10-Q 1 j1104301e10vq.txt PDG ENVIRONMENTAL, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2004 OR [ ] 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 (I.R.S. Employer or organization) Identification No.) 1386 BEULAH ROAD, BUILDING 801 PITTSBURGH, PENNSYLVANIA 15235 (Address of principal executive offices) (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 [X] No [ ] Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] As of December 7, 2004, there were 10,996,330 shares of the registrant's common stock outstanding. PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES INDEX

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, 2004 (unaudited) and January 31, 2004 3 (b) Consolidated Statements of Operations for the Three Months Ended October 31, 2004 and 2003 (unaudited) 4 (c) Consolidated Statements of Operations for the Nine Months Ended October 31, 2004 and 2003 (unaudited) 5 (d) Consolidated Statements of Cash Flows for the Nine Months Ended October 31, 2004 and 2003 (unaudited) 6 (e) Notes to Consolidated Financial Statements (unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk 15 Item 4. Controls and Procedures 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 6. Exhibits and Reports on Form 8-K 17 Signature and Certification 18

2 PART I. FINANCIAL INFORMATION PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS

OCTOBER 31, JANUARY 31, 2004 2004 ---- ---- (UNAUDITED) ASSETS CURRENT ASSETS Cash and Cash equivalents $ 24,000 $ 36,000 Accounts receivable - net 17,601,000 11,050,000 Costs and estimated earnings in excess of billings on uncompleted contracts 5,418,000 3,327,000 Inventory 766,000 512,000 Other current assets 505,000 247,000 --------------- ------------- TOTAL CURRENT ASSETS 24,314,000 15,172,000 PROPERTY, PLANT AND EQUIPMENT 8,425,000 7,804,000 Less: accumulated depreciation (7,094,000) (6,881,000) --------------- ------------- 1,331,000 923,000 GOODWILL 1,273,000 714,000 OTHER ASSETS 296,000 345,000 --------------- ------------- TOTAL ASSETS $ 27,214,000 $ 17,154,000 =============== ============= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 6,656,000 $ 3,760,000 Billings in excess of costs and estimated earnings on uncompleted contracts 3,654,000 1,449,000 Current portion of long-term debt 246,000 401,000 Accrued liabilities 3,173,000 1,309,000 --------------- ------------- TOTAL CURRENT LIABILITIES 13,729,000 6,919,000 LONG-TERM DEBT 6,439,000 5,306,000 ---------------- ------------- TOTAL LIABILITIES 20,168,000 12,225,000 LOSSES IN EQUITY INVESTMENT 29,000 20,000 STOCKHOLDERS' EQUITY Cumulative convertible 2% preferred stock - 14,000 Common stock 220,000 189,000 Additional paid-in capital 8,719,000 8,111,000 Deferred compensation - (6,000) (Deficit) retained earnings (1,884,000) (3,361,000) Less treasury stock (38,000) (38,000) --------------- ------------- TOTAL STOCKHOLDERS' EQUITY 7,017,000 4,909,000 --------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 27,214,000 $ 17,154,000 =============== =============

See accompanying notes to consolidated financial statements. 3 PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED OPERATIONS (UNAUDITED)

FOR THE THREE MONTHS ENDED OCTOBER 31, ----------------------------------- 2004 2003 ---- ---- CONTRACT REVENUE $ 18,903,000 $ 9,332,000 CONTRACT COSTS 16,024,000 7,592,000 ------------- ------------- Gross margin 2,879,000 1,740,000 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 1,676,000 1,533,000 ------------- ------------- Income from operations 1,203,000 207,000 OTHER INCOME (EXPENSE): Interest expense (104,000) (84,000) Equity in losses of equity investment (8,000) (11,000) Interest and other income 3,000 8,000 ------------- ------------- (109,000) (87,000) ------------- ------------- Income before income taxes 1,094,000 120,000 INCOME TAX PROVISION (88,000) (14,000) ------------- ------------- NET INCOME $ 1,006,000 $ 106,000 ============= ============= PER SHARE OF COMMON STOCK: BASIC $ 0.09 $ 0.01 ============= ============= DILUTIVE $ 0.09 $ 0.01 ============= ============= AVERAGE COMMON SHARE EQUIVALENTS OUTSTANDING 10,936,000 9,372,000 AVERAGE DILUTIVE COMMON SHARE EQUIVALENTS OUTSTANDING 834,000 255,000 ------------- ------------- AVERAGE COMMON SHARES AND DILUTIVE COMMON EQUIVALENTS OUTSTANDING FOR EARNINGS PER SHARE CALCULATION 11,770,000 9,627,000 ============= =============

See accompanying notes to consolidated financial statements. 4 PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED OPERATIONS (UNAUDITED)

FOR THE NINE MONTHS ENDED OCTOBER 31, ----------------------------------- 2004 2003 ---- ---- CONTRACT REVENUE $ 44,874,000 $ 26,973,000 CONTRACT COSTS 38,371,000 22,008,000 ------------- ------------- Gross margin 6,503,000 4,965,000 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 4,692,000 4,183,000 ------------- ------------- Income from operations 1,811,000 782,000 OTHER INCOME (EXPENSE): Interest expense (286,000) (271,000) Gain on sale of fixed assets 110,000 - Equity in losses of equity investment (24,000) (13,000) Interest and other income 9,000 43,000 ------------- ------------- (191,000) (241,000) ------------- ------------- Income before income taxes 1,620,000 541,000 INCOME TAX PROVISION (130,000) (62,000) ------------- ------------- NET INCOME $ 1,490,000 $ 479,000 ============= ============= PER SHARE OF COMMON STOCK: BASIC $ 0.14 $ 0.05 ============= ============= DILUTIVE $ 0.13 $ 0.05 ============= ============= AVERAGE COMMON SHARE EQUIVALENTS OUTSTANDING 10,710,000 9,372,000 AVERAGE DILUTIVE COMMON SHARE EQUIVALENTS OUTSTANDING 1,123,000 114,000 ------------- ------------- AVERAGE COMMON SHARES AND DILUTIVE COMMON EQUIVALENTS OUTSTANDING FOR EARNINGS PER SHARE CALCULATION 11,833,000 9,486,000 ============= =============

See accompanying notes to consolidated financial statements. 5 PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)

FOR THE NINE MONTHS ENDED OCTOBER 31, --------------------------------- 2004 2003 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,490,000 $ 479,000 ADJUSTMENTS TO RECONCILE NET INCOME TO CASH: Depreciation and amortization 507,000 667,000 Provision for allowance for doubtful accounts 150,000 - Gain on sale of fixed assets (110,000) - Stock based compensation 6,000 15,000 Equity in losses of equity investment 24,000 13,000 CHANGES IN ASSETS AND LIABILITIES OTHER THAN CASH: Accounts receivable (6,701,000) 29,000 Costs and estimated earnings in excess of billings on uncompleted contracts (2,091,000) (98,000) Inventory (224,000) (58,000) Other current assets (150,000) 84,000 Accounts payable 2,896,000 (547,000) Billings in excess of costs and estimated earnings on uncompleted contracts 2,205,000 157,000 Accrued liabilities 1,366,000 (273,000) ------------ -------------- (2,699,000) (706,000) ------------ -------------- NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (632,000) 468,000 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (740,000) (291,000) Proceeds from sale of fixed assets 131,000 - Additional investment in joint venture (15,000) - Acquisition of businesses (190,000) (234,000) Other assets (26,000) (6,000) ------------ -------------- NET CASH USED BY INVESTING ACTIVITIES (840,000) (531,000) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from private placement of common stock 448,000 - Proceeds from debt 1,400,000 400,000 Proceeds from exercise of stock options 117,000 - Redemption of preferred stock (13,000) - Principal payments on debt (492,000) (327,000) ------------ -------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 1,460,000 73,000 ------------ -------------- Change in Cash and Cash Equivalents (12,000) 10,000 Cash and Cash Equivalents, Beginning of Period 36,000 9,000 ------------ -------------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 24,000 $ 19,000 ============ ==============

See accompanying notes to consolidated financial statements. 6 PDG ENVIRONMENTAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED OCTOBER 31, 2004 (UNAUDITED) NOTE 1 -- BASIS OF PRESENTATION The consolidated financial statements include PDG Environmental, Inc. (the "Corporation") and its wholly-owned subsidiaries. In the quarter ending April 30, 2002, the Corporation formed IAQ Training Institute ("IAQ venture") a 50/50 joint venture to provide training in mold awareness and remediation. The IAQ venture is accounted for by the equity method of accounting whereby the Corporation records its proportionate shares of the IAQ venture's income or loss as a component of Other Income/(Expense). The condensed consolidated financial statements as of and for the three and nine month periods ended October 31, 2004 and 2003 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 on Form 10-K for the year ended January 31, 2004. 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. Certain prior year amounts have been reclassified to conform to the current year presentation. NOTE 2 - FEDERAL INCOME TAXES No federal income tax has been provided for the nine months ended October 31, 2004 due to the existence of unused net operating loss carryforwards. A state income tax provision was made in the current and prior year periods due to income in the current and prior year. Income taxes paid by the Corporation for the nine months ended October 31, 2004 and 2003 totaled approximately $52,000 and $27,000, respectively. NOTE 3 - TERM DEBT On August 3, 2000, the Corporation closed on a $4.7 million credit facility with Sky Bank, an Ohio banking association, consisting of a 3-year $3 million revolving line of credit, a 5-year $1 million equipment note, a 15-year $0.4 million mortgage and a 5-year $0.3 million commitment for future equipment financing. The new financing repaid all of the Company's existing debt. The line of credit, equipment note and commitment for future equipment financing are at an interest rate of prime plus 1% with financial covenant incentives which may reduce the interest rate to either prime plus 1/2% or prime. The mortgage 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. The Chief Executive Officer of the Corporation provided a limited personal guarantee for the credit facility. In November 2000, Sky Bank approved a $1.5 million increase in the line of credit to $4.5 million to fund the acquisition of Tri-State Restorations, Inc. ("Tri-State"), an asbestos abatement and demolition company in California. Additionally, Sky Bank increased the commitment for future equipment financing by $0.3 million to $0.6 million. In April 2001 and June 2001, the Company borrowed $273,000 and $283,000, respectively, against the commitment for future equipment financing to fund the fixed asset portion of the Tri-State acquisition and to fund other equipment purchases. In August 2001, the remaining $44,000 was borrowed against the commitment for future equipment financing to fund equipment purchases. The acquisition of Tri-State closed on June 1, 2001. On February 28, 2003 Sky Bank increased the line of credit by $600,000 to $5.1 million for a four-month period. 7 The availability on the line of credit was reduced to $4.5 million on July 1, 2003. In July 2003 Sky Bank approved a permanent $500,000 increase in the Company's line of credit to $5 million and in January 2004 Sky Bank approved a permanent $500,000 increase in the Company's line of credit to $5.5 million and in July 2004 Sky Bank approved a permanent $1,000,000 increase in the Company's line of credit to $6.5 million In April 2004 Sky Bank extended the maturity date on the line of credit until June 6, 2006. In October 2004 Sky Bank approved a temporary $1,000,000 increase in the Company's line of credit to $7.5 million until June 30, 2005. The increase in the line of credit was required to fund the increase in revenues generated by the hurricane recovery work beginning in the third quarter of fiscal 2005. On October 31, 2004, the balance on the line of credit was $6,100,000 with an unused availability of $1,400,000. The Corporation paid interest costs totaling approximately $306,000 and $277,000 during the nine months ended October 31, 2004 and 2003, respectively. NOTE 4 - PREFERRED STOCK In March 2004 in conjunction with the private placement of the Company's common stock, as discussed in Note 7, the remaining 6,000 shares of preferred stock were converted into 24,000 shares Common Stock with the accrued but unpaid dividends paid in cash. NOTE 5 - 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, 2004 2003 ---- ---- NUMERATOR: Net Income $ 1,006,000 $ 106,000 Preferred stock dividends - - ------------- ------------- Numerator for basic earnings per share--income available to common stockholders 1,006,000 106,000 Effect of dilutive securities: Preferred stock dividends - - ------------- ------------- Numerator for diluted earnings per share--income available to common stock after assumed conversions $ 1,006,000 $ 106,000 ============= ============= DENOMINATOR: Denominator for basic earnings per share--weighted average shares 10,936,000 9,372,000 Effect of dilutive securities: Convertible Preferred Stock - 29,000 Warrants - - Employee Stock Options 834,000 226,000 ------------- -------------

8 834,000 255,000 ------------- ------------- Denominator for diluted earnings per share--adjusted weighted-average shares and assumed conversions 11,770,000 9,627,000 ============= ============= BASIC EARNINGS PER SHARE $ 0.09 $ 0.01 ============= ============= DILUTED EARNINGS PER SHARE $ 0.09 $ 0.01 ============= ============= At October 31, 2004 and 2003; 415,000 and 1,159,000 options, and 3,500,000 and 250,000 warrants, respectively, were not included in the calculation of dilutive earnings per share as their inclusion would have been antidilutive.

FOR THE NINE MONTHS ENDED OCTOBER 31, 2004 2003 ---- ---- NUMERATOR: Net Income $ 1,490,000 $ 479,000 Preferred stock dividends - (1,000) ------------- ------------- Numerator for basic earnings per share--income available to common stockholders 1,490,000 478,000 Effect of dilutive securities: Preferred stock dividends - 1,000 ------------- ------------- Numerator for diluted earnings per share--income available to common stock after assumed conversions $ 1,490,000 $ 479,000 ============= ============= DENOMINATOR: Denominator for basic earnings per share--weighted average shares 10,710,000 9,372,000 Effect of dilutive securities: Convertible Preferred Stock - 29,000 Warrants 94,000 - Employee Stock Options 1,029,000 85,000 ------------- ------------- 1,123,000 114,000 ------------- ------------- Denominator for diluted earnings per share--adjusted weighted-average shares and assumed conversions 11,833,000 9,486,000 ============= ============= BASIC EARNINGS PER SHARE $ 0.14 $ 0.05 ============= ============= DILUTED EARNINGS PER SHARE $ 0.13 $ 0.05 ============= =============

At October 31, 2004 and 2003; 210,000 and 1,910,000 options, and 2,000,000 and 250,000 warrants, respectively, were not included in the calculation of dilutive earnings per share as their inclusion would have been antidilutive. NOTE 6 - STOCK OPTIONS The Company accounts for its stock-based compensation plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations. No stock-based employee compensation cost is reflected in net income, 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 following table illustrates 9 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 purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.

FOR THE THREE MONTHS ENDED OCTOBER 31, 2004 2003 ---- ---- Net income, as reported $ 1,006,000 $ 106,000 Deduct: Total stock-based employee compensation expense determined under fair value method for all awards net of related tax effects (32,000) (13,000) ------------- ------------- Pro forma net income $ 974,000 $ 93,000 ============= ============= Earnings per share: Basic-as reported $ 0.09 $ 0.01 ============= ============= Basic-pro forma $ 0.09 $ 0.01 ============= ============= Diluted-as reported $ 0.09 $ 0.01 ============= ============= Diluted-pro forma $ 0.08 $ 0.01 ============= =============

FOR THE NINE MONTHS ENDED OCTOBER 31, 2004 2003 ---- ---- Net income, as reported $ 1,490,000 $ 479,000 Deduct: Total stock-based employee compensation expense determined under fair value method for all awards net of related tax effects (32,000) (41,000) ------------------ ------------------ Pro forma net income $ 1,458,000 $ 438,000 ================== ================== Earnings per share: Basic-as reported $ 0.14 $ 0.05 ================== ================== Basic-pro forma $ 0.14 $ 0.05 ================== ================== Diluted-as reported $ 0.13 $ 0.05 ================== ================== Diluted-pro forma $ 0.12 $ 0.05 ================== ==================

During fiscal year 2005, 40,000 stock options were issued to the non-employee directors of the Company. NOTE 7 - PRIVATE PLACEMENT OF SECURITIES On March 4, 2004 the Corporation closed on a private placement transaction pursuant to which it sold 1,250,000 shares of Common Stock, (the "Shares"), to Barron Partners, LP (the "Investor") for an aggregate purchase price of $500,000. In addition, the Corporation issued two warrants to the Investor exercisable for shares of its Common Stock (the "Warrants"). The Shares and the Warrants were issued in a private placement transaction pursuant to Section 4(2) and Regulation D under the Securities Act of 1933, as amended. Offset against the proceeds is $52,000 of costs incurred in conjunction with the private placement transaction, primarily related to the cost of the registration of the common stock and common stock underlying the warrants, as discussed in the fourth paragraph of this note. The First Warrant provides the Investor the right to purchase up to 1,500,000 shares of the Corporation's Common Stock. The First Warrant has an exercise price of $0.80 per share resulting in proceeds of $1,200,000 to the Company upon its full exercise and expires five years from the date of issuance. The Corporation may 10 require the Investor to exercise the First Warrant in full at any time until December 4, 2005, if the average price of the Corporation's Common Stock exceeds $1.20 for ten consecutive trading days and the Corporation has a Registration Statement effective during the same ten consecutive trading days. The warrant holder may exercise through a cashless net exercise procedure after March 4, 2005 if the shares underlying the warrant are either not subject to an effective registration statement or, if subject to a registration statement, during a suspension of the registration statement. The Second Warrant provides the Investor the right to purchase up to 2,000,000 shares of the Corporation's Common Stock. The Second Warrant has an exercise price of $1.60 per share resulting in proceeds of $3,200,000 to the Corporation upon its full exercise and expires five years from the date of issuance. The Corporation may require the Investor to exercise the Second Warrant in full at any time until December 4, 2005 if the average price of the Corporation's Common Stock exceeds $2.40 for ten consecutive trading days and the Corporation has a Registration Statement effective during the same ten consecutive trading days. The warrant holder may exercise through a cashless net exercise procedure after March 4, 2005 if the shares underlying the warrant are either not subject to an effective registration statement or, if subject to a registration statement, during a suspension of the registration statement. In connection with these transactions, the Corporation and the Investor entered into a Registration Rights Agreement. Under this agreement, the Corporation was required to file within ninety (90) days of closing a registration statement with the U.S. Securities and Exchange Commission for the purpose of registering the resale of the Shares and the shares of Common Stock underlying the Warrants. The Company's registration statement was declared effective by the U.S. Securities and Exchange Commission on June 30, 2004. The Corporation utilized the proceeds from the sale of its Common Stock for general business purposes and to partially fund its acquisition strategy. NOTE 8 - GOODWILL At October 31, 2004 and January 31, 2004, the Corporation's goodwill was $1,273,000 and $714,000, respectively. The increase in goodwill during the current fiscal year was primarily attributable to a contingent earnout obligation related to an acquisition completed in fiscal 2002. 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 third quarter. 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 - COMMITMENTS AND CONTINGENCIES The Corporation is party to litigation matters and claims that are in the ordinary course of its operations, and while the results of such litigation and claims cannot be predicted with certainty, management believes that the final outcome of such matters will not have a material adverse effect on the Corporation's consolidated financial statements. In June 2001, the Corporation acquired the net assets of Tri-State Restorations, Inc. The terms of the acquisition provide for an "Earnout Payment" payable in cash based upon a calculation of net profits earned through May 2005. As of October 31, 2004, $623,000 had been earned and accrued, of which $50,000 had been paid under the agreement. 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The previous discussion and other sections of this Form 10-Q contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on 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. These statements are not guarantees of future performance and actual actions or results may differ materially from those stated herein. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict. The Corporation undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed by the Corporation from time to time with the Securities and Exchange Commission. OVERVIEW 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 impact of many of our contracts. Due to the complexity in the revenue recognition for the Corporation's projects, executive financial management is particularly 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 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 on Form 10-K for the year ended January 31, 2004, as amended, and supplemented elsewhere in this report. The Corporation provides environmental and specialty contracting services including asbestos and lead abatement, insulation, microbial remediation, demolition and related services throughout the United States. During the past fiscal year, the Corporation derived the majority of its revenues from the abatement of asbestos but have broadened its offering of services 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. CRITICAL ACCOUNTING POLICIES In general, there have been no significant changes in the Corporation's critical accounting policies since January 31, 2004. For a detailed discussion of these policies, please see Item 7 of the Corporation's Annual Report on Form 10-K for the year ended January 31, 2004. FORWARD LOOKING STATEMENTS 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 and beliefs concerning future developments and their potential effects on the Corporation. There can be no assurance that future developments affecting the 12 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 on Form 10-K for the year ended January 31, 2004 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. RESULTS OF OPERATIONS THREE MONTHS ENDED OCTOBER 31, 2004 AND 2003 During the three months ended October 31, 2004 ("Fiscal 2005"), the Corporation's contract revenues increased by 103% to $18.9 million compared to $9.3 million in the three months ended October 31, 2003 ("Fiscal 2004"). The increase was due a significant increase in contract activity at our Pittsburgh, Tampa and Ft. Lauderdale offices and in part due to the demand for services as a result of the four hurricanes which hit the southeastern United States in August and September of 2004. The Corporation's gross margin increased to $2.88 million in the third quarter of fiscal 2005 compared to $1.74 million in the third quarter of fiscal 2004. The increase in gross margin is due to a higher volume of work offset in part by negative contract adjustments of $0.6 million, due to cost overruns and unexpected conditions, primarily at our New York, Pittsburgh and Seattle offices. Selling, general and administrative expenses increased to $1.68 million in the current fiscal quarter as compared to $1.53 million in the three months October 31, 2003. This increase was due in part to the significantly higher level of operating activity and the addition of the Kleen-All and PT&L operations acquired in the first quarter of the current fiscal year. The Corporation reported income from operations of $1.2 million for the three months ended October 31, 2004 compared to income from operations of $0.21 million for the three months ended October 31, 2003 as a direct result of the factors discussed above. Interest expense increased to $0.10 million in the current quarter as compared to $0.08 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 Corporations borrowings are tied, and increase in borrowings throughout the quarter on the line of credit to finance the significantly higher level of operations. During the quarters ended October 31, 2004 and 2003, the Corporation made no provision for federal income taxes due to the utilization of net operating loss carryforwards for financial reporting purposes. State income tax provisions of $0.09 million and $0.01 million were made in the current and prior years fiscal quarter, respectively. NINE MONTHS ENDED OCTOBER 31, 2004 AND 2003 During the nine months ended October 31, 2004, the Corporation's contract revenues increased by 66% to $44.9 million compared to $27.0 million in the nine months ended October 31, 2003. The increase was due a significant increase in contract activity at our Los Angeles, Pittsburgh, Tampa and Ft. Lauderdale offices and in part to increased revenues from mold remediation. The increase at the Tampa and Ft. Lauderdale offices and in part at 13 the Pittsburgh office was partially due to the tremendous demand for services as a result of the four hurricanes which hit the southeastern United States in August and September of 2004. The Corporation's gross margin increased to $6.5 million in the first nine months of fiscal 2005 compared to $5.0 million in the first nine months of fiscal 2004. The increase in gross margin is due to a higher volume of work offset in part by negative contract adjustments of $1.1 million, due to cost overruns and unexpected conditions, primarily at our New York, Pittsburgh, Seattle and Los Angeles offices. Selling, general and administrative expenses increased to $4.69 million in the current nine-month period as compared to $4.18 million in the nine months ended October 31, 2003. This increase was due in part to the significantly higher level of operating activity and the addition of the Kleen-All and PT&L operations acquired in the first quarter of the current fiscal year. The Corporation reported income from operations of $1.8 million for the nine months ended October 31, 2004 compared to income from operations of $0.78 million for the nine months ended October 31, 2003 as a direct result of the factors discussed above. Interest expense increased to $0.29 million in the nine-month period as compared to $0.27 million in the same nine-month period of a year ago due to an increase in the prime rate of interest, to which a majority of the Corporations borrowings are tied, and increased borrowings throughout the current nine-month period on the line of credit to finance the significantly higher level of operations. The current fiscal period other income included a $0.11 million gain from the sale of fixed assets as the Company sold equipment that was currently not being utilized. During the nine-months ended October 31, 2004 and 2003, the Corporation made no provision for federal income taxes due to the utilization of net operating loss carryforwards for financial reporting purposes. State income tax provisions of $0.13 million and $0.06 million were made in the current and prior year fiscal periods, respectively. FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES During the nine months ended October 31, 2004, the Corporation's cash decreased by $0.01 million to $0.02 million. The decrease in cash and short-term investments during the first nine months of fiscal 2005 is attributable to cash outflows from operations of $0.63 million and cash outflows of $0.84 million associated with investing activities. These cash outflows were partially offset by $1.46 million of cash inflows associated with financing activities. Cash utilized by operating activities totaled $0.63 million in the nine months ended October 31, 2004. Cash outflows included the $0.11 million gain on the sale of fixed assets, a $6.7 million increase in accounts receivable caused by the significant increase in billings in the second and third quarters, a $2.1 million increase in costs and estimated earnings in excess of billings on uncompleted contracts, a $0.22 million increase in inventories and a $0.15 million increase in other current assets. These cash outflows were partially offset by cash inflows including $1.49 million of net income in the current fiscal period, a $2.9 million increase in accounts payable, a $2.2 million increase in billings in excess of costs and estimated earnings on uncompleted contracts, a $1.4 million increase in accrued liabilities related to the timing of payments and $0.51 million of depreciation and amortization. Investing activities cash outflows included $0.74 million for the purchase of property, plant and equipment, a $0.02 million additional investment in the IAQ venture and $0.19 million of payments related to the acquisition of businesses. These cash outflows were partially offset by $0.13 million of proceeds from the sale of fixed assets. Financing activities cash inflows consisted of $0.45 million from the private placement of the Company's common stock (which was net of $0.05 million of costs associated with registering the Company's common stock related to the private placement), $1.4 million of proceeds from debt consisting of net borrowings on the line of credit and $0.12 million from the exercise of employee stock options. These cash inflows were partially offset by $0.49 million 14 for the repayment of debt. At October 31, 2004, the Corporation's backlog totaled $36.6 million ($18.9 million on fixed fee contracts and $17.7 million on time and materials or unit price contracts). During the nine months ended October 31, 2003, the Corporation's cash increased by $0.01 million to $0.02 million. The increase in cash and short-term investments during the first nine months of fiscal 2004 is attributable to cash inflows from operations of $0.47 million and $0.07 million of cash inflows associated with finance activities. These cash inflows were partially offset by cash outflows of $0.53 million associated with investing activities. Cash provided by operating activities totaled $0.47 million in the nine months ended October 31, 2003. Cash inflows including $0.48 million of net income in the prior nine-month period, a $0.03 million decrease in accounts receivables, a $0.16 million increase in billings in excess of costs and estimated earnings on uncompleted contracts, a $0.08 million decrease in other assets and $0.67 million of depreciation and amortization. These cash inflows were partially offset by cash outflows including a $0.1 million increase in costs and estimated earnings in excess of billings on uncompleted contracts, a $0.06 million increase in inventories, a $0.55 million decrease in accounts payable and a $0.27 million decrease in accrued liabilities related to the timing of payments. Investing activities cash outflows included $0.29 million for the purchase of property, plant and equipment and a $0.23 million of payments related primarily to an acquisition completed in a prior fiscal year. Financing activities net cash inflows consisted of $0.4 million of proceeds from debt consisting of net borrowings on the line of credit partially offset by $0.33 million for the repayment of debt. 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 (as fully described in Note 16 to the Corporation's consolidated financial statements.) 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 a $64,000 change in borrowing costs based upon the balance outstanding at October 31, 2004. ITEM 4. CONTROLS AND PROCEDURES Based on an evaluation under the supervision and with the participation of the Company's management, the Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined under the Securities Exchange Act of 1934, as amended (Exchange Act)) were effective as of October 31, 2004 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no significant changes in the Company's internal control over financial reporting identified in management's evaluation during the third quarter of fiscal 2005 that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting. 15 16 PART II-- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Registrant 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 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: EXHIBIT INDEX PAGES OF SEQUENTIAL EXHIBIT NO. AND DESCRIPTION NUMBERING SYSTEM Exhibit 31 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 Certification Pursuant To 18 U.S.C. Section 1350, As Amended Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K The registrant did not file any current reports on Form 8-K during the three months ended October 31, 2004 except for the following: Form 8-K filed September 13, 2004 containing an Item 12 - Results of Operation and Financial Condition discussing the Company's earnings for the quarter ending July 31, 2004. 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PDG ENVIRONMENTAL, INC. By /s/John C. Regan -------------------------------- John C. Regan Chairman, Chief Executive Officer and Chief Financial Officer Date: December 14, 2004 18