Hill International, Inc. - Quarter Report: 2008 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

or

Commission File Number: 001-33961

HILL INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (856) 810-6200

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, and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

Large Accelerated Filer  ¨            Accelerated Filer  ¨            Non-Accelerated Filer  x            Smaller Reporting Company  ¨

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

There were 41,032,649 shares of the Registrant’s Common Stock outstanding at November 3, 2008.

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HILL INTERNATIONAL, INC. AND SUBSIDIARIES

Index to Form 10-Q

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HILL INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

See accompanying notes to consolidated financial statements.

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HILL INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands, except per share data)

(Unaudited)

See accompanying notes to consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to consolidated financial statements.

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HILL INTERNATIONAL, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

Note 1 – The Company

Hill International, Inc. (“Hill” or the “Company”) is a construction consulting firm headquartered in Marlton, New Jersey that provides both fee-based project management and construction claims consulting services to clients worldwide. Hill’s clients include the U.S. federal government, U.S. state and local governments, foreign governments, and the private sector. Hill’s business was established in 1976 as a closely held corporation. On September 28, 2006, the closely held Hill (“Old Hill”) merged with and into Arpeggio Acquisition Corp. (“Arpeggio”), a specified purpose acquisition company, at which time Arpeggio changed its name to “Hill International, Inc.” The Company is organized into two key operating divisions: the Project Management Group and the Construction Claims Group.

Note 2 – Basis of Presentation

The accompanying unaudited interim consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States and the interim financial statement rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, these statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the consolidated financial statements. The consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

The consolidated financial statements include the accounts of Hill and its wholly- and majority-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The interim operating results are not necessarily indicative of the results for a full year.

Note 3 – Acquisitions

PCI Group, LLC

On July 31, 2008, Hill purchased PCI Group, LLC (“PCI”), a firm that provides scheduling, construction claims, project management support, and software sales and support services throughout the western United States. PCI, which has about 40 employees, is based in Las Vegas and has additional offices in Phoenix, Sacramento, Seattle and Dallas.

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The purchase price was $6,400,000 consisting of $4,100,000 in cash plus shares of the Company’s common stock valued at $2,300,000. At closing, 82,436 shares of the Company’s common stock, representing $1,300,000 based on the closing price of the Company’s common stock on July 28, 2008, were issued to the sellers. The remaining $1,000,000 is contingent consideration and is being withheld for a period of not less than one year as a reserve against indemnification claims. On July 31, 2009, Hill will pay to the sellers the difference, if any, between $1,000,000 and the amount of any unresolved indemnification claims in shares of Hill common stock valued at the closing price of such shares on July 28, 2008. When all such claims have been resolved, Hill will pay the balance, if any, between the unpaid contingent consideration balance and the amount of all resolved indemnification claims in shares of Hill common stock valued at the closing price of such shares on July 28, 2008. The maximum number of shares issuable for the contingent consideration is 63,412 shares. These shares are not currently outstanding, however, they have been included in the computation of earnings per share for the three- and nine-month periods ended September 30, 2008. The Company has included the contingent consideration of $1,000,000 in other current liabilities in the consolidated balance sheet at September 30, 2008.

The acquisition was accounted for under the purchase method of accounting and accordingly, the results of operations and cash flows of PCI have been included in the accompanying consolidated financial statements for the period subsequent to the acquisition date. At September 30, 2008, the total purchase price, including the contingent consideration of $1,000,000 and acquisition expenses of $22,000, was $6,422,000. The following table summarizes the allocation (which is preliminary and subject to change) of the purchase price based on the estimated fair value of the assets acquired and liabilities assumed as of the acquisition date (in thousands):

Euromost Polska Sp. z o.o

On May 27, 2008, Hill International S.A., the Company’s wholly-owned subsidiary, acquired all of the outstanding capital stock of Euromost Polska Sp. z o.o (“Euromost”), a Warsaw-headquartered firm with about 130 employees that provides project management and other construction consulting services throughout Poland. Euromost also has offices in Krakow, Wroclaw and Gdynia. The consideration paid by Hill International S.A. consisted of cash amounting to €10,850,000 ($17,063,000 at the exchange rate at the date of

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acquisition) and a non-interest bearing note amounting to €500,000 ($786,000) payable on June 17, 2009. The note is subject to reduction to satisfy any of the sellers’ indemnification obligations. The sellers may receive additional consideration of up to €5,350,000 ($8,413,000) under an earn-out arrangement payable at the rate of €2,775,000 ($4,364,000) in 2009 and €2,575,000 ($4,049,000) in 2010 based on the future financial performance of Euromost for the years ending December 31, 2008 and 2009, respectively.

The acquisition was accounted for under the purchase method of accounting and accordingly, the results of operations and cash flows of Euromost have been included in the accompanying consolidated financial statements for periods subsequent to the acquisition date. At September 30, 2008, the total purchase price, including acquisition expenses of $528,000, was $18,377,000. The Company is in the process of obtaining a detailed valuation of the assets acquired and liabilities assumed and, therefore, the allocation of the purchase price and the valuation of the assets and liabilities are subject to refinement. The following table summarizes the allocation (which is preliminary and subject to change) of the purchase price based on the estimated fair value of the assets acquired and liabilities assumed as of the acquisition date (in thousands):

Gerens Management Group, S.A.

On February 15, 2008, Hill International S.A., the Company’s wholly-owned subsidiary, acquired 60% of the outstanding capital stock of Gerens Management Group, S.A. (“Gerens”), a Spanish-headquartered firm that provides project management services on major construction projects throughout Spain as well as in Western Europe and Latin America. The consideration paid by Hill International S.A. was €10,800,000 ($15,981,000 at the exchange rate at the date of acquisition) in cash. The remaining minority stockholders of Gerens, who own 40% of the company, consist of Gerens’ Managing Director as well as a group of major Spanish savings banks. Gerens, which has about 250 employees, immediately changed its name to Gerens Hill International, S.A. following the acquisition.

Gerens is headquartered in Madrid, Spain and has additional offices in Barcelona, Spain and Cancun, Mexico. The company has managed the construction of major projects in various sectors, including residential, commercial, healthcare, retail and leisure, infrastructure, and hotels and resorts. Gerens brings together extensive knowledge of the Spanish market and worldwide experience in the management and control of complex design and construction processes offering their clients project management and independent technical consultancy services.

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In connection with the acquisition, Gerens’ shareholders, including Hill International S.A., entered into an agreement whereby the minority shareholders have a right to compel Hill International S.A. to purchase any or all of their shares during the period from March 31, 2010 to March 31, 2020. Hill International S.A. also has the right to compel the minority shareholders to sell any or all of their shares during the period from March 31, 2011 to March 31, 2021. The purchase price for such shares shall be the greater of (a) €18,000,000 increased by the General Price Index (capped at 3.5% per annum) or (b) ten times the company’s earnings before interest and income taxes for the prior fiscal year, multiplied by a percentage which the shares to be purchased bear to the total number of shares outstanding at the time of the purchase. Such amount may be increased by increases in equity subsequent to the acquisition date, and can be paid in cash or shares of our common stock at the option of the sellers.

The acquisition was accounted for under the purchase method of accounting and accordingly, the results of operations and cash flows of Gerens have been included in the accompanying consolidated financial statements for periods subsequent to the acquisition date. The total purchase price, including acquisition expenses of $531,000, was $16,531,000. The Company is in the process of obtaining a detailed valuation of the assets acquired and liabilities assumed and, therefore, the allocation of the purchase price and the valuation of the assets and liabilities are subject to refinement. The following table summarizes the allocation (which is preliminary and subject to change) of the purchase price based on the estimated fair value of the assets acquired and liabilities assumed as of the acquisition date (in thousands):

The following unaudited pro forma information assumes the above acquisitions had occurred on December 31, 2006. The pro forma information, as presented below, is not necessarily indicative of the results that would have been obtained had the Euromost, Gerens and PCI acquisitions occurred on that date, nor is it necessarily indicative of the Company’s future results.

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The pro forma net income reflects adjustments for amortization of intangibles, stock-based compensation expense, interest charges and income taxes.

John Shreeves Holdings Ltd.

On January 4, 2008, Hill International (UK) Ltd., a wholly-owned subsidiary of the Company, acquired John Shreeves Holdings Ltd. and its operating subsidiary John Shreeves & Partners Ltd. (collectively “Shreeves”), a London-based firm that provides project management and cost consultancy services on primarily private-sector projects throughout the United Kingdom. The acquired business will continue to operate under the Shreeves brand name until its operations have been consolidated with Hill’s. Total consideration amounted to £1,850,000 ($3,700,000 at the exchange rate on the date of acquisition) consisting of a cash payment of £1,650,000 ($3,300,000) on the date of closing and a cash payment of £200,000 ($400,000) which was paid on July 3, 2008. The results of operations of Shreeves are not material to the consolidated results of operations of the Company.

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Note 4 – Comprehensive Earnings

The following table summarizes the Company’s comprehensive earnings:

Note 5 – Accounts Receivable

The components of accounts receivable are as follows:

Note 6 – Intangible Assets

The following table summarizes the Company’s acquired intangible assets as of September 30, 2008 and December 31, 2007:

Amortization expense related to intangible assets totaled $737,000 and $475,000 for the three months ended September 30, 2008 and September 30, 2007, respectively, and totaled $1,967,000 and $958,000 for the nine

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months ended September 30, 2008 and September 30, 2007, respectively. Estimated amortization expense based on our present intangible assets for the next five years:

Note 7 – Goodwill

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, the Company performs its annual goodwill impairment testing, by reportable segment, in the third quarter, or more frequently if events or changes in circumstances indicate that goodwill may be impaired. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for the businesses, the useful life over which cash flows will occur, and determination of the Company’s weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions on goodwill impairment for each reporting unit.

The following table summarizes the changes in the Company’s carrying value of goodwill during 2008 (in thousands):

Note 8 – Accounts Payable and Accrued Expenses

Below are the components of accounts payable and accrued expenses:

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Note 9 – Deferred Revenue

In certain instances the Company may collect advance payments from clients for future services. As the services are performed these advance payments are recognized as revenue. Deferred revenue is classified as current or long term based on the anticipated life of the project. The following table summarizes deferred revenue:

Note 10 – Notes Payable

Outstanding debt obligations are as follows:

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On September 30, 2008, the Company was a party to a loan and security agreement with Bank of America which provided for up to $35,000,000 to be made available on a revolving basis (the “Credit Facility”). The Credit Facility provided for a letter of credit sub-facility of $20,000,000. The Credit Facility was secured by substantially all of the Company’s assets, including, without limitation, its accounts receivable, equipment, securities, financial assets and proceeds from the sale of the foregoing, as well as by a pledge of 66.67% of the outstanding capital stock of the following subsidiaries: Hill International S.A., Hill International (UK) Ltd., Hill International (Middle East) Ltd. and James R. Knowles (Holdings) Ltd.

The Credit Facility was for a term extending until January 1, 2011. The Credit Facility provided for LIBOR loans and prime rate loans, payable at margins above either Bank of America’s prime rate or LIBOR based on the Company’s ratio of total debt to EBITDA ranging from 0 to 50 basis points above prime or 150 to 262.50 basis points above LIBOR. At September 30, 2008, the applicable margins were 0 basis points above Bank of America’s prime rate and 150 basis points above LIBOR. The Credit Facility contained covenants with respect to the Company’s minimum net worth, total debt to EBITDA ratios, fixed charge coverage ratios and billed accounts receivable to total debt ratios, as well as other financial covenants and certain restrictions on the incurrence of debt, on the making of investments, on the payment of dividends, on transactions with affiliates and other affirmative and negative covenants and events of default customary for facilities of its type. At September 30, 2008 the Company had $9,675,000 in outstanding letters of credit which reduced availability under the Credit Facility. On October 31, 2008, the Credit Facility was amended (see Note 19).

The Company also maintains a credit facility with a bank in the Middle East for 11,500,000 AED ($3,132,000) collateralized by certain overseas receivables. The interest rate on that facility is the three-month Emirates InterBank Offer Rate (“EIBOR”), which at September 30, 2008 was 4.0%, plus 2.0%. At September 30, 2008, there were no outstanding borrowings under this facility which expires on December 24, 2008.

The Company also maintains an unsecured credit facility with a bank in Spain for €750,000 ($1,078,000). The interest rate on that facility is the three month EURIBOR rate which at September 30, 2008 was 6.03%, plus 0.75%. At September 30, 2008 there were no outstanding borrowings under this facility which expires on December 18, 2008.

Note 11 – Supplemental Cash Flow Information

On March 24, 2008, options to purchase 1,000 shares of Hill’s common stock with an exercise price of $7.67 per share were exercised on a cashless basis when the fair market value was $12.59 resulting in Hill issuing 391 shares of its common stock.

On April 9, 2008, the Company issued 2,300,000 shares of its common stock in connection with the earn-out provision of the Merger Agreement with Arpeggio.

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On May 10, 2008, the Company issued 134,360 shares of its common stock, with a fair value of $1,955,000, to the former owner of KJM & Associates, Ltd. These shares had been held in escrow pending the satisfaction of certain indemnification obligations of the seller. The Company reflected this payment as additional purchase consideration and has increased goodwill.

In connection with the Euromost purchase, the Company issued a non-interest bearing note payable in the amount of €500,000 ($718,000) with a maturity date of June 17, 2009.

As the result of a Third Circuit Court of Appeals decision, the Company eliminated an accrued liability of $3,350,000 and the offsetting reduction in stockholders’ equity. See the discussion in Note 18 related to the Wartsila matter.

The following table provides additional cash flow information:

Note 12 – Equity in Earnings of Affiliates

Stanley Baker Hill, LLC

Equity in earnings of affiliates reflects ownership by the Company of 33.33% of the members’ equity of Stanley Baker Hill, LLC (“SBH”). SBH is a joint venture formed in February 2004 between Stanley Consultants, Inc., Michael Baker, Jr. Inc., and Hill.

SBH has a contract for an indefinite delivery and indefinite quantity for construction management and general architect-engineer services for facilities in Iraq with the U.S. Army Corps of Engineers.

At September 30, 2008 and December 31, 2007, the Company reported receivables totaling $2,605,000 and $3,394,000, respectively, from SBH for work performed by the Company as a subcontractor to SBH. Such amounts were payable in accordance with the subcontract agreement between the Company and SBH.

Revenue from SBH pursuant to such subcontract agreement for the three-month periods ended September 30, 2008 and September 30, 2007 was $7,417,000 and $4,788,000, respectively, and for the nine-month periods ended September 30, 2008 and September 30, 2007 was $20,911,000 and $7,925,000, respectively.

Hill TMG

Equity in earnings of affiliates also reflects ownership by the Company of 50.00% of the members’ equity of Hill TMG, a joint venture formed in May 2008 between Talaat Moustafa Group Holding Co. (“TMG”), and Hill. Hill TMG is managing the construction of several of TMG’s largest developments in Egypt and elsewhere in the Middle East.

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At September 30, 2008 the Company reported receivables totaling $659,000 for work performed by the Company as a subcontractor to Hill TMG. Such amounts are payable in accordance with the subcontract agreement between the Company and Hill TMG.

Revenue from Hill TMG pursuant to such subcontract agreement for the three-month period ended September 30, 2008 was $906,000 and for the nine-month period ended September 30, 2008 was $1,368,000.

The following table summarizes the amounts for each of the above affiliates:

Note 13 – Earnings per Share

Basic earnings per common share and diluted earnings per common share are presented in accordance with SFAS No. 128, Earnings per Share. Basic earnings per common share have been computed using the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share incorporate the incremental shares issuable upon the assumed exercise of stock options, warrants and unit purchase options, if dilutive. Dilutive shares were 475,828 shares and 4,342,072 shares for the three-month periods ended September 30, 2008 and 2007, respectively, and 415,520 shares and 4,353,138 shares for the nine-month periods ended September 30, 2008 and 2007. Certain stock options, warrants and units were excluded from the 2008 and 2007 calculation of diluted earnings per common share because their effect was antidilutive. The total number of such shares excluded from diluted earnings per common share was 18,261 shares and 825,978 shares for the three-month periods ended September 30, 2008 and 2007, respectively, and 6,131 shares and 1,532,436 shares for the nine-month period ended September 30, 2008 and 2007, respectively. The 2,300,000 common shares, which were issued in April 2008 in connection with the 2007 earn-out provision of the merger agreement with Arpeggio, have been included, effective January 1, 2008, in both the basic and diluted weighted average shares for the three- and nine-month periods ended September 30, 2008.

Note 14 – Share-Based Compensation

At September 30, 2008, the Company had 935,500 options outstanding with a weighted average exercise price of $8.40. During the nine-month period ended September 30, 2008, the Company granted 145,000 options, which vest over a five-year period, with a weighted average exercise price of $13.27 and a weighted-average contractual life of 6.67 years. The aggregate fair value of the options was $653,887 calculated using the Black-Scholes valuation model. The weighted-average assumptions used to calculate the fair value were: expected life – 4.66 years; volatility – 35.5% and risk free interest rate – 2.79%. During the first nine months of 2008, options for 20,000 shares with a weighted average exercise price of $7.66 were exercised and options for 44,500 shares with a weighted average exercise price of $9.07 were forfeited.

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At the June 10, 2008 Annual Meeting of Stockholders, the stockholders approved:

The Company recognized share-based compensation expense in selling, general and administrative expenses in the consolidated statement of earnings totaling $602,000 and $155,000 for the three-month periods ended September 30, 2008 and 2007, respectively, and $2,367,000 and $388,000 for the nine-month periods ended September 30, 2008 and 2007. Total expense related to the 2007 Restricted Stock Grant Plan, which was approved by the stockholders on June 10, 2008, amounted to approximately $275,000 and $1,740,000 for the three- and nine-month periods ended September 30, 2008, respectively.

Note 15 – Income Taxes

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”), which provides criteria for the recognition, measurement, presentation and disclosure of uncertain tax positions. The Company adopted the provisions of FIN 48 on December 31, 2006, the first day of our 2007 fiscal year. As a result of the implementation of FIN 48, the Company has analyzed filing positions in all of the federal, state and foreign filing jurisdictions where it is required to file income tax returns, as well as all open years in those jurisdictions. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As a result of this review, the Company concluded that there were no uncertain tax positions which would require a cumulative effect adjustment to retained earnings as of December 31, 2006.

The Company files income tax returns in the U.S. federal jurisdiction and in various states and foreign jurisdictions. The Company generally is no longer subject to U.S. federal, state or foreign examinations by tax authorities for tax years prior to 2004.

During the nine-month period ended September 30, 2008, the Company recognized an income tax benefit principally relating to a tax benefit of $2,506,000 due to the expirations of statutes upon the filing of certain income tax returns resulting in the reduction in the reserves for uncertain tax positions and an expense of $1,300,000 relating to a one-time modification of the cash to accrual adjustment.

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The following table indicates the changes to the Company’s uncertain tax positions for the period ended September 30, 2008, including interest and penalties:

The Company’s policy is to record income tax related interest and penalties in income tax expense. At September 30, 2008, $1,878,000 for potential interest and penalties related to uncertain tax positions was included in the balance above.

The effective income tax rates for the three-month periods ended September 30, 2008 and 2007 were 26.0% and 21.8%, respectively, and the effective income tax rates for the nine-month periods ended September 30, 2008 and 2007 were 11.7% and 22.7%, respectively. Excluding the effect of the cash-to-accrual adjustment and the reserve reduction included in the table above, the effective income tax rate would have been 18.2% for the nine-month period ended September 30, 2008.

Note 16 – Business Segment Information

The Company’s business segments reflect how executive management makes resource decisions and assesses its performance. The Company bases these decisions on the type of services provided (Project Management and Construction Claims services) and secondarily by their geography (Americas, Europe, the Middle East/North Africa and Asia/Pacific).

The Project Management business segment provides extensive construction and project management services to construction owners worldwide. Such services include program management, project management, construction management, project management oversight, staff augmentation, management consulting, and estimating and cost management services.

The Construction Claims business segment provides such services as claims consulting, litigation support, expert witness testimony, cost and damages assessment, delay and disruption analysis, lender advisory, and adjudication services to clients worldwide.

The Company evaluates the performance of its segments primarily on operating profit before corporate overhead allocations and income taxes.

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The following tables reflect the required disclosures for the Company’s reportable segments for the three- and nine-month periods ended September 30, 2008 and 2007 (in thousands):

Three Months Ended:

Consulting Fee Revenue:

Total Revenue:

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Operating Profit:

Depreciation and Amortization Expense:

In the fourth quarter of 2007, the Company revised the method by which it allocates revenue to geographic areas for project management contracts. The Company now allocates revenue based on the site of the actual project which provides a more accurate portrayal of the areas in which the Company operates. Previously, the Company allocated revenue based on the location of the client. For construction claims contracts, the Company allocates revenue based on the location of the office performing the work. The amounts for the three months ended September 30, 2007 have been revised to reflect the new method.

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Consulting Fee Revenue by Geographic Region:

Total Revenue by Geographic Region:

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Consulting Fee Revenue By Client Type:

Total Revenue By Client Type: