PDG Environmental, Inc. 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2006


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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 0-13667

PDG Environmental, Inc.

(Exact name of registrant as specified in its charter)


Delaware		22-2677298
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


1386 Beulah Road, Building 801 Pittsburgh, Pennsylvania (Address of principal executive offices)		15235 (Zip Code)

412-243-3200
(Registrant’s telephone number, including area code)

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

Indicated by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of January 8, 2007, there were 20,502,130 shares of the registrant’s common stock outstanding.

PART I. FINANCIAL INFORMATION

PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


	October 31,			January 31,
	2006			2006
	(unaudited)			(Restated)
Assets

Current Assets
Cash and cash equivalents	$	135,000		$	230,000
Contracts receivable		23,381,000			23,903,000
Costs and estimated earnings in excess of billings on uncompleted contracts		5,546,000			5,174,000
Inventories		631,000			596,000
Prepaid income taxes		225,000			734,000
Deferred income tax asset		1,156,000			470,000
Other current assets		419,000			131,000


Total Current Assets		31,493,000			31,238,000

Property, Plant and Equipment		10,601,000			10,137,000
Less: accumulated depreciation		(8,258,000	)		(7,838,000	)

		2,343,000			2,299,000


Goodwill		2,770,000			2,316,000
Deferred Income Tax Asset		425,000			216,000
Intangible and Other Assets		5,876,000			6,423,000


Total Assets	$	42,907,000		$	42,492,000


Liabilities and Stockholders’ Equity

Current Liabilities
Accounts payable	$	7,022,000		$	6,488,000
Billings in excess of costs and estimated earnings on uncompleted contracts		1,981,000			2,044,000
Current portion of long-term debt		181,000			513,000
Accrued liabilities		4,715,000			4,494,000


Total Current Liabilities		13,899,000			13,539,000

Long-Term Debt		11,570,000			9,059,000
Series C Redeemable Convertible Preferred Stock		2,347,000			2,803,000


Total Liabilities		27,816,000			25,401,000


Stockholders’ Equity
Common stock		410,000			345,000
Common stock warrants		1,628,000			1,881,000
Additional paid-in capital		19,160,000			15,582,000
Retained earnings (deficit)		(6,069,000	)		(679,000	)
Less treasury stock, at cost		(38,000	)		(38,000	)


Total Stockholders’ Equity		15,091,000			17,091,000


Total Liabilities and Stockholders’ Equity	$	42,907,000		$	42,492,000

See accompanying notes to consolidated financial statements.

PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED OPERATIONS
(UNAUDITED)


	For the Three Months
	Ended October 31,
	2006			2005
Contract revenues	$	19,783,000		$	26,186,000
Contract costs		17,772,000			22,071,000


Gross margin		2,011,000			4,115,000

Selling, general and administrative expenses		2,932,000			2,436,000
(Gain) loss on Sale of Fixed Assets		12,000			(10,000	)


Income (loss) from operations		(933,000	)		1,689,000

Other income (expense):
Interest expense		(246,000	)		(114,000	)
Non-cash interest expense for preferred dividends and accretion of discount		(195,000	)		(242,000	)
Non-recurring charge for employee fraud		(150,000	)		—
Non-cash impairment charge for goodwill		(111,000	)		—
Interest and other income		3,000			3,000


		(699,000	)		(353,000	)


Income (loss) before income taxes		(1,632,000	)		1,336,000

Income tax provision		365,000			331,000


Net income (loss)	$	(1,997,000	)	$	1,005,000


Per share of common stock:

Basic	$	(0.10	)	$	0.07


Dilutive	$	(0.10	)	$	0.05


Average common share equivalents outstanding		20,445,000			15,100,000

Average dilutive common share equivalents outstanding		—			8,836,000


Average common shares and dilutive common equivalents outstanding for earnings per share calculation		20,445,000			23,936,000

See accompanying notes to consolidated financial statements.

PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED OPERATIONS

(UNAUDITED)


	For the Nine Months
	Ended October 31,
	2006			2005
Contract revenues	$	58,579,000		$	56,457,000
Contract costs		52,128,000			47,558,000


Gross margin		6,451,000			8,899,000

Selling, general and administrative expenses		9,188,000			5,837,000
(Gain) Loss on Sale of Fixed Assets		17,000			(10,000	)


Income (loss) from operations		(2,754,000	)		3,072,000

Other income (expense):
Interest expense		(716,000	)		(310,000	)
Non-cash interest expense for preferred dividends and accretion of discount		(1,870,000	)		(322,000	)
Gain on sale of equity investment		—			48,000
Equity in income of equity investment		—			4,000
Non-recurring charge for employee fraud		(748,000	)		—
Non-cash impairment charge for goodwill		(111,000	)		—
Interest and other income		16,000			22,000


		(3,429,000	)		(558,000	)


Income (loss) before income taxes		(6,183,000	)		2,514,000

Income tax provision (benefit)		(793,000	)		809,000


Net income (loss)	$	(5,390,000	)	$	1,705,000


Per share of common stock:

Basic	$	(0.28	)	$	0.12


Dilutive	$	(0.28	)	$	0.10


Average common share equivalents outstanding		19,543,000			13,911,000

Average dilutive common share equivalents outstanding		—			5,734,000


Average common shares and dilutive common equivalents outstanding for earnings per share calculation		19,543,000			19,645,000

See accompanying notes to consolidated financial statements.

PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED CASH FLOWS

(UNAUDITED)


	For the Nine Months
	Ended October 31,
	2006			2005
Cash Flows from Operating Activities:
Net income (loss)	$	(5,390,000	)	$	1,705,000
Adjustments to Reconcile Net Income to Cash:
Depreciation and amortization		1,284,000			666,000
Deferred income taxes		(895,000	)		—
Interest expense for preferred dividends and accretion of discount		1,870,000			322,000
Provision for uncollectible accounts		140,000			—
Impairment charge for goodwill		111,000			—
(Gain) loss on sale of equity investment and fixed assets		17,000			(58,000	)
Stock based compensation		209,000			—
Equity in (income) of equity investment		—			(4,000	)
Changes in Assets and Liabilities Other than Cash:
Contracts receivable		382,000			(6,606,000	)
Costs and estimated earnings in excess of billings on uncompleted contracts		(372,000	)		(3,102,000	)
Inventories		(35,000	)		(204,000	)
Prepaid income taxes		509,000			(45,000	)
Other current assets		869,000			633,000
Accounts payable		534,000			3,123,000
Billings in excess of costs and estimated earnings on uncompleted contracts		(63,000	)		11,000
Current income tax liabilities		—			(305,000	)
Accrued liabilities		(458,000	)		1,840,000

Total Changes in Assets and Liabilities Other than Cash		1,366,000			(4,655,000	)

Net Cash Used by Operating Activities		(1,288,000	)		(2,024,000	)

Cash Flows from Investing Activities:
Purchase of property, plant and equipment		(775,000	)		(1,004,000	)
Proceeds from sale of equity investment and fixed assets		24,000			60,000
Additional investment in joint venture		—			(18,000	)
Acquisition of businesses		—			(5,339,000	)
Increase in other assets		(57,000	)		(62,000	)

Net Cash Used by Investing Activities		(808,000	)		(6,363,000	)

Cash Flows from Financing Activities:
Proceeds from private placement of common and preferred stock		—			7,160,000
Proceeds from debt		2,664,000			2,373,000
Proceeds from exercise of stock options and warrants		861,000			272,000
Payment of accrued earnout liability		—			(294,000	)
Payment of insurance premium financing		(1,039,000	)		(959,000	)
Principal payments on debt		(485,000	)		(215,000	)

Net Cash Provided by Financing Activities		2,001,000			8,337,000


Change in Cash and Cash Equivalents		(95,000	)		(50,000	)
Cash and Cash Equivalents, Beginning of Period		230,000			333,000

Cash and Cash Equivalents, End of Period	$	135,000		$	283,000


Supplementary disclosure of non-cash Investing and Financing Activity:
Increase in goodwill and accrued liabilities for contingent payment	$	561,000		$	387,000

Financing of annual insurance premium	$	1,157,000		$	959,000

See accompanying notes to consolidated financial statements.

PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED OCTOBER 31, 2006

(UNAUDITED)

NOTE 1 — BASIS OF PRESENTATION

The consolidated financial statements include PDG Environmental, Inc. (the “Corporation” or “Company”) and its wholly-owned subsidiaries.

The condensed consolidated financial statements as of and for the three and nine-month periods ended October 31 2006 and 2005 are unaudited and are presented pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, these condensed consolidated financial statements should be read in conjunction with the Company’s Annual Report, as amended on Form 10-K/A for the year ended January 31, 2006 and the Company’s Quarterly Reports as amended on Form 10-Q/A for the quarters ended April 30, 2006 and July 31, 2006. In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments (which are of a recurring nature) necessary for the fair statement of the results for the interim periods.

Due to variations in the environmental and specialty contracting industry, the results of operations for any interim period are not necessarily indicative of the results expected for the full fiscal year.

NOTE 2 — FEDERAL INCOME TAXES

A current federal income tax expense of $95,000 was provided for the nine-month period ended October 31, 2006. A federal income tax provision of $581,000 was provided for the nine-month period ended October 31, 2005.

State income tax provision of $8,000 and $228,000 were made in the current and prior year periods, respectively. The prior year’s provision is due to income in the prior year.

At October 31, 2006 it was determined that the recognition of deferred income tax assets for all of the net operating loss carryforwards for both federal and state purposes and the federal Research & Development Tax Credit would not be appropriate. Therefore, at October 31, 2006 a $1.0 million valuation allowance against deferred income tax assets was provided.

The deferred benefit of $0.89 million for federal and state income taxes reflects the effect of carrying back the current year’s loss to fiscal years ended January 31, 2005 and 2006 thereby generating a refund of federal income taxes previously paid and the realization of a portion of the net operating loss carryforwards for both federal and state purposes and the federal Research & Development Tax Credit.

At October 31, 2006, the Corporation has approximately $1.82 million of net operating loss carryforwards for federal income tax purposes expiring in 2027 and approximately $0.63 million of federal credit carryforwards, primarily Research and Development Tax Credits, expiring from 2022 to 2027.

Income taxes paid by the Corporation for the nine months ended October 31, 2006 and 2005 totaled approximately $11,000 and $1,165,000, respectively. Also, during the nine months ended October 31, 2006, the Corporation received a $400,000 refund of federal income tax payments made in the prior fiscal year.

NOTE 3 – TERM DEBT

The Corporation’s mortgage on its Pittsburgh operating location is at an interest rate of 9.15% fixed for three years and is then adjusted to 2.75% above the 3-year Treasury Index every three years.

On May 18, 2005 Sky Bank permanently increased the line of credit to $8 million and extended the maturity date to June 6, 2007. Additionally, the interest rate on the line of credit was lowered to prime plus ¹/4%.

On September 8, 2005 Sky Bank permanently increased the line of credit to $11 million. Additionally, the interest rate on the line of credit may be lowered from the current prime plus ¹/4% rate to a London Interbank Offer Rate (“LIBOR”) based pricing upon the attainment of certain operating leverage ratios. The initial LIBOR rate would be LIBOR plus 2.75% but would decrease to LIBOR plus 2.25% upon the attainment of improved operating leverage ratios.

In May 2005 Sky Bank also approved an equipment financing note of a maximum of $400,000 with a four year term and a 7.25% interest rate. As of January 31, 2006, the note had been fully utilized financing equipment.

On December 22, 2005 Sky Bank increased the amount available under the base line of credit from $11 million to $13 million via a temporary increase in the line of credit. The temporary increase expired on June 6, 2006 and reverted to $11 million of availability.

On May 10, 2006 Sky Bank approved an increase to the line of credit to $15 million and extended the maturity date to June 6, 2008. Additionally, the interest rate on the line of credit was lowered to prime.

The majority of the Corporation’s property and equipment are pledged as security for the above obligations.

On October 31, 2006, the balance on the line of credit was $10,800,000 with an unused availability, based upon the asset based lending formula, of $2,671,000.

The Corporation paid interest costs totaling approximately $687,000 and $288,000 during the nine months ended October 31, 2006 and 2005, respectively.

NOTE 4 — NET EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share:


	For the Three Months
	Ended October 31,
	2006			2005
Numerator:
Net Income (loss)- Numerator for basic earnings per share—income available to common stockholders	$	(1,997,000	)	$	1,005,000

Effect of dilutive securities:
Preferred stock dividends and accretion of discount		—			242,000


Numerator for diluted earnings per share—income available to common stock after assumed conversions	$	(1,997,000	)	$	1,247,000


Denominator:

Denominator for basic earnings per share—weighted average shares		20,445,000			15,100,000

Effect of dilutive securities:
Convertible Preferred Stock and related accrued dividends		—			5,610,000
Warrants		—			2,117,000
Employee Stock Options		—			1,109,000

		—			8,836,000


Denominator for diluted earnings per share—adjusted weighted-average shares and assumed conversions		20,445,000			23,936,000


Basic earnings per share	$	(0.10	)	$	0.07

Diluted earnings per share	$	(0.10	)	$	0.05

At October 31, 2006 and 2005; 2,657,000 and 40,000 options, and 5,689,000 and 3,500,000 warrants, respectively, were not included in the calculation of dilutive earnings per share as their inclusion would have been antidilutive. The conversion of the Series C Redeemable Convertible Preferred Stock was not included in the calculation of dilutive earnings per share as of October 31, 2006 as their inclusion was antidilutive. The conversion of the Series C Redeemable Convertible Preferred Stock was included in the calculation of dilutive earnings per share as of October 31, 2005 as their inclusion was dilutive.


	For the Nine Months
	Ended October 31,
	2006			2005
Numerator:

Net Income (loss)- Numerator for basic earnings per share—income available to common stockholders	$	(5,390,000	)	$	1,705,000

Effect of dilutive securities:
Preferred stock dividends and accretion of discount		—			322,000


Numerator for diluted earnings per share—income available to common stock after assumed conversions	$	(5,390,000	)	$	2,027,000


Denominator:

Denominator for basic earnings per share—weighted average shares		19,543,000			13,911,000

Effect of dilutive securities:

Convertible Preferred Stock and related accrued dividends		—			3,814,000
Warrants		—			936,000
Employee Stock Options		—			984,000


		—			5,734,000


Denominator for diluted share—adjusted weighted-average shares and assumed conversions		19,543,000			19,645,000


Basic earnings per share	$	(0.28	)	$	0.12

Diluted earnings per share	$	(0.28	)	$	0.10

At October 31, 2006 and 2005; 2,657,000 and 290,000 options, and 5,689,000 and 2,000,000 warrants, respectively, were not included in the calculation of dilutive earnings per share as their inclusion would have been antidilutive. The conversion of the Series C Redeemable Convertible Preferred Stock was not included in the calculation of dilutive earnings per share as of October 31, 2006 as their inclusion was antidilutive. The conversion of the Series C Redeemable Convertible Preferred Stock was included in the calculation of dilutive earnings per share as of October 31, 2005 as their inclusion was dilutive.

NOTE 5 – STOCK OPTIONS

On February 1, 2006, the Corporation changed its accounting method for its stock-based compensation plans and adopted the recognition and measurement principles of FASB Statement No. 123R, “Accounting for Stock-Based Compensation”. In adopting FASB 123R, the Corporation utilized the modified prospective approach where by only the effect of granted but unvested options was recognized on a prospective basis. Prior to the current fiscal year, the Corporation accounted for its stock-based compensation plans under APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations. During the three and nine month periods ended October 31, 2006, the Company recognized $34,000 and $148,000 of stock-based employee compensation cost. During the prior three and nine month periods ended October 31, 2005 no compensation expense was recognized as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The effect on the current fiscal quarter and the pro forma disclosure of the effect on the prior fiscal quarter may not be representative of the effects on reported net income in future years.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation for the three and nine month periods ended October 31, 2005. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period.


	For Three Months			For the Nine Months
	Ended October 31,			Ended October 31,
	2005			2005
Net income, as reported	$	1,005,000		$	1,705,000
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects of a $43,000 and $322,000 benefit, respectively		(52,000	)		(389,000	)


Pro forma net income	$	953,000		$	1,316,000


Earnings per share:

Basic-as reported	$	0.07		$	0.12

Basic-pro forma	$	0.06		$	0.09

Diluted-as reported	$	0.05		$	0.10

Diluted-pro forma	$	0.05		$	0.08

At October 31, 2006, the Corporation had 498,450 stock options subject to time vesting. The average volatility of the expected market price of the Corporation’s common stock is 0.63, the weighted average dividend yield is 0%, the weighted average expected life of the options is 10 years and the weighted average forfeiture rate is 3%.

During the three months ended July 31, 2006, 40,000 stock options were issued to the non-employee directors of the Company upon their reelection to the Corporation’s Board of Directors.

During the three months ended April 30, 2005, 250,500 stock options were issued to employees of the Corporation for the achievement of performance measures and 250,000 stock options were issued to the employee director of the Company in conjunction with his execution of a new employment agreement. The weighted average fair value of the stock options granted during the three months ended April 30, 2005 was $1.20 per share.

During the three months ended October 31, 2005, 40,000 stock options were issued to the non-employee directors of the Company and 470,000 stock options were issued to former employees of Flagship when they became employees of the Company. The weighted average fair value of the stock option granted during the three months ended October 31, 2005 was $0.75 per share.

During the six months ended July 31, 2006 and 2005, 311,000 and 532,000 shares, respectively, of the Corporation’s common stock were issued due to the exercise of stock options.

NOTE 6 – PRIVATE PLACEMENT OF SECURITIES – JULY 2005

Common Private Placement

Securities Purchase Agreement

On July 1, 2005, the Company executed a securities purchase agreement (the “Common Purchase Agreement”) with various institutional and accredited investors (the “Common Investors”) pursuant to which it agreed to sell in a private placement transaction (the “Common Private Placement”) for an aggregate purchase price of $1,500,000 (a) 1,666,667 shares of the Company’s Common Stock, par value $0.02 per share (the “Common Shares”), (b) warrants to purchase 416,667 shares of the Company’s Common Stock at an exercise price of $1.11 per share (“First Common Offering Warrants”) and (c) warrants to purchase 416,667 shares of the Company’s Common Stock at an exercise price of $1.33 per share (“Second Common Offering Warrants” and, together with the First Common Offering Warrants, the “Common Offering Warrants”). The $0.90 purchase price per share for the Common Shares approximately represents 80% of the average of the daily volume weighted average price of the Common Stock for the 20 day period prior to the execution of the Common Purchase Agreement. The Company closed the Common Private Placement on July 6, 2005. On November 21, 2005 the Company’s registration statement covering the common stock, the common stock to be received upon the conversion of the preferred stock and the common stock to be received upon the exercise of the warrants for common stock was declared effective by the U.S. Securities and Exchange Commission.

Common Warrants

The First Common Offering Warrants issued to each Common Investor provide such Common Investor the right to purchase shares of the Company’s Common Stock, in aggregate, up to an additional 25% of the total number of Common Shares purchased by such Common Investor in the Common Private Placement at an exercise price of $1.11 per share. The First Common Offering Warrants contain a cashless exercise provision, whereby if at any time after one year from the date of issuance of this Warrant there is no effective Registration Statement registering, or no current prospectus available for, the resale of the Warrant Shares by the Warrant Holder, then the Warrant may also be exercised at such time by means of a “cashless exercise” in which the Warrant Holder shall be entitled to receive common shares for the number of Warrant Shares equal to the appreciation in the warrant above the exercise price at the time of the exercise. The First Common Offering Warrants expire five years from the date of issuance and contain adjustment provisions upon the occurrence of stock splits, stock dividends, combinations, reclassifications or similar events of the Company’s capital stock, issuances of the Company’s securities for consideration below the exercise price and pro rata distributions of cash, property, assets or securities to holders of the Company’s Common Stock. If the First Common Offering Warrants are exercised in full in cash, the Company would receive upon such exercise aggregate proceeds of $462,500.

The Second Common Offering Warrant issued to each Common Investors provides such Common Investor the right to purchase shares of the Company’s Common Stock, in aggregate, up to an additional 25% of the total number of Common Shares purchased by such Common Investor in the Common Private Placement at an exercise price of $1.33 per share. The Second Common Offering Warrants contain a cashless exercise provision, whereby if at any time after one year from the date of issuance of this Warrant there is no effective Registration Statement registering, or no current prospectus available for, the resale of the Warrant Shares by the Warrant Holder, then the Warrant may also be exercised at such time by means of a “cashless exercise” in which the Warrant Holder shall be entitled to receive common shares for the number of Warrant Shares equal to the appreciation in the warrant above the exercise price at the time of the exercise. The Second Common Offering Warrants expire five years from the date of issuance and contain adjustment provisions upon the occurrence of stock splits, stock dividends, combinations, reclassifications or similar events of the Company’s capital stock, issuances of Company’s securities for consideration below the exercise price and pro rata distributions of cash, property, assets or securities to holders of the Company’s common stock. If the Second Common Offering Warrants are exercised in full in cash, the Company would receive upon such exercise aggregate proceeds of $554,167.

The net proceeds to the Corporation from the offering, after costs associated with the Common Stock portion of the offering, of $1,349,000 have been allocated among common stock and warrants based upon their relative fair values. The Corporation used the Black-Scholes pricing model to determine the fair value of the warrants to be $360,000.

Preferred Private Placement

Securities Purchase Agreement

On July 1, 2005, the Company executed a securities purchase agreement (“Preferred Purchase Agreement”) with various institutional and accredited investors (the “Preferred Investors”) pursuant to which it agreed to sell in a private placement transaction (the “Preferred Private Placement”) for an aggregate purchase price of $5,500,000 (a) 5,500 shares of the Company’s Series C Convertible Preferred Stock, stated value $1,000 per share (the “Preferred Shares”), (b) warrants to purchase 1,375,000 shares of the Company’s Common Stock at an exercise price of $1.11 per share (“First Preferred Offering Warrants”), (c) warrants to purchase 1,375,000 shares of the Company’s Common Stock at an exercise price of $1.33 per share (“Second Preferred Offering Warrants” and, together with the First Preferred Offering Warrants,” the “Preferred Offering Warrants”) and (d) warrants (“Over-Allotment Warrants”) to purchase (1) up to 1,375 shares of Series C Preferred Stock (the “Additional Preferred Shares”), (2) warrants to purchase up to 343,750 shares of Common Stock at $1.11 per share (“First Additional Warrants”) and (3) warrants to purchase up to 343,750 shares of Common Stock at $1.33 per share (“Second Additional Warrants” and, together with the First Additional Warrants, the “Additional Warrants”). The Preferred Private Placement closed on July 6, 2005.

Preferred Warrants

The First Preferred Offering Warrants issued to each Preferred Investor provide such Preferred Investor the right to purchase shares of the Company’s Common Stock, in aggregate, up to an additional 25% of the total number of shares of Common Stock issuable upon the conversion of the Preferred Stock purchased by such Preferred Investor in the Preferred Private Placement at an exercise price of $1.11 per share. The First Preferred Offering Warrants contain a cashless exercise provision, whereby at any time the Warrant may also be exercised at such time by means of a “cashless exercise” in which the Warrant Holder shall be entitled to receive common shares for the number of Warrant Shares equal to the appreciation in the warrant above the exercise price at the time of the exercise. The First Preferred Offering Warrants expire five years from the date of issuance and contain adjustment provisions upon the occurrence of stock splits, stock dividends, combinations, reclassifications or similar events of the Company’s capital stock, issuances of Common Stock for consideration below the exercise price and pro rata distributions of cash, property, assets or securities to holders of the Company’s common stock. If the First Preferred Offering Warrants are exercised in full in cash, the Company would receive upon such exercise aggregate proceeds of $1,526,250.

The Second Preferred Offering Warrants issued to each Preferred Investor provide such Preferred Investor the right to purchase shares of the Company’s Common Stock, in aggregate, up to an additional 25% of the total number of shares of Common Stock issuable upon the conversion of the Preferred Stock purchased by such Preferred Investor in the Preferred Private Placement at an exercise price of $1.33 per share. The Second Preferred Offering Warrants contain a cashless exercise provision, whereby at any time the Warrant may also be exercised at such time by means of a “cashless exercise” in which the Warrant Holder shall be entitled to receive common shares for the number of Warrant Shares equal to the appreciation in the warrant above the exercise price at the time of the exercise. The Second Preferred Offering Warrants expire five years from the date of issuance and contain adjustment provisions upon the occurrence of stock splits, stock dividends, combinations, reclassifications or similar events of the Company’s capital stock, issuances of the Company’s securities for consideration below the exercise price as well as pro rata distributions of cash, property, assets or securities to holders of the Company’s common stock. If the Second Preferred Offering Warrants are exercised in full in cash, the Company would receive upon such exercise aggregate proceeds of $1,828,750.

The net proceeds to the Corporation from the offering, after costs associated with the Preferred Stock portion of the offering, of $4,877,000 have been allocated among common stock and warrants based upon their relative fair values. The Corporation used the Black-Scholes pricing model to determine the fair value of the warrants to be $1,204,000.

Terms of the Preferred Stock

The rights and preferences of the Preferred Shares are set forth in the Certificate of Designation, Preferences and Rights of Series C Preferred Stock (the “Certificate of Designation”). The Preferred Shares have a face value of $1,000 per share and are convertible at any time at the option of the holder into shares of Common Stock (“Conversion Shares”) at the initial conversion price of $1.00 per share (the “Conversion Price”), subject to certain adjustments including (a) stock splits, stock dividends, combinations, reclassifications, mergers, consolidations, sales or transfers of the assets of the Company, share exchanges or other similar events, (b) certain anti-dilution adjustments. For a complete description of the terms of the Preferred Shares please see the Certificate of Designation.

After valuing the warrants for the purchase of the Corporation’s common stock issued with the convertible Preferred Shares ($1,204,000), the beneficial conversion contained in the Preferred Shares ($1,645,000) and the costs associated with the Preferred Stock portion of the financing ($623,000) the convertible preferred stock was valued at $2,028,000. The difference between this initial value and the face value of the Preferred Stock of $3,429,000 will be accreted back to the Preferred Stock as preferred dividends utilizing an effective interest rate of 25.2%. The accretion period is the shorter of the four-year term of the preferred or until the conversion of the preferred stock. For the three and nine month periods ended October 31, 2006 the accretion of the aforementioned discount was $95,000 and $303,000, respectively. In accordance with FAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” the accretion of the discount on the preferred stock is classified as interest expense in the Statement of Consolidated Operations.

A cumulative premium (dividend) accrues and is payable with respect to each of the Preferred Shares equal to 8% of the stated value per annum. The premium is payable upon the earlier of: (a) the time of conversion in such number of shares of Common Stock determined by dividing the accrued premium by the Conversion Price or (b) the time of redemption in cash by wire transfer of immediately available funds. For the three and nine-month periods ended October 31, 2006 the accrued dividend was $76,000 and $268,000, respectively. At October 31, 2006 dividends of $386,000 are accrued. In accordance with FAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” the accretion of the preferred stock dividend is classified as interest expense in the Statement of Consolidated Operations.

Over-Allotment Warrants

The Over-Allotment Warrants issued to each Preferred Investor provides such Preferred Investor the right to purchase at an exercise price of $1,000 per share (a) Additional Preferred Shares, in aggregate, up to 25% of the total number of shares of Series C Preferred Stock purchased by such Preferred Investor in the Preferred Private Placement, (b) First Additional Warrants exercisable for a number of shares of Common Stock in an amount, in aggregate, up to 6.25% of the total number of shares of Common Stock issuable upon conversion of the Series C Preferred Stock purchased by such Preferred Investor in the Preferred Private Placement at an exercise price of $1.11 per share and (c) Second Additional Warrants exercisable for a number of shares of Common Stock in an amount, in aggregate, up to 6.25% of the total number of shares of the Common Stock issuable upon conversion of the Series C Preferred purchased by such Purchaser in the Preferred Private Placement at an exercise price of $1.33 per share. The Over-Allotment Warrants expire upon the later of (x) 90 days after the effectiveness of the Preferred Registration Statement (as defined below) and (y) the date upon which the Company obtains stockholder approval of the Certificate of Amendment.

From late October 2005 through mid December 2005, all holders of shares of our Series C Preferred exercised their over-allotment warrants resulting in the issuance of (i) 1,375 shares of Series C Preferred, (ii) warrants to purchase 343,750 shares of the Company’s Common Stock at an exercise price of $1.11 per shares and (iii) warrants to purchase 343,750 shares of the Company’s Common Stock at an exercise price of $1.33 per share. The warrants expire five years from the date of issuance. The exercise of the over-allotment warrants resulted in proceeds of $1,375,000 to the Company.

After valuing the warrants for the purchase of the Corporation’s common stock issued with the convertible Preferred Shares ($322,000), the beneficial conversion contained in the Preferred Shares ($432,000) and the costs associated with the exercise of the over-allotment ($69,000) the convertible preferred stock, issued in October 2005 from the exercise of the over-allotment option, will initially be valued at $552,000. The difference between this initial value and the face value of the Preferred Stock of $1,375,000 will be accreted back to the Preferred Stock as preferred dividends utilizing an effective interest rate of 25%. The accretion of the discount related to the over-allotment option was $24,000 and $85,000 for the three and nine months ended October 31, 2006.

Warrant Derivative Liability

Both the preferred and Common Stock portions of the July 2005 private placement included registration rights agreements that imposed liquidating damages in the form of a monetary remuneration should the holders be subject to blackout days (i.e. days when the holders of the Corporation’s Common Stock may not trade the stock) in excess of the number permitted in the registration rights agreements. On November 21, 2005 the Corporation’s Registration Statement on Form S-2 was declared effective by the Securities & Exchange Commission. Other than the aforementioned monetary penalty, there are no provisions requiring cash payments or settlements if registered shares cannot be provided upon conversion/exercise or the shareholders cannot sell their shares due to a blackout event. After assessing the provisions of the registration rights agreements and the related authoritive guidance a $20,000 warrant derivative liability was provided. No gain or loss on the derivative was recorded in the quarter ended July 31, 2006 and the liability was recorded in accrued liabilities.

Conversion of Preferred Stock to Common Stock

In fiscal 2006, four holders voluntarily converted 860 shares of Series C Preferred Stock and received 895,521 shares of Common Stock. The conversion resulted in 35,521 shares of Common Stock being issued relative to accrued dividends on the Series C Preferred Stock. The aforementioned conversion resulted in a charge against income in fiscal 2006 of approximately $502,000 for the related unamortized discount relative to the converted shares.

During the nine-months ended October 31, 2006, seven holders converted 2,202.5 shares of Series C Preferred Stock and received 2,325,631 shares of Common Stock. The conversion resulted in 123,131 shares of Common Stock being issued relative to accrued dividends on the Series C Preferred Stock. The aforementioned conversion resulted in a charge against income in the three and nine-month periods ending October 31, 2006 of approximately $0 and $1,214,000, respectively, for the related unamortized discount relative to the converted shares.

Exercise of Warrants for Common Stock

During the three-months ended April 30, 2006, two warrant holders of the $1.11 and $1.33 per share exercise price warrants exercised for 618,055 shares of the Company’s Common stock with proceeds of $692,000 to the Company.

In fiscal 2006, one warrant holder of $1.11 per share exercise price warrants exercised for 390,625 shares of the Company’s common stock with proceeds of $434,000 to the Company.

NOTE 7 – ACQUISITION

On August 25, 2005, the Company, pursuant to an Asset Purchase Agreement, (the “Agreement”), completed its acquisition of certain assets of Flagship Services, Group, Inc., Flagship Reconstruction Partners, Ltd., Flagship Reconstruction Associates – Commercial, Ltd., and Flagship Reconstruction Associates – Residential, Ltd. (“Flagship”), for $5,250,000 in cash paid at closing, a promissory note for $750,000 at an interest rate of 6% due one-year from the closing, 236,027 shares of the Company’s restricted common stock valued at $250,000 ($1.06 per share), a warrant to purchase up to 250,000 shares of the Company’s restricted common stock at an exercise price of $1.00 and a warrant to purchase up to 150,000 shares of the Company’s restricted common stock at an exercise price of $1.06. The warrants were valued at $186,000 in the aggregate. The warrants were exercised during fiscal 2006. The Agreement also includes contingent payment provisions over the first eighteen-month period commencing on the closing date, pursuant to which the Company is required to pay 35% of the net earnings of the former Flagship operation in excess of $500,000. At October 31, 2006, $1,053,000 had been earned and accrued relative to the earn-out agreement. The owner of Flagship entered into an eighteen-month employment and non-competition agreement with the Company. The acquisition of Flagship greatly enhances the Company’s disaster response and restoration capabilities. The operations of the former Flagship operation were included in the Company’s operations subsequent to August 19, 2005.

An independent valuation was performed in fiscal 2006. The valuation resulted in the allocation of the purchase price as follows:


	Allocated Value		Amortization Period
Fixed assets	$	50,000		3 to 7 years
Covenant-not-to-compete		78,000		4 ¹/2 years
Customer relationships		5,766,000		10 years
Subcontractor relationships		530,000		5 years
Goodwill		160,000		N/A

For the three and nine month periods ended October 31, 2006, amortization expense of the aforemented intangibles was $525,000 and $175,000, respectively.

The following unaudited pro forma condensed results of operations assume that the acquisition was consummated on February 1, 2005:


	Three months ended		Nine months ended
	October 31, 2005		October 31, 2005
Sales	$	30,033,000	$	73,770,000


Net Income	$	1,299,000	$	2,852,000


Net income per common shares:
Basic	$	0.09	$	0.19


Dilutive	$	0.06	$	0.15


Weighted average shares outstanding:
Basic		15,218,000		15,020,000


Dilutive		24,172,000		22,605,000

NOTE 8 – GOODWILL

At October 31, 2006 and January 31, 2006, the Corporation’s goodwill was $2,770,000 and $2,316,000, respectively. The increase in goodwill during the current fiscal period was due to contingent earnout obligation related to the acquisition of Flagship in fiscal 2006. During the quarter ended October 31, 2006, the Company determined that the goodwill related to its Northwestern operation was impaired due to the issues raised relative to the employee fraud discussed in Note 9, the Company’s intention to close the Seattle operation and the operating issues that the Company’s Northwest operations continue to experience. Therefore, a non-cash provision of $111,000 was made to reduce the goodwill related to that operation to zero.

SFAS No. 142 “Goodwill and Other Intangible Assets” prescribes a two-phase process for impairment testing of goodwill, which is performed annually, absent any indicators of impairment. The first phase screens for impairment, while the second phase (if necessary) measures impairment. The Corporation has elected to perform its annual analysis during the fourth quarter of each year based upon goodwill balances as of the end of the year. Although no indicators of impairment have been identified during fiscal 2005, there can be no assurance that future goodwill impairment tests will not result in a charge to earnings.

NOTE 9 – EMPLOYEE FRAUD

For the nine months ended October 31, 2006, the Company recorded a $0.75 million non-recurring charge relative to employee fraud at its Seattle office. This charge arises following an internal investigation commenced in October 2006 into operations at the Company’s Seattle office, which indicated fraudulent

activities undertaken by one or more former employees. The Company took immediate action including retaining legal counsel, fraud investigators, and forensic accountants to assist in determining the actual amount of the loss, appropriate legal action, and pursuit of insurance payments and other means of recovery for such losses. The Company was able to discover this incident through its internal control procedures, which alerted the Company to the issues, and the Company is confident that the fraudulent activities, while serious, are isolated.

As a result of the investigation, previously filed Quarterly Reports on Form 10-Q for the quarters ended April 30, 2006 and July 31, 2006 were amended and restated to correct an error caused by employee fraud, which increased the net loss by $421,000 for the six-months ended July 31, 2006. Additionally the previously filed Annual Report on Form 10-K for the year ended January 31, 2006 was restated and the previously report net income was reduced by $388,000. The Forms 10-K/A and 10-Q/A were filed as amendments on January 18, 2007.

The Company has filed a claim against the Company’s employee theft insurance policy. The Company expects to receive a $0.5 million insurance recovery and will record that benefit as a component of Other Income when the recovery is assured.

The Company has evaluated the impact of the employee fraud on its internal control over financial reporting and undertaken corrective measures (see “Item 4 – Controls and Procedures” below).

NOTE 10 – NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109, ” which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are effective as of the beginning of the Company’s 2008 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The adoption of FIN 48 is not expected to have a material effect on the Company’s results of operations, cash flows, or financial condition.

In September 2006, FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”), “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS No. 157 requires companies to disclose the fair value of its financial instruments according to a fair value hierarchy. Additionally, companies are required to provide certain disclosures regarding instruments within the hierarchy, including a reconciliation of the beginning and ending balances for each major category of assets and liabilities. SFAS 157 is effective for the Company’s fiscal year beginning February 1, 2008. The adoption of SFAS No. 157 is not expected to have a material effect on the Company’s results of operations, cash flows, or financial condition.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans- an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS No. 158”). SFAS No. 158 requires an employer that sponsors one or more single-employer defined benefit plans to recognize the over-funded or under-funded status of a benefit plan in its statement of financial position, recognize as a component of other comprehensive income, net of tax, gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit costs pursuant to SFAS No. 87, “Employers Accounting for Pensions,” or SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end, and disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition assets or obligations. The recognition and disclosure provisions required by SFAS No. 158 are effective for the Company’s fiscal year ending January 31, 2007. The measurement date provisions are effective for fiscal years ending after December 15, 2008. The adoption of SFAS No. 158 will not have a material effect on the Company’s results of operations, cash flows, or financial condition.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both the balance sheet and income statement approach when quantifying a misstatement. SAB 108 is effective for the Company’s fiscal year ending January 31, 2007. The adoption of SAB 108 did not have a material effect on the Company’s results of operations, cash flows, or financial condition.

NOTE 11 – SUBSEQUENT EVENT

In connection with the private placements in July 2005, the Company entered into registration rights agreements with the Common Stockholders and Preferred Stockholders. Under these registration rights agreements, the Company agreed to file a registration statement for the purpose of registering the resale of the common stock and the shares of common stock underlying the convertible securities we issued in the private placements. The registration rights agreements require the Company to keep the registration statement effective for a specified period of time. In the event that the registration statement is not filed or declared effective within the specified deadlines or is not effective for any period exceeding a permitted Black-Out Period (45 consecutive Trading Days but no more than an aggregate of 75 Trading Days during any 12-month period), then the Company will be obligated to pay the Preferred and Common Stockholders up to 12% of their purchase price per annum. On November 21, 2005 the Company Registration Statement was declared effective by the Securities & Exchange Commission. On May 10, 2006 the Post Effective Amendment #1 was declared effective by the Securities & Exchange Commission. As of January 18, 2007, the Company has utilized twenty-five of permitted aggregate Black-Out days and seventeen of the consecutive Black-Out days. Other than the aforementioned monetary penalty, there are no provisions requiring cash payments or settlements if registered shares cannot be provided upon conversion/exercise or the shareholders cannot sell their shares due to a blackout event.

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The statements contained in this Management’s Discussion and Analysis of the Consolidated Condensed Financial Statements and other sections of this Form 10-Q that are not purely historical are 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, including without limitation, statements regarding the Corporation’s or Corporation management’s expectations, hopes, beliefs, intentions or strategies regarding the future. These forward-looking statements are based on the Corporation’s current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” and similar expressions are intended to identify forward-looking statements. There can be no assurance that future developments and actual actions or results affecting the Corporation will be those that the Corporation has anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond the Corporation’s control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by such forward-looking statements. These risks and uncertainties include, but are not limited to, the continuing validity of the underlying assumptions and estimates of total forecasted project revenues, costs and profits and project schedules; the outcomes of pending or future litigation, arbitration or other dispute resolution proceedings; the availability of borrowed funds on terms acceptable to the Corporation; the ability to retain certain members of management; the ability to obtain surety bonds to secure the Corporation’s performance under certain construction contracts; possible labor disputes or work stoppages within the construction industry; changes in federal and state appropriations for infrastructure projects; possible changes or developments in worldwide or domestic political, social, economic, business, industry, market and regulatory conditions or circumstances; and actions taken or not taken by third parties including the Corporation’s customers, suppliers, business partners, and competitors and legislative, regulatory, judicial and other governmental authorities and officials; and other risks and uncertainties discussed under the heading “Risk Factors” in the Corporation’s Annual Report, as amended on Form 10-K/A for the year ended January 31, 2006 filed with the Securities and Exchange Commission. The Corporation undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.

OVERVIEW

We provide environmental and specialty contracting services including asbestos and lead abatement, insulation, microbial remediation, disaster response, loss mitigation and reconstruction, demolition and related services throughout the United States. During the current fiscal period, revenues from disaster response, loss mitigation and reconstruction were 47% of total revenues vs. 53% of revenues from abatement of asbestos. The Company has broadened its offering of services in recent years to include a number of complementary services which utilize its existing infrastructure and personnel. Cash flows from contracting services are primarily generated from periodic progress billings on large contracts under which the Corporation performs services and single project billings on small short duration projects.

The Corporation operates in a complex environment due to the nature of our customers and our projects. Due to the size and nature of many of our contracts, the estimation of overall risk, revenue and cost at completion is complicated and subject to many variables. Depending on the contract, this poses challenges to the Corporation’s executive management team in overseeing contract performance and in evaluating the timing of the recognition of revenues and project costs, both initially and when there is a change in project status. Thus, the Corporation’s executive management team spends considerable time in evaluating and structuring key contracts, in monitoring project performance, and in assessing the financial status of our major contracts. Due to the complexity in the revenue recognition for the Corporation’s projects, executive financial management is attentive to developments in individual contracts that may affect the timing and measurement of contract costs and related revenues.

The Corporation continues to manage its projects to minimize risk and the negative financial impact upon the Corporation. More information on risks and the Corporation’s efforts to manage risks is available in Item 1 under the caption “Risk Factors” in the Corporation’s Annual Report, as amended on Form 10-K/A for the year ended

January 31, 2006 and supplemented elsewhere in this report. Additionally, please refer to the Corporation’s Annual Report, as amended, on Form 10-K/A for the year ended January 31, 2006 for a discussion of the components of the significant categories in the Corporation’s consolidated Statement of Operations.

CRITICAL ACCOUNTING POLICIES

In general, there have been no significant changes in the Corporation’s critical accounting policies since January 31, 2006, except as noted in the following paragraph. For a detailed discussion of these policies, please see Item 7 of the Corporation’s Annual Report, as amended, on Form 10-K/A for the year ended January 31, 2006.

On February 1, 2006, the Corporation changed its accounting method for its stock-based compensation plans and adopted the recognition and measurement principles of FASB Statement No. 123R, “Accounting for Stock-Based Compensation”. In adopting FASB 123R, the Corporation utilized the modified prospective approach where by only the effect of granted but unvested options was recognized on a prospective basis. Prior to the current fiscal year, the Corporation accounted for its stock-based compensation plans under APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations. During the current fiscal three and nine months periods ended October 31, 2006, the Company recognized $34,000 and $148,000, respectively, of stock-based employee compensation cost. The effect on the current fiscal three and nine month periods may not be representative of the effects on reported net income in future quarters or years.

RESULTS OF OPERATIONS

Three Months Ended October 31, 2006

During the three months ended October 31, 2006 (“Fiscal 2007”), the Corporation’s contract revenues decreased by 24.5% to $19.8 million compared to $26.2 million in the three months ended October 31, 2005 (“Fiscal 2006”). The decrease was primarily due to the absence of significant hurricane response revenue in the current fiscal quarter as compared to the prior fiscal quarter.

The Corporation’s gross margin decreased to $2.01 million in the third quarter of fiscal 2007 as compared to $4.11 million in the third quarter of fiscal 2006. Gross margin as a percentage of revenue decreased to 10.2% for the current quarter from 15.7% for the prior year quarter. Field margins, which are defined as the difference between contract revenues and direct field costs increased to 25.2% for the current quarter from 24.8% due to an unusually low field margin for asbestos abatement jobs in the prior year fiscal quarter partially offset by the lack of higher margin hurricane response revenue in the current fiscal quarter. Additionally, the current fiscal quarter included a $0.47 million decrease in revenue and margin for a change in the estimated recovery from a contract claim in our Seattle office. In addition to direct field costs, contract costs include certain supervisory costs that are relatively fixed in nature. Other direct costs as a percentage of revenue increased to 15.1% for the current fiscal quarter from 9.1% for the prior fiscal quarter as a result of a lower revenue base and the other direct costs associated with the Tampa restoration operation started in February 2006.

Selling, general and administrative expenses increased to $2.95 million in the current fiscal quarter as compared to $2.44 million in the three months ended October 31, 2005. The increase is principally due to the inclusion of the operations of Flagship for an entire three-month period during the current fiscal quarter as opposed to two month during the prior fiscal quarter, the provision of $0.1 million to the bad debt expense, and initiation of stand-alone reconstruction operations out of our Tampa location in February 2006. As a percentage of contract revenues, selling, general and administrative expense increased by 5.62% to 14.92% vs. 9.30% for the prior year fiscal quarter as a result of the above and a lower revenue base.

The Corporation reported a loss from operations of $0.93 million for the three months ended October 31, 2006 compared to income from operations of $1.69 million for the three months ended October 31 2005, a decrease of $2.62 million as a direct result of the factors discussed above.

Interest expense increased to $0.25 million in the current quarter as compared to $0.11 million in the same quarter of a year ago as a result of an increase in the prime rate of interest to which a majority of the Corporation’s borrowings are tied, increased borrowings to fund operations and very low interest costs for July and August 2005 as the proceeds of the private placement had been utilized to reduce the borrowings on the line of credit prior to the purchase of the Flagship operation.

Non-cash interest expense for preferred dividends and accretion of the discount relates to the private placement in July 2005 of $5.5 million of redeemable convertible preferred stock and the subsequent issuance of $1.375 million of redeemable convertible preferred stock from the exercise of the over-allotment option. As the preferred shares are mandatorily redeemable, the actual dividend and the accretion of the discount associated with the preferred stock are required to be reflected as interest expense. The current fiscal period had a $195,000 expense, which included, the actual dividend of $76,000 and the accretion of the discount associated with the preferred stock of $119,000. The prior fiscal period had a $242,000 expense, which included the actual dividend of $110,000 and $132,000 for the accretion of the discount. There were no conversions in either the current and the prior fiscal period.

For the three months ended October 31, 2006, the Company recorded a $0.15 million non-recurring charge relative to employee fraud at its Seattle office. This charge arises following an internal investigation commenced in October 2006 into operations at the Company’s Seattle office, which indicated fraudulent activities undertaken by one or more former employees.

During the quarter ended October 31, 2006, the Company determined that the goodwill related to its Northwestern operation was impaired due to the issues raised relative to the aforementioned suspected employee fraud, the Company’s intention to close the Seattle operation and the operating issues that the Company’s Northwest operations continue to experience.. Therefore, a non-cash provision of $111,000 was made to reduce the goodwill related to that operation to zero.

During the quarter ended October 31, 2006, the Corporation recorded a $0.51 million current federal income provision, a $0.22 million state income tax provision and $0.36 million deferred tax benefit. At October 31, 2006 the Corporation provided a $1.0 million valuation reserve to reduce the deferred income tax assets generated by the net operating loss carryforwards for both federal and state purposes and the federal Research & Development Tax Credit to an appropriate level.

During the quarter ended October 31, 2005, the Corporation made a $0.21 million provision for federal income taxes and a $0.13 million provision for state income taxes.

Nine Months Ended October 31, 2006

During the nine months ended October 31, 2006 (“Fiscal 2007”), the Corporation’s contract revenues increased by 3.8% to $58.6 million compared to $56.5 million in the nine months ended October 31, 2005 (“Fiscal 2006”). The increase was due the acquired operations of the former Flagship operation, included subsequent to its acquisition in late August 2005, offset in part by a decline in asbestos revenues and the absence of significant hurricane response revenue in the current period.

The Corporation’s gross margin decreased to $6.5 million in the first nine-months of fiscal 2007 compared to $9.0 million in the first nine-months of fiscal 2006. Gross margin as a percentage of revenue decreased to 11.0% for the current period from 15.8% for the prior year period. Field margins, which are defined as the difference between contract revenues and direct field costs, increased to 26.5% in the current period vs. 26.4% in the prior fiscal period due to an increased percentage of higher margin non-asbestos revenue in the current period offset in part by a lack of higher margin hurricane response revenue. Additionally, the current fiscal quarter included a $0.47 million decrease in revenue and margin for a change in the estimated recovery from a contract claim. In addition to direct field costs, contract costs include certain supervisory costs that are relatively fixed in nature. Other direct costs increased to $9.1 million from $6.0 million reflecting the inclusion of nine months of the former Flagship operations in the current fiscal period vs. two months in the prior fiscal period, three new offices opened in the current year and the new Tampa restoration operation.

Selling, general and administrative expenses increased to $9.2 million in the current fiscal period as compared to $5.8 million in the prior fiscal period. The significant increase is principally due to the inclusion of the operations of Flagship, the provision of $0.14 million to bad debt expense, the addition of three new offices opened during the second half of fiscal 2006 and the initiation of stand-alone reconstruction operations out of our Tampa location. As a percentage of contract revenues, selling, general and administrative expense increased by 5.40% to 15.74% vs. 10.34% for the prior year fiscal period. The three new offices opened in the second half of fiscal 2006 and the stand alone Tampa restoration operation begun in February 2006 had relatively low revenues as operations were ramped up at those locations but their increasing costs contributed to the increase in the percentage of direct costs when compared to revenues.

The Corporation reported a loss from operations of $2.75 million for the current fiscal period end October 31, 2006 compared to income from operations of $3.07 million for the prior fiscal period, a decrease of $5.8 million as a direct result of the factors discussed above.

Interest expense increased to $0.72 million in the current period as compared to $0.32 million in the same fiscal period of a year ago as a result of an increase in the prime rate of interest to which a majority of the Corporation’s borrowings are tied, increased borrowings to support a significantly higher level of operations and very low interest costs for July 2005 as the proceeds of the private placement had been utilized to reduce the borrowings on the line of credit prior to the purchase of the Flagship operation.

Non-cash interest expense for preferred dividends and accretion of the discount relates to the private placement in July 2005 of $5.5 million of redeemable convertible preferred stock and the subsequent issuance of $1.375 million of redeemable convertible preferred stock from the exercise of the over-allotment option. As the preferred shares are mandatorily redeemable, the actual dividend and the accretion of the discount associated with the preferred stock are required to be reflected as interest expense. The current fiscal period had a $1,870,000 expense, which included, the actual dividend of $268,000 and the accretion of the discount associated with the preferred stock of $1,602,000. The accretion of the discount included a $1,214,000 charge due to the conversion of 2,203 shares of preferred stock into 2,203,000 shares of our common stock. The remaining unamortized discount is required to be expensed at the time of conversion. The prior fiscal period had a $322,000 expense, which included the actual dividend of $147,000 and $175,000 for the accretion of the discount. There were no conversions in the prior fiscal period.

During the nine-months ended October 31, 2006, the Company determined that the goodwill related to its Northwestern operation was impaired. Therefore, a non-cash provision of $111,000 was made to reduce the goodwill related to that operation to zero.

During the nine-month period, 2006, the Corporation had a $0.095 million provision for current federal income taxes and a $0.007 million provision for current state income.

At January 31, 2006 the Corporation assessed its recent operating history and concluded that recognition of the valuation allowance against deferred income tax assets was not required, therefore the entire valuation allowance was recognized as a deferred tax benefit at January 31, 2006. In making the evaluation at January 31, 2006, the Corporation concluded that it was more likely than not that the deferred income tax assets would be realized. The deferred benefit for federal income taxes reflects the effect of carrying back the current year’s loss to fiscal years ended January 31, 2005 and 2006 thereby generating a refund of federal income taxes previously paid and the realization of a portion of a portion of the net operating loss carryforwards for both federal and state purposes and the federal Research & Development Tax Credit. At October 31, 2006 the Corporation provided a $1.0 million valuation reserve to reduce the deferred income tax assets generated by the net operating loss carryforwards for both federal and state purposes and the federal Research & Development Tax Credit to an appropriate level.

For the nine months October 31, 2006, the Corporation had a deferred income tax benefit of $0.89 million as a result of carrying back of the current period’s loss to fiscal years ended January 31, 2005 and 2006 thereby generating a refund of federal and state income taxes previously paid.

During the nine-month period ended October 31, 2005, the Corporation made a $0.58 million provision for federal income taxes and a $0.23 million for state income taxes.

FINANCIAL CONDITION

Liquidity and Capital Resources

During the nine months ended October 31, 2006, the Corporation’s cash decreased by $0.095 million to $0.135 million.

The decrease in cash and short-term investments during the first nine months of fiscal 2007 is attributable to outflows from operations of $1.29 million and cash outflows of $0.81 million associated with investing activities. These cash outflows were partially offset by cash inflows of $2.0 million from financing activities.

Cash utilized by operating activities totaled $1.29 million in the nine months ended October 31, 2006. Cash outflows included, a $0.37 million increase in costs and estimated earnings in excess of billings on uncompleted contracts, the current period loss of $5.39 million, a $0.9 million deferred income tax benefit and a $0.46 million decrease in accrued liabilities related to the timing of payments. These cash outflows were partially offset by cash inflows including $1.87 million of preferred stock dividends and accretion of the discount on the related preferred stock which are non-cash in nature as the dividends on the preferred stock accumulate until conversion or maturity, $0.21 million of stock based compensation, a $0.14 million provision for uncollectible accounts, a $0.11 million non-cash impairment charge for goodwill, a $0.38 million decrease in accounts receivables, a $0.51 million decrease in prepaid income taxes, a $0.87 million decrease in other current assets, a $0.53 million increase in accounts payable, and $1.28 million of depreciation and amortization.

Investing activities cash outflows included $0.77 million for the purchase of property, plant and equipment and a $0.06 million increase in other assets.

Financing activities cash inflows consisted of $2.40 million net borrowing on the line of credit, $0.26 million of borrowing from new term loans and $0.86 million from the exercise of employee stock options and stock warrants. These cash inflows were partially offset by $1.52 million for the repayment of debt and insurance premium financing.

At October 31, 2006, the Corporation’s backlog totaled $40.3 million ($25.6 million on fixed fee contracts and $14.7 million on time and materials or unit price contracts).

At October 31, 2006, the Corporation had approximately $2.74 million of costs and estimated earnings in excess of billings on uncompleted contracts and approximately $0.50 million of accounts receivable that represented contract claims. The Corporation is pursuing claims of approximately $4.0 million relative to the aforementioned contracts.

During the nine months ended October 31, 2005, the Corporation’s cash decreased by $0.05 million to $0.28 million.

The decrease in cash and short-term investments during the first nine months of fiscal 2006 is attributable to cash outflows from operations of $2.02 million and cash outflows of $6.36 million associated with investing activities. These cash outflows were partially offset by $8.34 million of cash inflows associated with financing activities.

Cash utilized by operating activities totaled $2.02 million in the nine months ended October 31, 2005. Cash outflows included, a $6.61 million increase in accounts receivable caused by the significant increase in billings, a $3.10 million increase in costs and estimated earnings in excess of billings on uncompleted contracts, a $0.20 million increase in inventories, a $0.05 million increase in prepaid income taxes and a $0.31 million decrease in

current income tax liabilities. These cash outflows were partially offset by cash inflows including $1.71 million of net income in the current fiscal period, $0.32 million of preferred stock dividends and accretion of the discount on the related preferred stock which are non-cash in nature as the dividends on the preferred stock accumulate until conversion or maturity, a $0.63 million decrease in other current assets, a $3.12 million increase in accounts payable, a $1.84 million increase in accrued liabilities related to the timing of payments and $0.67 million of depreciation and amortization.

Investing activities cash outflows included $5.34 million for the acquisition of the Flagship operation in August 2005, $1.0 million for the purchase of property, plant and equipment, a $0.06 million increase in other assets and the $0.02 million of capital contributions in the IAQ joint venture prior to the sale of its interest by the Company. These cash outflows were partially offset by $0.06 million of proceeds from the sale of the Company’s equity investment in the IAQ joint venture.

Financing activities cash inflows consisted of $7.16 million from the private placement of the Company’s common and convertible preferred stock in July 2005 and the subsequent exercise of the over-allotment option provided to preferred shareholders (which was net of $0.72 million of costs associated with the private placement and the exercise of the over-allotment option), $2.05 million net borrowing on the line of credit, $0.32 million of proceeds from a $0.4 million equipment line provided by the Company’s bank and $0.27 million from the exercise of employee stock options. These cash inflows were partially offset by $1.17 million for the repayment of debt and insurance premium financing and $0.29 million of earnout payments related to the acquisition of businesses acquired in prior years.

The Corporation believes funds generated by operations, amounts available under existing credit facilities and external sources of liquidity, such as the issuance of debt and equity instruments, will be sufficient to finance capital expenditures, the settlement of earnout obligations, the settlement of commitments and contingencies and working capital needs for the foreseeable future. However, there can be no assurance that such funding will be available, as our ability to generate cash flows from operations and our ability to access funding under the revolving credit facilities may be impacted by a variety of business, economic, legislative, financial and other factors which may be outside the Corporation’s control. Additionally, while the Corporation currently has significant, uncommitted bonding facilities, primarily to support various commercial provisions in the Corporation’s contracts, a termination or reduction of these bonding facilities could result in the utilization of letters of credit in lieu of performance bonds, thereby reducing the Corporation’s available capacity under the revolving credit facilities. There can be no assurance that such facilities will be available at reasonable terms to service the Corporation’s ordinary course obligations.

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The only market risk, as defined, that the Company is exposed to is interest rate sensitivity. The interest rate on the equipment notes and revolving line of credit fluctuate based upon changes in the prime rate. Each 1% change in the prime rate will result in an $111,000 change in annual borrowing costs based upon the balance outstanding at October 31, 2006.

ITEM 4. CONTROLS AND PROCEDURES

During their review of our consolidated financial statements as of October 31, 2006 and for the three and nine month periods then ended, our external auditors notified our management and Audit Committee of the existence of a “material weakness” in our internal controls related to the monitoring of remote locations. The Company’s internal control system was designed such that general managers of remote locations had responsibility for authorizing and approving payroll charges for field employees, invoicing of customers, and collection of receivables for jobs originating in their office. This situation provided the opportunity for remote managers to defraud the company and substantially delay management from identifying the fraudulent time charges and invoices.

The Chief Executive Officer and the Chief Financial Officer of the Company (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation as of the end of the period covered by this report, that the Company’s disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 that the material weaknesses cited did compromise the financial reporting process resulting in the restatement of our consolidated financial statements as of January 31, 2006 and for the year then ended. As previously disclosed in our Current Report on Form 8-K dated December 20, 2006 and filed on December 20, 2006, the Company stated that it would need to restate historical financial statements for the fiscal year ended January 31, 2006 and for the quarters ended April 30, 2006 and July 31, 2006 to correct for the impact of the employee fraud at our Seattle office.

Our management has discussed this material weakness with the Audit Committee. Our management is taking actions to remediate the control deficiencies. Specifically, we are requiring that all customer billings be sent to the customer from the corporate office. Additionally, we have enhanced the monitoring and communication process with each remote location to better monitor branch operations and we are investigating improvements to the payroll process relative to the tracking of time worked by our hourly employees. This evaluation of alternative enhancements should be completed in the fourth fiscal quarter of 2007 with implementation projected for the first fiscal quarter of fiscal 2008.

As a consequence of the monitoring of remote locations material weakness noted above, we are applying other procedures designed to improve the reliability of our financial reporting. While our efforts to remediate this material weakness are ongoing, management believes that the financial statements included in this report are fairly stated in all material respects. We will continue to monitor the effectiveness of our internal control over financial reporting, particularly as it relates to the monitoring of remote locations, and will take further actions as deemed appropriate.

There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the fiscal quarter ended October 31, 2006 that have materially affected or are reasonably likely to materially affect these controls except as noted in the previous paragraph..

PART II— OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is subject to dispute and litigation in the ordinary course of business. None of these matters, in the opinion of management, is likely to result in a material effect on the Registrant based upon information available at this time.

ITEM 1A. RISK FACTORS

There were no material changes from the Corporation’s risk factors disclosed in Item 1A of the Corporation’s Annual Report, as amended, on Form 10-K/A for the fiscal year ended January 31, 2006

ITEM 6. EXHIBITS

(a) The following exhibits are being filed with this report:


Exhibits
Number	Description
		EXHIBIT INDEX	Pages of Sequential
		Exhibit No. and Description	Numbering System
Exhibit 31.1	Certification Pursuant to Rule 13a-14(a) of the Securities Act of 1934, as amended, and Section 302 Of The Sarbanes-Oxley Act of 2002

Exhibit 31.2	Certification Pursuant to Rule 13a-14(a) of the Securities Act of 1934, as amended, and Section 302 Of The Sarbanes-Oxley Act of 2002

Exhibit 32.1	Certification Pursuant To 18 U.S.C. Section 1350, As Amended Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002

Exhibit 32.2	Certification Pursuant To 18 U.S.C. Section 1350, As Amended Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002


	Page
Part I. Financial Information

Item 1. Consolidated Financial Statements and Notes to Consolidated Financial Statements

(a) Condensed Consolidated Balance Sheets as of October 31, 2006 (unaudited) and January 31, 2006		3

(b) Consolidated Statements of Operations for the Three Months Ended October 31, 2006 and 2005 (unaudited)		4

(c) Consolidated Statements of Operations for the Nine Months Ended October 31, 2006 and 2005 (unaudited)		5

(d) Consolidated Statements of Cash Flows for the Nine Months Ended October 31, 2006 and 2005 (unaudited)		6

(e) Notes to Consolidated Financial Statements (unaudited)		7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18

Item 3. Quantitative and Qualitative Disclosures About Market Risk		23

Item 4. Controls and Procedures		24

Part II. Other Information

Item 1. Legal Proceedings		25

Item 1A. Risk Factors		25

Item 6. Exhibits		25

Signature and Certification		26
EX-31.1
EX-31.2
EX-32.1
EX-32.2


		PDG ENVIRONMENTAL, INC.

		By		/s/John C. Regan

		John C. Regan
		Chairman and Chief Executive Officer

		By		/s/Todd B. Fortier

		Todd B. Fortier
		Chief Financial Officer

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