Navigant Consulting (NCI)

We maintain our Sell rating on shares of NCI.

Second-quarter results showed signs of weakness. Although management moderately increased its full-year revenue and EBITDA guidance, the magnitude of the increase was less than the expected contribution from the recently acquired Chicago Partners. As such, management effectively lowered its guidance for operations in the core business.

Utilization rates also declined sequentially during the second quarter. The company reported consultant utilization of 79% compared to 83% in the first quarter. In the company's two largest segments, Dispute & Investigative Services and Business Consulting Services, utilization declined 700 and 400 basis points sequentially, to 77% and 80%, respectively. Heading in to the third quarter, during which the company stumbled in 2007, we remain cautious.

Our price target of $14.00 reflects a multiple of 15x our 2008 estimate. As such, we continue to rate the shares a Sell at this time.

OVERVIEW

Navigant Consulting (NCI) is a provider of specialized consulting services with billable consultant headcount of 1,928 full time equivalents (FTEs) as of Q2 2008. The company's staff of seasoned consultants and industry leaders provides litigation support and investigative services, claims management and analysis, corporate finance services, discovery services, government contracting services, and operations advisory and management process outsourcing services. Navigant Consulting primarily focuses on customers in industries undergoing substantial regulatory and structural changes, including construction, energy, financial services, and healthcare. Navigant derives the majority of its revenue before reimbursements from professional service fees.

We note that the company made significant investments in its corporate finance practice during recent years. In 2005, the company built out its evaluation practice, which has approximately 55 professionals in the U.S. Further, the company also invested in infrastructure development in fiscal year 2006. The company has also utilized acquisitions to build out its expertise in other attractive industry segments. In March 2006, the company completed the acquisition of Precept Programme Management, a leading independent dispute advisory and program management consulting firm in the U.K., primarily catering to the construction industry. In July 2007, the company announced the acquisition of Troika (UK) Limited, a financial services consulting firm based in London. This followed the acquisitions of A.W. Hutchison & Associates, a provider of construction litigation consulting services, and the Canadian forensic accounting and litigation consulting practices of Kroll, Inc. (a subsidiary of Marsh & McLennan Companies) in fiscal year 2005.

While demand remains solid for the majority of the company's business practices, it is not experiencing the same type of robust growth that it had seen over the past two years. Sales cycles have lengthened and management believes that corporate customers are looking to better manage internal costs, following the significant expense outlays associated with Sarbanes-Oxley related issues. In addition, the ramp-up time associated with new business wins is now taking longer than expected. As such, utilization rates are likely to remain below management's expectations and prior year results in the near term. We note that company-wide utilization declined 400 basis points (bps) sequentially in the fourth quarter of fiscal year 2005 to 67%. Although company-wide utilization rebounded back to 71% in the first quarter of 2006, it was still 100 basis points (bps) below the first quarter of fiscal year 2005. During the second quarter of 2006, utilization was 70%, and decreased to 69% in the third quarter and 68% in Q4.

The weak trend in utilization continued in 2007, with levels for the first three quarters of the year of 69%, 69%, and 68%, respectively. The utilization problem came to a head in the third quarter of 2007, as management cited lower-than-projected utilization as the primary reason that earnings were substantially below expectations. Management has begun taking steps to restructure the business in order to better align capacity with demand. These steps involve reducing headcount in some practice areas.

We note that Navigant Consulting has been extremely aggressive in its hiring practices and absorbed significant headcount related to its strong acquisition activity. Given the higher expense base associated with the increase in human capital outlays, and lower utilization rates, we expect margins to remain under pressure for the next few quarters.

During the second quarter of 2008, the company acquired Chicago Partners, LLC, a leading Chicago-based economic and financial analysis consulting firm. Chicago Partners provides economic and financial analyses of legal and business issues for law firms, corporations and government agencies and includes more than 90 leading academic and industry professional consultants, with backgrounds in economics, accounting and finance. John Garvey, President of Chicago Partners, will serve as the Head of the Economics Segment. Management expects Chicago Partners to contribute roughly $30 million in revenue at an approximate 20% EBITDA margin during 2008. Under the terms of the agreement, Navigant paid approximately $50 million in cash and $23 million in stock to acquire Chicago Partners, which can also earn additional purchase consideration based on achieving certain post-closing performance targets. Chicago Partners' total revenue for 2007 was $46 million. This acquisition was completed on May 1, 2008 and is expected to be modestly accretive within the first 12 months.

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