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Perspecta Inc. (NYSE:PRSP)
Q3 2020 Earnings Call
Feb 12, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to the Perspecta Third Quarter Fiscal Year 2020 Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]

I would now like to turn the conference over to Michael Pici, Vice President of Investor Relations. Please go ahead.

Michael Pici -- Vice President, Investor Relations

Thank you and welcome everyone to our third quarter fiscal year 2020 earnings conference call. Presenting today are Mac Curtis, our CEO; and John Kavanaugh, our CFO. This call is being webcast on the Investor Relations portion of our website at perspecta.com, where we also have posted the earnings release and financial presentation slides, which supplements our comments today.

Turning to Slide 2 of the presentation. Before we begin, please note that during this call, we will make several forward-looking statements that are subject to the known and unknown risks and uncertainties that could cause actual results to differ materially from anticipated results. For a full discussion of these risks and uncertainties, please refer to our SEC filings, including our latest Form 10-K. In addition, these statements represent our views as of today and subsequent events may cause our views to change. Though, we may elect to update the forward-looking statements, we specifically disclaim any obligation to do so.

Finally, as shown on Slide 3, we'll discuss some non-GAAP financial measures that we believe provide useful information for investors. The slide presentation for today's call includes reconciliations to the most closely comparable GAAP measures.

At this time, it's my pleasure to turn the call over to Mac, who will begin on Slide 4.

Mac Curtis -- President and Chief Executive Officer

Thank you, Mike and thank you all for joining us this afternoon. Before I go further, I want to introduce Mike Pici, who joined us recently as the company's Vice President of Investor Relations. Mike brings over 20 years of relevant experience to his new role, and we're excited to have him on the team. For today's call, first, we will address the recent NGEN announcement and then discuss our third quarter results. Obviously, we're disappointed with the outcome of the Navy's recent announcement regarding the Service Management, Integration, and Transport or SMIT portion of the NGEN program.

I want to begin by providing an update on the contract schedule. First, we are currently under a contract extension it takes us through December of 2020, which consist of a six-month extension through September and three one-month options. We will go through the debrief process currently scheduled for February 24 to obtain insight into the award decision and we'll determine our next steps after that. Second, in accordance with the performance work statement in the new SMIT contract, there is a requirement for a nine-month transition out once the contract starts. This is a setback to our plans. No question. As a company, we will weather the storm.

Operationally, we are performing very well. We will discuss another solid quarter's results in a minute. In fact, it is the seventh quarter in a row of strong performance. We've basically completed the integration required to form Perspecta and are ahead of schedule in delivering the cost synergies are originally contemplated. We've also integrated the recent Knight Point acquisition and we're seeing strong bookings, as a result of the combination. We have an $80 billion pipeline of qualified opportunities to prosecute over the next three years.

Importantly, over this time frame, we only have about 8% of our business in recompete versus the typical 20% plus based on a five-year period of performance. That means more investment dollars focused on new business versus recompete. We have a 1.4 TTM book-to-bill with an approximate new business percentage of 65%. Excluding NGEN, our book-to-bill is 1.6 TTM with an approximate 72% in new business. We have and will continue to be successful in winning new business.

Over the last two quarters, we've been awarded $1.3 billion of awards, adding three new customers and we're focused on continuing to grow our program portfolio. The Perspecta value proposition created provides a solid foundation for continued growth. We are confident we can grow our business. We have the team in place to do this. Our dedication to meeting our customers' complex missions, providing innovative solutions and support, motivating our employees to succeed and generating value to our shareholders, continues to be our top priority.

John will now provide some additional comments on the NGEN financial implications.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Thanks, Mac and good afternoon, everyone. Obviously, as Mac stated, we are disappointed with the outcome of the Navy's decision. First off, in our press release this evening, we disclosed that the Navy's recent decision will likely result in a non-cash pre-tax impairment charge of approximately $860 million, primarily related to goodwill and intangible assets that will be recognized in the fourth quarter. This charge will be adjusted out for non-GAAP reporting purposes. While we normally don't discuss contract level financial details. Given the importance of the recent announcement, we will provide as much transparency as we can at this point, while not compromising any competitively sensitive data. We're providing this information to help you better understand Perspecta without NGEN.

In order to provide a baseline, the network portion of the NGEN program or SMIT, represents approximately 18% to 19% of our expected FY '20 revenues, which is about 200 basis points higher than our historical performance. As we have been addressing pent-up demand over the last couple of quarters.

In terms of margin impact, the SMIT component has minimal capital intensity and has been benefiting from end of contract program efficiencies and is currently running approximately 500 basis points below our company's year-to-date adjusted EBITDA margin of approximately 17.5%. In terms of financial implications, there is no impact to FY '20 from a non-GAAP perspective.

Looking forward to FY '21 and FY '22, since NGEN was expected to remain relatively stable, it was not an incremental growth driver. Therefore, we still expect to grow consistent with our long-term growth targets of an FY '20 baseline that excludes the SMIT contract. As discussed earlier, we are under contract through December 2020, which consist of a six-month extension through September, and three, one-month options, which takes us through our third quarter of fiscal year 2021. Factoring in the moderation of the pent-up demand, and only three quarters of performance. We see FY '21 SMIT revenue, approximately $250 million lower and an adjusted EBITDA margin, approximately 100 basis points lower than FY '20. Assuming the contract end date of December 2020, there will be no revenue or profits from the SMIT portion in FY '22.

In terms of adjusted free cash flow, we expect FY '20's contribution from SMIT to be approximately $70 million to $80 million.

From a net leverage perspective, we ended the third quarter at 3.1 times for our credit agreement. Since the leverage ratio is a backward looking metric using trailing 12-month EBITDA, we won't see the full financial impact on our net leverage ratio and so roughly the fourth quarter of fiscal year '22, which is almost two years from now. In the meantime, we're confident our business can grow and replace the NGEN cash generation over the next few years.

Now, I will turn it back over to Mac to discuss our third quarter performance.

Mac Curtis -- President and Chief Executive Officer

Thanks, John. I'm very pleased with Perspecta's performance in the third quarter, which was in line with our expectations. Today, I want to share four key messages. First, we delivered another solid quarter of operations with strong revenue growth, robust earnings and excellent free cash flow; second, we've had another strong business development quarter; third, our ability to deliver on our commitments; and fourth, we continue to fine-tune the details to build a company we are proud of.

First, we again exceeded consensus estimates on all of our key financial metrics. Quarter-after-quarter, we're delivering on our gross margin, earnings and cash commitments. Revenue was up 5% year-over-year, adjusted EBITDA was up 7%, and adjusted diluted EPS was up 17%. Free cash flow conversion rate for the quarter was again above our full year target at 109% of adjusted net income. With this strong execution by the entire team, we are raising our revenue, EPS and free cash flow conversion guidance. Now John will share more on this in a moment. Second, bookings were strong with $1.6 billion, representing a book-to-bill ratio in the third quarter of 1.4 times. This continues a positive streak for us. Our book-to-bill ratio for the trailing 12 months is 1.4 times. I'm very proud to share that 77% of our bookings this quarter represent new business for Perspecta. These will be key to our future growth as we achieve full run rate.

Our Defense and Intelligence segment is continuing its steady performance. This quarter, we won new work in the key growth area of enterprise infrastructure as a service through teaming with our commercial partners to support the Army's pilot program. We were successful on our recompete programs, we see multiple renewals and extensions as well as additional work on existing programs. Overall, our business development teams are driving outstanding results to achieve both near and longer-term objectives.

Before I move off the Defense and Intelligence segment, I want to comment on our trusted workforce business, specifically background investigations. We continue to work through the OPM to DCSA transition and are confident we will maintain our steady state market leading position. Our pipeline in this business is growing and we see a real opportunity and the continuous evaluation and continuous vetting space.

Our Civilian and Healthcare segment had an exceptionally strong quarter of bookings. We won our largest new award this year from the US Department of State Consular Affairs Office, our newest enterprise infrastructure program or CAEIO to provide enterprise infrastructure support and operate the Global Consular Affairs IT environment. This contract has a maximum ceiling of $810 million with the one-year base period and six one-year option periods. We are pleased with this win and look forward to cultivating a long-standing partnership.

Also included in our bookings this quarter are two fed-civ contracts that we mentioned on our Q2 call. As a reminder, we won a prime slot on the new General Services Administration, CIO Modernization and Enterprise Transformation blanket purchase agreement, also known as GSA COMET BPA. In addition, we were awarded an initial task order of $16 million to provide agile application development. Finally, we were awarded a five-year contract with maximum ceiling value of $147 million from the Department of Homeland Security to enhance its security posture against network attacks and cyber threats.

In the early weeks of Q4, our Civilian and Healthcare segment continue the momentum. As we were notified the Department of Labor reawarded their information technology operations and maintenance contract to Perspecta after their corrective action from a previous protest. This contract represents new work at a value of $277 million with a one-year base period and six one-year option periods. We look forward to partnering with the Department of Labor on modernizing their IT environment.

As I stated in my opening remarks, over the last two quarters, we've secured three new customers; Department of State, Department of Labor and US Senate. These are great examples of our investment efforts paying off and the future is bright for our Civilian and Health segment as these new business wins further enhances the diversity of the portfolio and the wins this quarter reinforce our commitment of not sacrificing growth for margins.

Looking ahead, our three-year qualified pipeline remains robust at $80 billion including $17 billion of proposals already submitted and awaiting decision, which is heavily weighted toward new business. Third, we continue to deliver on our commitments that we've made to our customers, mission, employees and shareholders. John and I have been very focused on building credibility by doing what we say we're going to do.

I want to provide evidence of this by focusing on four key areas. The value of our deep customer relationships, levering the power perspective, transparency around our business and our financial performance. Our customer relationships are aligned with mission needs focused on IT infrastructure modernization, cloud migration, cyber security, accelerating digital investment and adoption. Key to these relationships is our ability to deliver service offerings and solutions, which are unique to each of their needs.

You've heard me speak in the past about the Power of the Pyramid. We have two anchor programs, and are prime examples of leveraging our capabilities and a consolidated offering. One is Army Cyber Command, and the second is the new US Department of State Consular Affairs Office contract. These wins represent new business for Perspecta and a total contract value of $1.7 billion. These deals demonstrate the power of Perspecta because of our full suite of capabilities, coupled with the deep customer insight to drive successful prime bids, who are not present in the independent businesses prior to the formation of the company. A final example of delivering on our commitments is our financial performance.

Now, fourth, we continue to fine-tune the business while remaining focused on meeting the critical mission of our customers. Perspecta Labs, our innovation engine continues to develop new intellectual property that we transfer into existing programs and leverage in our proposals for new business. As an example, we are applying our Commercial Solutions For Classified technologies as part of Perspecta's IT service offerings and using certain IT in the US Cyber Command program.

Second, the recent key wins due to our capabilities are aligned with critical customer needs in the areas of IT modernization, cloud computing, cyber security, infrastructure engineering and support. Third, our employees and leadership are engaged and dedicated to executing on our financial and non-financial objectives. We have aligned our business development organization to support our strategic growth expectations, and our general managers bring years of experience and customer relationships to grow the business. In summary, I'm very proud of the performance we delivered this quarter, our ability to support our customer's mission and the employees and leadership team we have in place to drive us forward.

With that, let me turn the call back over to John.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Thanks, Mac. In terms of our third quarter results, I'm extremely pleased with our performance, making it seven quarters in a row of solid execution. The performance on or ahead of plan for our key financial metrics. We are, again, raising our full year guidance for revenue, adjusted diluted earnings per share and adjusted free cash flow conversion.

Turning to Slide 5, revenue for the quarter was $1.13 billion, which was up 5% from the third quarter of fiscal year 2019, and as expected, down 4% from the second quarter of fiscal year 2020 due to the $60 million in transition services and one-time revenue from the sale of the IT assets related to the NASA desktop support closeout we recognized last quarter. In Q3, we recognized approximately $15 million in revenue anticipated in Q4 related to accelerated purchases driven by customer demand.

The Defense and Intelligence segment continued its momentum, as we ramped up recent wins and met increased demand on NGEN. Revenues for the segment increased 15% year-over-year. The Civilian and Healthcare segment revenue decreased 14% year-over-year, mainly due to NASA and other program run off. Q3 new business awards, Mac referenced earlier, provide momentum moving into FY '21. Overall, our contract mix was a little heavier in terms of costs plus in the quarter. As a percentage of total revenue, 54% was fixed price, 18% time of materials and 28% costs-plus.

Q3 adjusted EBITDA was $195 million, which was up 7% year-over-year as adjusted EBITDA margin increased from 16.9% to 17.3%, driven by strong fixed price program execution. Depreciation declined slightly to $38 million. Acquisition related intangibles amortization, which is backed out of adjusted net income and adjusted diluted EPS, was $54 million. Q3 adjusted net income was $90 million, resulting in adjusted diluted earnings per share of $0.55 against a diluted share count of $162.5 million. Adjusted diluted EPS was up 17% year-over-year.

Turning to Slide 6. During the third quarter, we generated $120 million of cash flow from operating activities and $98 million of adjusted free cash flow or 109% of adjusted net income. The difference between the cash metrics is $40 million of capital expenditures, which includes finance lease payments, $17 million for the initial sale of qualifying receivables and $35 million of separation integration and restructuring payments. For the quarter, our operational days sales outstanding metric was 59 days.

During the third quarter, we paid down $149 million of debt, and returned $23 million to shareholders, 10 million in quarterly dividends and $13 million in share repurchases. We ended the quarter with $69 million of cash and $2.7 billion of debt, including $271 million of finance lease obligations. During the quarter, we completed the sale leaseback of the former EDS headquarters in Herndon and another owned property for total net cash proceeds of $77 million. These proceeds provide us more dry powder to pursue our growth initiatives. We recognize a combined gain of approximately $33 million from both transactions, but have excluded the gain from our adjusted EBITDA and adjusted diluted EPS and the net proceeds from our adjusted free cash flow.

Turning to Slide 7. Based on our financial and business development performance in the third quarter, we are raising our fiscal year 2020 guidance. We now expect revenue for the year to be $4.45 billion to $4.5 billion, which is an increase of $25 million to the lower end of our previous guidance. We expect adjusted diluted earnings per share of $2.12 to $2.18, which is an increase of $0.02 to the lower end of prior guidance. And there is no change to our adjusted EBITDA margin range of 17% to 18%. Lastly, we are raising our adjusted free cash flow conversion guidance from 105% plus to 110% plus of adjusted net income, as we continue to have a laser focus on cash collections and aggressively manage working capital.

Operator, we're now ready to take any questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Gavin Parsons of Goldman Sachs. Please go ahead.

Gavin Parsons -- Goldman Sachs -- Analyst

Hey. Good evening, gentlemen.

Mac Curtis -- President and Chief Executive Officer

Hey, Gavin.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Hey, Gavin.

Gavin Parsons -- Goldman Sachs -- Analyst

Thanks for all the color on NGEN. That's extremely helpful. The $70 million to $80 million free cash flow, is that the full impact that we should expect on medium-term free cash or are there dynamics of whether it be overhead allocation or changes in capex or D&A that make it more or less than that. Thanks.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Yeah. So, Gavin, this is John. So, appreciate that again. Our intention here was to give you as much transparency as we can, OK. And obviously we're trying to ring-fence this scale and size. So, the $70 million to $80 million, it's effectively -- it's tax affected, it's overall adjusted free cash flow impact or contribution right from the SMIT component, OK. As you saw, for this year, we've raised or obviously adjusted free cash flow guidance metric. So, everything is fine.

Gavin Parsons -- Goldman Sachs -- Analyst

Got it. And then just on the strength of the book-to-bill ex-NGEN at $1.6 billion, if I back into implied organic growth for the year, I think, it's slightly negative. So, can you just help reconcile how long it takes for that 1.6 times ex-NGEN book-to-bill to convert to organic growth or what we should expect that to drive growth ex-NGEN?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Yeah. So, first of all, we are expecting right now you take a look at our revised revenue guidance, if you look at the mid-points roughly 5% growth, 3% of that is organic, OK. So, again, feeling really good about the great business development results, the momentum we're getting. You saw what we're doing relative to both within the quarter, and then more importantly, on a trailing 12 months, and we even provided you again the metrics excluding NGEN, OK, which is 1.6 times trailing 12-months and a significant amount of new effectively 72% new.

Gavin Parsons -- Goldman Sachs -- Analyst

I mean, is there a certain amount of time that it takes for those bookings to convert to revenue or is it six months, 12 months, 18 months, I know it's all of them on a one by one basis, but there's...

Mac Curtis -- President and Chief Executive Officer

Yeah. That's a good question, Gavin. It does depend on the type of contract it is and I can give a couple of examples, the Department -- the US Senate, which is a contract that we won. Probably I think in -- maybe 90 days ago, that's up and running, fully staffed up and running. So, the complexity associated with the Department of State Consular Affairs, which is a new piece of business. That's going to be over a period of time, right? And a lot of the transition is worked out with the customer. That could be a six-month kind of transition in Department of Labor. Probably a little less than that.

And a part of it, too is, we've got a lot of job openings and one of the things we do a very good job of is moving people around in the business to fill those jobs. It's also about career advancement, it's also about career opportunity. So, I think that when you think about seven agencies a little quicker, right? In some cases, when you look at things like the ARCYBER, and in some case, you've got authority [Phonetic] to operate systems that takes a little bit longer.

But for the ones we won, the three new customers we referred, we're up and running. We're moving out, bringing people on board. I'm not going to give you there's too many specifics, but in one case and the department staged [Phonetic] hundreds of people. And so we have to go, in some cases with a clearance process. But those are -- those are that have been moving along, I can tell you, ARCYBER, that's up and running. We are probably 98%, almost 100% staffed there. Now, we start to migrate to Bellator [Indecipherable]. So, we really, really focus on that NGEN, Gavin. So, to get the revenue generation as quick as we possibly can.

Does that answer your question?

Gavin Parsons -- Goldman Sachs -- Analyst

Yeah. Absolutely. Thank you. Helpful.

Mac Curtis -- President and Chief Executive Officer

Yeah.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Thanks, Gavin.

Operator

[Operator Instructions] And our next question comes from Gautam Khanna of Cowen. Please go ahead.

Gautam Khanna -- Cowen -- Analyst

Hey, guys. How are you?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Hey.

Mac Curtis -- President and Chief Executive Officer

Hi, Gautam.

Gautam Khanna -- Cowen -- Analyst

Hey. So, I had a couple questions, and I apologize, I'm certain you addressed this in the opening remarks, but I was late to the call. The EBITDA represented by the SMIT portion of the contract, did you quantify that or can you do so now, for my benefit?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Yeah. So, this is John here, Gautam. So, again, in the spirit of trying to provide as much transparency, right, we're trying to make sure people understand the NGEN, SMIT component. So, in my prepared remarks, it was effectively about 500 bps lower then our Q3, if you will, year-to-date EBITDA which was roughly 17.5%. So, reasons are, again, that component, I think, as you know has minimal capital intensity and it had been benefiting right from end of the program efficiencies. Mac?

Mac Curtis -- President and Chief Executive Officer

So, we are running this program -- this particular program for seven years. And so as you would expect there you get pretty efficient with what you're doing and how you operate the program, I think it was to John's point.

Gautam Khanna -- Cowen -- Analyst

Got it. So, is 12.5% EBITDA margins on a revenue base of how much on an annual basis?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Yeah. So, what we provided here in the prepared remarks, it's roughly, if you will, 18% to 19% of our revenue. So, you've seen our revenue range. You can assume through the midpoint-ish that's why we provided. Got it.

Gautam Khanna -- Cowen -- Analyst

Great. Yeah. Thank you. I apologize.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Sure.

Gautam Khanna -- Cowen -- Analyst

For making you repeat that. As a follow-up, have you been debriefed yet by the customer? And do you have a sense for maybe whether this is something you're likely to protest or maybe we'll keep the business longer as that process plays out or when do you get debriefed and when do you make that decision?

Mac Curtis -- President and Chief Executive Officer

Yeah. So, that's a good question, Gautam. So, our debrief is scheduled for February 24. And so just by way of process what happens, you have debrief on February 24, you've got about five days to decide, or you want protest or not. And frankly, where do you want to protest to. You can protest to the agency which would be the Navy, you can protest to GAO or you can protest the Court of Federal Claims. Historically, in our space, most protest to GAO and that's a separate process where normally they go through this 100-day valuation. There is a lot of to and fro between the GAO, the attorneys and the agency to kind of figure out what's what.

And at some point in that period of time, they provide an opinion back to the agency. So, that's kind of in the services piece, that's kind of where you go. So, from our view, look, we've got a mission to continue to deliver on. We'll go through the debrief and we'll make a decision that you always have stated before, stated in the last call. You go into a debrief to learn exactly what happened, why it happened and where you are right, where you are wrong. And then you make -- you hopefully come out knowing more than you went in with and then you make a decision accordingly. So, you're probably looking at just by schedule somewhere which would be the 29 February, which is actually a data issue, because it's a leap year. So, that's kind of the way we think about it. Is that helpful?

Gautam Khanna -- Cowen -- Analyst

Yeah. That's extremely helpful. And somebody asked it earlier and I apologize, but just are there any other linkages we should think about, you mentioned the free cash flow impact, are there any other linkages that we should think about indirect that affect wrap rates or your broader competitiveness elsewhere, if in fact this business does go away for good just thoughts about kind of de-leverage, if you will.

Mac Curtis -- President and Chief Executive Officer

Well, I'm going to turn it over to John to say, but just from the name, if you will, you look at a transition. And then into the -- obviously end versus the previous question about storage. We're not going to go into too much transition, but clearly this is not our first rodeo, when you think about how you would transition a program out. And by the way, that is a nine-month transition, as you may -- you all may or may not know, it is in the PWS, performance work statements for us, if this is the case to transition out. So, you look at how you deal with those costs associated we are running the business. Now, frankly, most of this contract is kind of labor-based and so you deal with it accordingly. We haven't had a debrief yet, don't want to get ahead of ourselves, but there is a process by which you do this, so you deal with the whole cost envelope of running a program like this. So, John, I'll turn it over to you.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Yeah. And I would just echo that Gautam. So, first off, as we said in our prepared remarks, we're under contract through obviously December with being through September with three-month options, we clearly had developed already contingency plans in the event of a SMIT announcement that didn't go our way. The other things I would comment on from any kind of stranded or overhead absorption, a lot of the people are on customer-owned facilities. We would immediately, clearly, right size the indirect structure and we've got again a very demonstrated proven ability to be very disciplined and cost takeout. So, I feel good about where we are relative to plans we had in place.

Mac Curtis -- President and Chief Executive Officer

And I think the follow-on to that Gautam would be, look, we've got hundreds of -- we've got thousand -- plenty of jobs, opened of plenty work for most of it, many of this workforce, because I mean, look, we just -- it's hundreds and hundreds and hundreds of people we're hiring now. These are Perspecta employees, many of them have worked on this program for a long time, and we think about our family first to move employees from one program to other. The stuff -- things happen in this business. We do a great job of moving employees around. So, we got a great core of a really smart people who've done a really good job that we've got plenty of work for in the business on direct contract.

Gautam Khanna -- Cowen -- Analyst

Okay. No. That's very helpful. And maybe to change the subject and I apologize, but there was a recent report that the DoD had kind of whittled the backlog of background investigations to just over $200,000, down from whatever it was $700,000-plus, a couple of years back. I was wondering, how does -- you guys have talked about that business being kind of strong and there is an opportunity to pick up share. I was wondering, if you could elaborate what your expectations for that base of businesses over the next couple of years because that was another thing that has gotten people nervous when they look at those headline backlog numbers. Just how do we -- how should we think of a broader context for Perspecta on that?

Mac Curtis -- President and Chief Executive Officer

Yeah, so, let me get -- that's a good question. And so, again, although, we constantly talk about not talking about specific contract with the portfolio where we're doing it today. And again, when we think about the background investigation business what is going on and we've been very transparent about this. I mean, we talked about it in previous quarter. At one point, the backlog and 2018 and 2019 got up to $720,000. And so obviously, we got a lot of attention on Capitol Hilland. And so, we are one of the mainstays helping the government work that backlog down to something of close to about $200,000, $220,000.

So, now, we are in a steady state inventory. And we basically said, look, we'll never see those kind of numbers and from FY '18 and FY '19, it was a surge capacity. We helped the government deal with that problem and now we're comeback to steady state. I think, a couple of key points here is in their steady state, it is always going to be between $200,000 and $220,000, because you have people coming in and people going out. So, I think, that's one of the things that we are seeing, we manage this business by portfolio. And as John said, the ups and downs in this particular business around our FY '20 guidance. And so that's the way we think about looking at the business.

Now, a couple of other comments about this. And is in this, $200,000-plus one of the things that is it -- is the nuance is the complexity of the cases, the type of cases, whether it is top secret to confidential, that sort of the complexity of cases hasn't changed since over the last couple of years. So, this $200,000 case backlog are as complex and similar to what it was before. I think, that's an important point to make when you think about the revenue and the cost of doing background investigation. So, I think, we may need some more explanation on that offline, but that's a fact. And I think we can sort of talk about that. I think, nothing to kind of continue, we know that this is -- frankly, we manage by portfolio. This was clearly a headwind going in into Q4, and again, we manage by portfolio, 400 contracts in the main.

Couple other things that I will tell you. This process as it moves from the ALS [Phonetic] Personnel Management to the Defense Counterintelligence agency will see the largest change over the last 50 years. It is getting completely realigned. While, there always be background investigations, the notion of a couple of things, moving to DCSA, you've got this continuous evaluation, continuous vetting process. And then you've got the whole notion and the mission of DCSA being responsible for insider threat.

So, there are a lot of opportunities in this business. This market is changing. There is no question about it. And we are right there, it's one of the four key strategic initiatives we've got is trusted workforce 2.0. So, they are building new systems to deal with AI and machine learning. We are building that system. And we're looking at how this industry is going to morph itself into more electronic-based, as well as leveraging the workforce in the field to deal with issues associated with continuous evaluation continuous vetting.

So, I think, kind of more news at 11, the customer is working through these details, but we see this as a huge opportunity, it's changing. It's not the way it was 50 years ago and I think we're riding along with that and we look at this again as part of managing the portfolio and the guidance going forward. That's a long-winded answer to your question. But I think there is more to it, there is a lot more to it than just saying, hey, it was up in '18 and '19 as debt. Well, we know that. We predicted that we've been talking about that. So, there is a steady state and there are a lot of opportunities in this market. Sorry, for the long-winded answer.

Gautam Khanna -- Cowen -- Analyst

No. I appreciate the color. Thank you very much, guys, and best of luck.

Mac Curtis -- President and Chief Executive Officer

Thanks, Gautam.

Operator

Our next question comes from Matt Sharpe of Morgan Stanley. Please go ahead.

Matt Sharpe -- Morgan Stanley -- Analyst

Yes. Good evening, gentlemen.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Hi, Matt.

Matt Sharpe -- Morgan Stanley -- Analyst

[Indecipherable] for John. Can you guys just help us understand the dynamic we're observing in funded versus unfunded backlog. I think, while total backlog was up notably per the 1.4 times book-to-bill, I think, funded year-over-year was down some 20% or so. Is there a sort of duration shift that's going on or some sort of customer buying pattern that's shifting here that's driving that?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Hey, Matt. This is John. So, yeah, so obviously our backlog right now is about $13.3 billion funded right now effectively about $1.8 billion. There is always kind of snapshot dynamics on a funded amount in general though, OK. What's important to us as you see the kind of business development results that we have been driving, OK. You see what amount has been new, OK. So we feel good about continuing to grow this moving forward. But there are a multiple dynamics that you can get into, but the key is continuing to drive the book-to-bills, continuing the percentage of new and continuing the momentum that we've been demonstrating.

Mac Curtis -- President and Chief Executive Officer

And again, to add to John when we put the total contract value in it, very, very, very, very seldom, do we see an option not being exercised. In some cases, it may be year end money that's operation and maintenance versus other procurement dollars. So, it's a -- in a color money, it's a confusing picture, but no, we don't read a whole lot into that at all. It's more timing than it is anything else as opposed to commitment.

Matt Sharpe -- Morgan Stanley -- Analyst

Okay. Got it. Thanks. That helps. And then just on the hardware pieces engine. Are you guys experiencing any headwind at this point in time or degradation to revenue or is that more of a 4Q event when HPI starts to ramp in? And have you guys quantified or can you quantify what to expect in terms of the headwind from that component to the engine contract?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Yeah. So, this is John, Matt, then I'll turn it over to Mac. So, on the end-user hardware component that you're referring to as we talked about previously, we're working very closely with HPI and work has been going fine. That's not impacted by the SMIT announcement and things are going fine there. I won't get into specific level contract detail on that, because that is not our normal practice. Obviously, we provided it for SMIT to provide transparency for baselining, but we're basically moving forward HPI. Mac?

Mac Curtis -- President and Chief Executive Officer

Yeah. I think and as we go in this transition period, a lot of this is being done under the support to HPI is being done under the existing contract. Now, we're not buying the hardware per se that HPI's buying, but we are doing the integration, we are touching the network and we'll continue to do that. In fact, we just got a four-month extension. From the Navy under our existing contract it's just the NGEN contract to continue HPI get engaged and kind of a lot of what they need to do going forward. So, it's a healthy relation. The commission is all about making sure we support the Navy. I mean, that's first and foremost and so good relationship with HPI and we'll continue to make sure we help them be successful and EU end-user [Phonetic] hardware.

Matt Sharpe -- Morgan Stanley -- Analyst

Got it. Thanks, gentlemen. Appreciate it.

Mac Curtis -- President and Chief Executive Officer

Yeah.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Thanks, Matt.

Operator

[Operator Instructions] And our next question is a follow-up from Gavin Parsons of Goldman Sachs. Please go ahead.

Gavin Parsons -- Goldman Sachs -- Analyst

Hey. Thanks for the follow-up. Yeah. Thanks. If I look at total free cash flow this year going into next year, excluding NGEN. Do you think you can grow free cash flow next year or maybe asked another way, are there any kind of big one time helps or headwinds this year that don't recur next year. Thanks.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

So, what I would say right now, Gavin, obviously, we're not going to talk about FY '21 guidance on this call, we'll certainly be talking about on our fourth quarter call. But what I would say is as follows. You've seen since we've been a company, what we've been able to do there. We have industry-leading operational DSOs, OK. We do a excellent job in working capital management, OK. We are a cash generating machine, we've just taken up again this year, right, from 105% plus to 110% plus. So, as I said in my prepared remarks, OK, relative to the business, if you will, excluding network SMIT I'm confident, OK. We're going to continue to grow. We're going to continue to have a laser focus on cash generation. So, again, we'll be providing guidance at another point in time, but I like what we're doing in the business, we had a lot of good discipline and a lot of good focus.

Gavin Parsons -- Goldman Sachs -- Analyst

Got it. And then if you don't mind, maybe just updating us on capital deployment priorities, you mentioned the change in leverage from the decline in NGEN EBITDA contribution?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Sure. So, from a capital allocation, we will continue a balanced approach. Obviously, we're going to remain focused on, obviously, deleveraging and you heard what we did in the quarter, we paid $149 million in debt. We got the leverage down to 3.1 times per our credit agreement. We will continue to return capital to shareholders, right. It's a key part of our allocation strategy. We'll remain opportunistic, if you will, on the buybacks. So what we did in the quarter and we will continue to pursue tuck-ins, we'll be very selective and strategic. So, overall, my message would be, we will remain responsible and disciplined in capital allocation. We've got good financial flexibility and we're going to continue to drive this business.

Gavin Parsons -- Goldman Sachs -- Analyst

Got it. And then Mac, appreciate all the color on background investigations. Can I ask what that did this quarter, up, down, year-over-year, sequentially?

John Kavanaugh -- Senior Vice President and Chief Financial Officer

So, again, as we've talked about right as Mac said multiple times now, we always knew FY '19 would be a high watermark, we knew that would be higher than FY '20 and we would see some obviously trending down. It is a headwind going into Q4, it is already embedded in our FY '20 guidance. We feel very excited about the future for reasons Mac talked about.

Gavin Parsons -- Goldman Sachs -- Analyst

Got it. And then maybe on that front, if you could just address you mentioned the additional software, some of the work you're doing there is, and then obviously the more complex investigations. I mean, are there -- is the cost per investigation moving up at a pretty significant clip, because if I look at the total investigators that seems to be down by about 15% over the last three quarters.

Mac Curtis -- President and Chief Executive Officer

Yeah. I think what -- I think what I would tell you and as we talk about this, and with customer, that the cost is about the same, Gavin, it is my point. And, again, I think that -- and it's primarily the rationale, because we are still in that -- we still haven't gotten into the movement of CE/CV. There's still a lot of PRs, the primary evaluation. And that's kind of getting hung up a little bit, too. I won't get too detailed here. So, if you think about the $200,000, what I'm saying is the mix is about the same as the $200,000 as it was primarily before you got to $700,000 and, therefore, the prices really haven't changed much and the cost hasn't changed much. And look, we are happy to go offline and give you a kind of a lot more detail on this. And I think we've talked about that and so that might be worthwhile because that's what the -- when you dig into the background information, that's what it shows is the prices are primitive. The backlog has come down, inventories is having about $200,000 plus, but we're not seeing much change in the -- historically, in the costs.

Gavin Parsons -- Goldman Sachs -- Analyst

Okay. That's helpful. Thanks a lot.

Mac Curtis -- President and Chief Executive Officer

Yeah.

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Thanks, Gavin.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Michael Pici for any closing remarks.

Michael Pici -- Vice President, Investor Relations

Operator, thank you for your assistance with today's call, and thank you all for your interest in Perspecta and look forward to speaking with you soon.

Operator

[Operator Closing Remarks]

Duration: 46 minutes

Call participants:

Michael Pici -- Vice President, Investor Relations

Mac Curtis -- President and Chief Executive Officer

John Kavanaugh -- Senior Vice President and Chief Financial Officer

Gavin Parsons -- Goldman Sachs -- Analyst

Gautam Khanna -- Cowen -- Analyst

Matt Sharpe -- Morgan Stanley -- Analyst

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