oregon and Minnesota.

Officials from the PEI Energy Corporation who were spearheading district heating in PEI
indicated they needed seventeen additional heat exchangers along with necessary valves
and heat meters for upcoming projects in 1990.

District heating was-Itek's primary market, but Mr Tanton knew from his experience with
the pulp and paper and mining industries that the valves and heat meters might have
applications in those industries also. This was confirmed by Naval and ISS marketing
personnel. However, he was not anxious to pursue those markets right away because he
had all he could handle in the district heating market.
1
ASME-U Specifications for pressure vessels in Canada were administered by provincial government departments under
legislation similar to the P.E.I. Boiler and Pressure Vessels Act. In the U.S.A., regulation of pressure vessels is conducted by
the American Society of Mechanical Engineers (ASME). No pressure vessel can be sold by a company anywhere in the USA
unless their plant and quality control procedures were inspected and approved. This was signified by an ASME-U stamp. Al
was familiar with their regime and, in fact, he had just completed a consulting project in Nova Scotia for a firm that was
awarded ASME artification. Al estimated the process would take 6-12 months and cost Itek approximately $100,000.

Elge Heat Exchangers

Elge was a relatively small company located in Linkoping, Sweden and employed about
110 people. It was bought by the giant conglomerate ASEA-Brown-Bavaria in 1985, and
later sold to the management of the company in 1988.

The Elge heat exchangers soon became the leader in the district heating market in Europe
by virtue of a technological breakthrough developed in 1980. Prior to 1980, heat
exchangers were either plate type or tubular bundle type. The plate type consisted of
layer upon layer of copper plates that were separated by seals. The tubular bundle type
consisted of a circular bundle of copper tubes.

The plate type had the disadvantage of leaking after long periods of sustained use at high
pressure and high temperatures. The tubular bundles were limited because of the number
of tubes that were required to achieve capacities of heat exchange necessary for district
heating. Elge developed the idea of constructing the "battery"2 with copper tubing that
was wound in concentric circles.
This relatively simple principle eliminated any leaking by eliminating the need for seals
and greatly increased the capacity. One Elge heat exchanger that was approximately five
feet high and two feet in diameter had the same capacity of ten tubular bundle type heat
exchangers or of a boiler that occupied a thousand cubic feet of space. See Exhibit 1 for
diagrams and promotional information.

The proposal to Itek included North American marketing rights and a license to perform
sub-assembly manufacturing. The battery or tubing works were to be shipped to Itek and
Itek was
2
Battery is the term used to describe the internal system of insulation and copper tubing in a heat exchanger.

responsible for forming the casing around the battery and welding the top and bottom to
complete the heat exchanger. Elge assisted in the financing of Itek by giving them all the
equipment except for a computer assisted welding machine. They provided promotional
materials in both English and French and offered to train both manufacturing and sales
personnel that were hired by Itek

The projected gross profit for heat exchangers was 40% of sales. Elge had strict rules
against price cutting. They said 'When we have to cut prices to make a sale, then it's time
for us to go back to our shop and develop better technology"

Naval Valves

Naval OY was also a relatively small company with about 100 employees. It was located
in Laitila, Finland and produced welded steel ball valves for district heating and other
high pressure applications. See Exhibit 2 for illustrations.

Although ball valves are not a new idea, the unique design of the Naval ball valve gave it
several advantages over other ball valves and the more commonly used "gate" valves.

The key advantage of the Naval ball valve was its relative cost. For example, a standard
3" ball valve was sold to customers at $340.00 which compared favourably to a standard
gate valve which sold for $550.00. Exhibit 2 shows that the Naval valve does not have
flanges like gate valves for connecting it to pipes. The Naval valve was designed to be
welded directly to the pipes which it controlled. This unique design feature combined
with the low price allowed the valve to be a throw away when it eventually became
dysfunctional.

The most common malfunction of a valve was when it began to leak. Gate valves have to
be removed and repaired thereby requiring users to stock a supply of replacement parts.
The Naval system of simply replacing the valve lowered inventory costs and reduced
downtime for replacement.

The unique stainless steel construction combined with the flexible joints that sealed the
ball tightly in place, regardless of whether it was opened or dosed, were important
features. These features extended the useful life of the valve and reduced problems of
leakage and seizing under high pressures.

Naval signed an agreement giving Itek exclusive distribution rights for Canada at a price
that would return Itek a margin on sales of approximately 40%. Distribution rights were
limited in the United States because another company was servicing the oil industry
there. Naval indicated that when Itek was up and running with heat exchangers, they were
interested in a subassembly agreement with Itek.

Al indicated that this would probably involve putting the handle on and painting the
valve. Naval OY agreed to advance inventory in the early stages of Itek with no fixed
payment terms until the company was on a more solid financial footing.

ISS Heat Meters

ISS Electronics was a large company based in Denmark with facilities all over the world
that produced and sold electronic products. It was one division of a multi-faceted
company involved in ventures that ranged from management of large buildings in the
United States to making parts for the European automobile industry

Itek had an agreement to market the ISS Combimeter exclusively in Atlantic Canada as
well as territorial marketing rights in other parts of Canada and the United States. The
gross margin on Combimeters could range from 20% to 40% depending upon the volume
sold. ISS also paid an additional 5% margin over the volume margins for accurate sales
forecasts. This was because they had installed a state-of-the-art "just in time" production
system which, combined with accurate sales forecast, held the potential for significant
cost savings.

The Combimeter was a meter which measured the flow of heat and fluids electronically
Unlike conventional flow and heat meters, the Combimeter had no moving parts and was
much more precise than the mechanical alternatives. See Exhibit 3 for illustration and
details.

Mr Tanton felt that there were a number of significant selling points for the ISS meters
that gave them a competitive advantage over other market offerings. It was one of the few
types that allowed measurement of both heat and flow with the same meter.

The 'black box' electronic technology made the meter more accurate and less susceptible
to leaking and wearing out. If a problem did occur, then the computer assisted servicing
made repairs quick and efficient. All of these features, combined with a competitive edge,
led Mr Tanton to conclude that this item held great sales potential not only in district
heating systems, but also for use in the mining and forest industries.

Conclusion
Al reflected on the events of the past year. He had successfully established his own
business despite his limited financial resources. The equipment from Elge (approximate
value $70,000) provided him with an equity base. He was able to secure a working
capital loan of $100,000 from a local development agency on the strength of his sales
orders and the equity base provided by the used Elge equipment.

Both Elge and Naval had been particularly supportive by agreeing to accept payment for
their components after Itek was paid for fulfilling the initial orders. ISS was not as
cooperative and they were also pressing Itek to take on a $20,000 parts inventory for
servicing their meters. This was not Al's only problem with ISS.

He had installed their electronic meters, but he had never serviced them. They had
instituted a 'Just-in-time' production system, therefore, the margin they allowed was
affected by the accuracy of Itek's annual sales forecast for meters by type and size.

All of the companies agreed to help Itek with it's marketing and sales effort by providing
promotional materials, leads and technological training for sales staff at their head
offices. Although prospects initially were promising, Al knew that follow-up was needed
if his present contacts and leads were going to generate sales contracts. To keep costs
down, Al planned on himself and one helper as the only employees for the first year. Al
sat down to sketch out a general plan of action for the upcoming year.

Exhibit 1
Elge Heat Exchanger

ELGE Shell & Coll Heat Exchangers

Type R and Type S - Technical Description

Applications
The Type R and Type S shell and Coil beat ex. changers are suitable for a wide range of
applications, inducting:

 Space Heating and Cooling

 Process Applications
 Domestic Hot Water
 Heat Recovery

Heat Trans for Media

The Type R and Type S shell and coil heat exchangers are designed to be used with
different medias, including:

 Water - Water
 Oil - Steam
 Oil - Water
 Steam - water
Battery

The battery is manufactured from drawn, smooth, spiral wound coopor tubes with an oval
cross section. The tubes as separated by spacer elements which form channels with
uniform now areas. The copper tubes are joined 108 col ON chamber with low flow
resistance.

Pressure Vessel

The pressure vessel is made from carbon 0001. and Is fined with carbon sleet
hemispherical heads.

Insulation

The beef exchangers are Insulated with liberglass, and covered with an aluminum jacket.
The insulation can be easily removed to facilitate Inspections of the pressure vessel.

Pressures and Temperatures

Battery Pressure Vessel

Design Pressure. psig 250 250

Tog Pressure. P69 325 325
Design Temperature, F 400 400

Pipe Connections

Type R - All connections are made of A53, sch 40 carbon sleet, arid can be suppled with
weld ends or class 250 flanges.

Type S - The pressure vessel connections we made of A53, sch 40 Carbon steel, and can
be suppled with weld ends or flanges. The battery connections sea copper plain and for
soldering.

Foot Stand

The host exchangers are delivered wall adjustable

I" for installation.

ASME

The Shell and Coll bast exchangers meet the requirements of the ASME boiler and
pressure vessel code. and we delivered with an ASUE axis symbol stamp. The data Pigs
is permanently attached 10 In@ press" vessel. Each heat exchanger is supplied with a
manufacturers done report.
Source: Company records
 Exhibit 2
Naval OY Steel Ball Valve

1. The body of the valve is completely welded.

2. The carbonized PTFE-seals are long-lasting against rough use, unpurities and
chemicals.

3. The high quality plate springs pressing the seals against the bell guarantee that the
bell valve works won at high temperatures.

4. The round, polished stainless ball ensures that the valve will work perfectly for
years.

5. The flexible joint between the bell and the stem allows the bell move smoothly against
the seals regardless the pressure.

6. The blow-out proof stem Is safe. It the stem seals are damaged leakages will be
negligible.

7. The double O-rings at the stem need no servicing. I

8. The long stem and round appearance sake It easy to insulate the valve.

9. The strong handle design allows plenty of room for hand between Insulation end the
handle.
10. The Naval-ball valve is light and easy to use. There are no heavy and unsure parts.

APPLICATIONS

WELDED STEEL BALL VALVE: district heating. networks oilpipes. pressure air pipes.
and oxygen free water pipelines.

WELDED BALL VALVE OF ACID-RESISTANT STEEL: process pipelines acids.

alkalies, row water and water with oxygen.

Source: Company records

 Exhibit 3
Combimeter 6.1.56-A

Combimeter, Type Ft50

Electronic Flow Transducer

Characteristics
• Flow meter. built on the Faraday principle
• No moving Doris
• Small pressure drop
• Complies with the requirements of PTB and SP (West Germ . d Swedish testing
authorities for flow and energy meters).
Application

The Flow Transducer Type FT 50 is an electronic volume meter which in connection

with temperature sen. sors and on integrator can be used for measuring energy
consumption In hot water hosting systems.

The Flow Transducer is applied as an alternative to mechanical host metering.

The flow metering principle Is based on Faraday's Law of Induction, whereby the now
measurement Is carried out without any moving parts.

The Meter Consists of Two Units

1) Flow Unit
2) Power Unit

Mode of Operation

The flow unit measures the volume of water flow and transmits the measured values to
on integrator by means of signal pulses, where each pulse corresponds to a flow of 100
litres of water.

The power unit provides the flow unit and the connected integrator (if supplied) with the
required voltage. Two fight diodes Indicate connection at mains voltage and
measurement of now respectively.

Installation

The flow unit is mounted either in the pipe or in the flow pipe. The unit is supplied with
65 or 80 mm flanges according to DIN 2535 / BS 4504 which can be mounted vertically
or horizontally. Straight pipe sections before and after the flow unit are not required.
Isolating valves should always be installed before and after the flow unit. The flow unit
should always be installed, so that there is room for removing the cover. The power unit
is connected to the mains. Connection should be effected to an independent group, i.e. a
supply which is usually not switched off.

The power unit can be remote mounted from the flow unit.

Flow Unlit

The flow unit is factory set to transmit one pulse for each 100 litres of water flow. The
flow unit can optionally be supplied with 12.5. 25 or 50 litres per pulse.
The flow metering tube is of stainless steel with polysultone insert.
Flange connection of cast iron PN 25. Housing of pressure die-cast silumin.

Power Unit
The unit contains a transformer, an hours-run counter, m3-counter and two light diodes.
The housing and cover are made of ABS plastic material.

Insertion for Cables

PG 13.5 with tightening rings.
PG 7 with relief.

Connection from Flow Unit to Power Unit

3 meter cable, which on ordering can be changed to max. 100 meter at an additional
price.

Source: Company records