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Section 1: 10-Q (FORM 10-Q)

Document
UNITED STATES
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 December 31, 2019
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ____________

Commission File Number: 001-38033
402771097_perslogopriblutmrgba38.jpg
PERSPECTA INC.
(Exact Name of Registrant as Specified in Its Charter)
 
 
 
 
Nevada
82-3141520
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
15052 Conference Center Drive, Chantilly, Virginia
20151
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code: (571) 313-6000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value per share
PRSP
New York Stock Exchange

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.  x Yes  o No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). x Yes  o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  o
Accelerated filer o
Non-accelerated filer x
Smaller reporting company o    
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

161,471,817 shares of common stock, par value $0.01 per share, were outstanding as of January 31, 2020.



EXPLANATORY NOTE

On May 31, 2018, Perspecta Inc. (together with its consolidated subsidiaries for all periods following the spin-off defined below, “Perspecta”) became an independent company through the consummation of the spin-off (the “Spin-Off”) of the United States Public Sector business (“USPS”) of DXC Technology Company (“DXC”). Following the Spin-Off and pursuant to an Agreement and Plan of Merger dated October 11, 2017 (the “Merger Agreement”), on May 31, 2018, Perspecta completed the combination of USPS with Vencore Holding Corp. (“Vencore HC”) and KGS Holding Corp. (“KGS HC”) (the “Mergers”). As a result of these transactions, the businesses owned by Vencore HC and KGS HC became wholly owned by Perspecta. For further information about the Mergers, please refer to our Annual Report on Form 10-K for the year ended March 31, 2019.

Because the Spin-Off and the Mergers were not consummated until May 31, 2018, the unaudited Condensed Consolidated Combined Financial Statements presented in this Quarterly Report on Form 10-Q include only the legacy USPS activity for the period from April 1, 2018 to May 31, 2018, and Perspecta, including entities acquired in the Mergers, from June 1, 2018 through December 31, 2018 and April 1, 2019 through December 31, 2019.

In this Quarterly Report on Form 10-Q, unless the context otherwise requires, all references to “Vencore” are to Vencore HC, KGS HC, and their respective subsidiaries on a combined basis. The term “Parent” refers to DXC for the period from April 1, 2018 to May 31, 2018. In addition, “the Company,” “we,” “our” and “us” refer to USPS for the period from April 1, 2018 to May 31, 2018, before giving effect to the Spin-Off and Mergers, and to Perspecta and its consolidated subsidiaries, including the combined business of Vencore HC and KGS HC, after giving effect to the Spin-Off and the Mergers beginning June 1, 2018.




TABLE OF CONTENTS

Item
 
 
Page
 
 
 
 
 
 
 
1.
 
2.
 
3.
 
4.
 
 
 
 
 
 
 
 
 
 
 
 
1.
 
1A.
 
2.
 
3.
 
4.
 
5.
 
6.
 
 
 
 
 
 
 


Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Index to Condensed Consolidated Combined Financial Statements (unaudited)
 
Page
 

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PERSPECTA INC.
CONDENSED CONSOLIDATED COMBINED STATEMENTS OF OPERATIONS
(unaudited)

 
 
Three Months Ended
 
Nine Months Ended
(in millions, except per share amounts)
 
December 31, 2019
 
December 31, 2018
 
December 31, 2019
 
December 31, 2018
Revenue
 
$
1,126

 
$
1,075

 
$
3,405

 
$
2,936

 
 
 
 
 
 
 
 
 
Costs of services
 
863

 
816

 
2,607

 
2,226

Selling, general and administrative
 
77

 
76

 
230

 
226

Depreciation and amortization
 
92

 
76

 
283

 
214

Restructuring costs
 

 
1

 
4

 
3

Separation, transaction and integration-related costs
 
20

 
19

 
59

 
84

Interest expense, net
 
34

 
37

 
105

 
84

Other (income) expense, net
 
(35
)
 
2

 
(37
)
 
(26
)
Total costs and expenses
 
1,051

 
1,027

 
3,251

 
2,811

 
 
 
 
 
 
 
 
 
Income before taxes
 
75

 
48

 
154

 
125

Income tax expense
 
22

 
10

 
41

 
34

Net income
 
$
53

 
$
38

 
$
113

 
$
91

 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
  Basic
 
$
0.33

 
$
0.23

 
$
0.70

 
$
0.55

  Diluted
 
$
0.33

 
$
0.23

 
$
0.69

 
$
0.55


The accompanying notes are an integral part of these unaudited condensed consolidated combined financial statements.

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PERSPECTA INC.
CONDENSED CONSOLIDATED COMBINED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)

 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
December 31, 2019
 
December 31, 2018
 
December 31, 2019
 
December 31, 2018
Net income
 
$
53

 
$
38

 
$
113

 
$
91

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Cash flow hedge adjustments, net of tax
 
7

 
(18
)
 
(14
)
 
(13
)
Comprehensive income
 
$
60

 
$
20

 
$
99

 
$
78



The accompanying notes are an integral part of these unaudited condensed consolidated combined financial statements.

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PERSPECTA INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(in millions, except per share and share amounts)
 
December 31, 2019
 
March 31, 2019
ASSETS
 
 
 

Current assets:
 
 
 
 
Cash and cash equivalents
 
$
69

 
$
88

Receivables, net of allowance for doubtful accounts of $1 and $0
 
526

 
484

Other receivables
 
45

 
92

Prepaid expenses
 
115

 
141

Other current assets
 
89

 
73

Total current assets
 
844

 
878

Property and equipment, net of accumulated depreciation of $182 and $148
 
326

 
368

Goodwill
 
3,294

 
3,179

Intangible assets, net of accumulated amortization of $460 and $299
 
1,422

 
1,466

Other assets
 
303

 
192

Total assets
 
$
6,189

 
$
6,083

LIABILITIES and STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Current maturities of long-term debt
 
$
88

 
$
80

Current finance lease obligations
 
116

 
137

Current operating lease obligations
 
41

 

Accounts payable
 
206

 
246

Accrued payroll and related costs
 
146

 
91

Accrued expenses
 
372

 
396

Other current liabilities
 
58

 
64

Total current liabilities
 
1,027

 
1,014

Long-term debt, net of current maturities
 
2,294

 
2,297

Non-current finance lease obligations
 
155

 
168

Deferred tax liabilities
 
171

 
171

Other long-term liabilities
 
336

 
271

Total liabilities
 
3,983

 
3,921

Commitments and contingencies
 


 


Stockholders’ equity:
 
 
 
 
Common stock, par value $0.01 per share; 750,000,000 shares authorized; 166,218,067 and 165,844,994 shares issued; 161,532,459 and 163,099,080 shares outstanding
 
2

 
2

Additional paid-in capital
 
2,264

 
2,242

Retained earnings
 
85

 
2

Accumulated other comprehensive loss
 
(37
)
 
(23
)
Treasury stock at cost, 4,685,608 shares and 2,745,914 shares
 
(108
)
 
(61
)
Total stockholders’ equity
 
2,206

 
2,162

Total liabilities and stockholders’ equity
 
$
6,189

 
$
6,083


The accompanying notes are an integral part of these unaudited condensed consolidated combined financial statements.

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PERSPECTA INC.
CONDENSED CONSOLIDATED COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)

(in millions, except shares in thousands and per share amounts in ones)
Common Stock
Additional
Paid-in Capital
Retained Earnings
Accumulated Other
Comprehensive Loss
Treasury Stock
Total Stockholders’ Equity
Shares
 
Amount
Balance at March 31, 2019
165,845

 
$
2

$
2,242

$
2

$
(23
)
$
(61
)
$
2,162

Net income

 


31



31

Other comprehensive loss, net of tax

 



(18
)

(18
)
Stock-based compensation

 

5




5

Repurchases of common stock

 




(15
)
(15
)
Stock option exercises and other common stock transactions
42

 






Dividends declared ($0.06 per common share)

 


(10
)


(10
)
Balance at June 30, 2019
165,887

 
2

2,247

23

(41
)
(76
)
2,155

Net income

 


29



29

Other comprehensive loss, net of tax

 



(3
)

(3
)
Stock-based compensation

 

10




10

Repurchases of common stock

 




(17
)
(17
)
Stock option exercises and other common stock transactions
100

 




(1
)
(1
)
Dividends declared ($0.06 per common share)

 


(10
)


(10
)
Balance at September 30, 2019
165,987

 
2

2,257

42

(44
)
(94
)
2,163

Net income

 


53



53

Other comprehensive income, net of tax

 



7


7

Stock-based compensation

 

6




6

Repurchases of common stock

 




(13
)
(13
)
Stock option exercises and other common stock transactions
231

 

1



(1
)

Dividends declared ($0.06 per common share)

 


(10
)


(10
)
Balance at December 31, 2019
166,218

 
$
2

$
2,264

$
85

$
(37
)
$
(108
)
$
2,206

(in millions, except shares in thousands and per share amounts in ones)
Common Stock
Additional
Paid-in Capital
Retained Earnings (Accumulated Deficit)
Accumulated Other
Comprehensive Income (Loss)
Treasury Stock
Parent Company Investment
Total Stockholders’ Equity
Shares
 
Amount
Balance at March 31, 2018

 
$

$

$

$

$

$
2,729

$
2,729

Impact of adoption of new accounting standard

 





4

4

Net income

 





49

49

Transfers to Parent, net

 





(145
)
(145
)
Balance at May 31, 2018

 





2,637

2,637

Dividend to DXC prior to May 31, 2018

 

(984
)




(984
)
Spin-Off activity
142,426

 
2

2,635




(2,637
)

Mergers activity
23,273

 

578





578

Net loss

 


(20
)



(20
)
Other comprehensive loss, net of tax

 



(1
)


(1
)
Dividends declared ($0.05 per common share)

 

(8
)




(8
)
Balance at June 30, 2018
165,699

 
2

2,221

(20
)
(1
)


2,202

Net income

 


24




24

Other comprehensive income, net of tax

 



6



6

Stock-based compensation

 

1





1

Repurchases of common stock
(923
)
 




(23
)

(23
)
Stock option exercises and other common stock transactions
43

 

1





1

Dividends declared ($0.05 per common share)

 

(4
)
(4
)



(8
)
Balance at September 30, 2018
164,819

 
2

2,219


5

(23
)

2,203

Net income

 


38




38

Other comprehensive loss, net of tax

 



(18
)


(18
)
Stock-based compensation

 

4





4

Repurchases of common stock
(967
)
 




(21
)

(21
)
Stock option exercises and other common stock transactions
50

 

1



(1
)


Dividends declared ($0.05 per common share)

 


(9
)



(9
)
Balance at December 31, 2018
163,902

 
$
2

$
2,224

$
29

$
(13
)
$
(45
)
$

$
2,197


The accompanying notes are an integral part of these unaudited condensed consolidated combined financial statements.

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PERSPECTA INC.
CONDENSED CONSOLIDATED COMBINED STATEMENTS OF CASH FLOWS
(unaudited)
 
 
Nine Months Ended
(in millions)
 
December 31, 2019
 
December 31, 2018
Cash flows from operating activities:
 
 
 
 
Net income
 
$
113

 
$
91

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
283

 
214

Stock-based compensation
 
21

 
7

Deferred income taxes
 
4

 
(17
)
Gain on sale or disposal of assets, net
 
(23
)
 
(25
)
Other non-cash charges, net
 
3

 
(13
)
Changes in assets and liabilities, net of effects of acquisitions:
 
 
 
 
Receivables, net
 
49

 
78

Prepaid expenses and other current assets
 
38

 
(22
)
Accounts payable, accrued expenses and other current liabilities
 
(20
)
 
(23
)
Deferred revenue and advanced contract payments
 
(24
)
 
(13
)
Income taxes payable and liability
 
(6
)
 
20

Other assets and liabilities, net
 
2

 
(3
)
Net cash provided by operating activities
 
440

 
294

Cash flows from investing activities:
 
 
 
 
Payments for acquisitions, net of cash acquired
 
(265
)
 
(312
)
Extinguishment of acquired debt and related costs
 

 
(994
)
Proceeds from sale of assets
 
77

 
25

Purchases of property, equipment and software
 
(11
)
 
(12
)
Payments for outsourcing contract costs
 
(4
)
 
(7
)
Net cash used in investing activities
 
(203
)
 
(1,300
)
Cash flows from financing activities:
 
 
 
 
Principal payments on long-term debt
 
(69
)
 
(82
)
Proceeds from debt issuance
 

 
2,500

Payments of debt issuance costs
 
(3
)
 
(46
)
Proceeds from revolving credit facility
 
175

 
50

Payments on revolving credit facility
 
(125
)
 
(50
)
Payments on finance lease obligations
 
(110
)
 
(124
)
Repurchases of common stock
 
(46
)
 
(43
)
Repurchases of common stock to satisfy tax withholding obligations
 
(2
)
 
(1
)
Dividend to DXC
 

 
(984
)
Dividends paid to Perspecta stockholders
 
(28
)
 
(17
)
Net transfers to Parent
 

 
(88
)
Net cash (used in) provided by financing activities
 
(208
)
 
1,115

Net change in cash and cash equivalents, including restricted
 
29

 
109

Cash and cash equivalents, including restricted, at beginning of period
 
99

 

Cash and cash equivalents, including restricted, at end of period
 
128

 
109

Less restricted cash and cash equivalents included in other current assets
 
59

 
9

Cash and cash equivalents at end of period
 
$
69

 
$
100

Supplemental cash flow disclosures:
 
 
 
 
Interest paid
 
$
97

 
$
84

Income taxes paid, net
 
11

 
25

Supplemental schedule of non-cash investing and financing activities:
 
 
 
 
Leased assets acquired through finance lease obligations
 
$
69

 
$
104

Leased assets acquired through operating lease obligations
 
47

 

Dividends declared but not yet paid
 
10

 
8

Stock issued for the acquisition of Vencore
 

 
578


The accompanying notes are an integral part of these unaudited condensed consolidated combined financial statements.

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PERSPECTA INC.
NOTES TO CONDENSED CONSOLIDATED COMBINED FINANCIAL STATEMENTS (unaudited)


Note 1Overview and Basis of Presentation

Background

Perspecta is a leading provider of end-to-end enterprise information technology (“IT”), mission, and operations-related services across the United States (“U.S.”) federal government to the Department of Defense (“DoD”), the intelligence community, and homeland security, civilian and health care agencies, as well as to certain state and local government agencies through two reportable segments: (1) Defense and Intelligence, which provides services to the DoD, intelligence community, branches of the U.S. Armed Forces, and other DoD agencies, and (2) Civilian and Health Care, which provides services to the Departments of Homeland Security, Justice, and Health and Human Services, as well as other federal civilian and state and local government agencies.

The accompanying unaudited condensed consolidated combined financial statements and notes present the combined results of operations, financial position, and cash flows of USPS for the periods prior to the completion of the Spin-Off and the combination with Vencore HC and KGS HC. Accordingly, the term “Parent” refers to DXC for periods from April 1, 2018 to May 31, 2018. As used in these notes, “the Company,” “we,” “us,” and “our” refer to the combined businesses of USPS for the period from April 1, 2018 through May 31, 2018, and to Perspecta and its consolidated subsidiaries for the periods from June 1, 2018 through December 31, 2018 and April 1, 2019 through December 31, 2019.

Basis of Presentation

The accompanying unaudited condensed consolidated combined financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). As discussed above, the Spin-Off and the Mergers were not consummated until May 31, 2018. In the period prior to consummation of the Spin-Off and Mergers, these financial statements include the combined financial statements of USPS, derived from the consolidated combined financial statements and accounting records of Parent as if USPS were operated on a stand-alone basis during the periods presented and were prepared in accordance with GAAP and, subsequent to the Spin-Off and Mergers, these financial statements represent the consolidated financial statements of Perspecta and its subsidiaries. Accordingly, the accompanying unaudited financial statements are presented as described below.
The period prior to the Spin-Off and Mergers includes the combined financial results and cash flows of USPS for the period from April 1, 2018 to May 31, 2018. The periods subsequent to the Spin-Off and Mergers include:

the consolidated financial statements of Perspecta for the period from June 1, 2018 to December 31, 2018;
the consolidated financial statements of Perspecta for the period from April 1, 2019 to December 31, 2019; and
the consolidated financial position of Perspecta as of December 31, 2019 and March 31, 2019.
 
After the Spin-Off, DXC does not have any beneficial ownership of Perspecta or USPS. The chairman of the board of directors of Perspecta (the “Board of Directors”) is the former chief executive officer of DXC and served as the chairman of the DXC board of directors until December 31, 2019. Consequently, transactions prior to December 31, 2019 between DXC and Perspecta are reflected as related party transactions pursuant to the disclosure requirements of Accounting Standards Codification (“ASC”) Topic 850, Related Party Disclosures. For additional information about the allocation of expenses from DXC prior to the Spin-Off and certain continuing responsibilities between the Company and DXC, see Note 13 – “Related Party Transactions.”

Principles of Consolidation and Combination

The unaudited condensed consolidated combined financial statements as of and for the three and nine months ended December 31, 2019 and 2018 reflect the financial position and results of operations of the Company and its consolidated subsidiaries. The combined financial statements as of and for periods prior to the consummation of the Spin-Off, reflect the financial position and results of operations of USPS as described above.

The financial statements for the periods prior to the Spin-Off are prepared on a carved-out and combined basis from the financial statements of DXC. The unaudited condensed consolidated combined statements of operations of USPS reflect allocations of general corporate expenses from DXC, including, but not limited to, executive management, finance, legal, IT, employee benefits administration, treasury, risk management, procurement and other shared services. These

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allocations were made on a direct usage basis when identifiable, with the remainder allocated on the basis of revenue, expenses, headcount or other relevant measures. Management of Perspecta considers these allocations to be a reasonable reflection of the utilization of services by, or the benefits provided to, USPS. The allocations may not, however, reflect the expense USPS would have incurred as a stand-alone company for the periods presented. Actual costs that may have been incurred if USPS had been a stand-alone company would depend on a number of factors, including the chosen organizational structure, what functions were outsourced or performed by employees and strategic decisions made in areas such as IT and infrastructure.

Prior to consummation of the Spin-Off, USPS generated cash in the normal course of its business. Parent swept the cash USPS generated via transfers to Parent’s cash management system. Parent’s receivables sales facility and long-term debt, other than capital lease obligations, have not been attributed to USPS for the periods prior to consummation of the Spin-Off because Parent’s borrowings were not the legal obligation of USPS.

The unaudited condensed consolidated combined financial statements for prior periods, included herein, may not be indicative of the financial position, results of operations and cash flows of the Company in the future or if USPS had been operated as a consolidated group during all periods presented.
In the opinion of management of the Company, the accompanying interim unaudited condensed consolidated combined financial statements contain all adjustments, including normal recurring adjustments, necessary to present fairly our results of operations and cash flows.
Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.

Amounts subject to significant judgment and/or estimates include, but are not limited to, determining the fair value of assets acquired and liabilities assumed, the evaluation of impairment of goodwill and other long-lived intangible assets, costs to complete fixed-price contracts, fair value, certain deferred costs, valuation allowances on deferred tax assets, loss accruals for litigation, and inputs used for computing stock-based compensation and pension related liabilities. These estimates are based on management’s best knowledge of historical experience, current events, and various other assumptions that management considers reasonable under the circumstances.

Reclassifications

Certain prior period balances in the accompanying financial statements have been reclassified to conform to the current period presentation. These reclassifications had no impact on total assets, total liabilities, total equity, income before taxes or net income.

Note 2Recent Accounting Pronouncements

Recently Adopted Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842) Section A—Leases (“ASU 2016-02”). ASU 2016-02, along with related amendments (“ASC 842”), requires lessees to record, at lease inception, a lease liability for the obligation to make lease payments and a right-of-use (“ROU”) asset for the right to use the underlying asset for the lease term on their balance sheets. Management developed a detailed implementation plan, which included, among other things, implementation of a new lease accounting system, an update to our policies, development of disclosures, evaluation of our controls, and application of the guidance across our contract population. The Company adopted the standard on April 1, 2019 using the optional transition method. Under this method, the Company applied the standard through a cumulative-effect adjustment in the period of adoption. In addition, the Company has elected to adopt additional practical expedients, including combining lease and non-lease components, applying the discount rate to a portfolio of leases with similar lease durations based on the original lease duration, and maintaining prior lease classification upon adoption. The adoption of ASC 842 resulted in the recognition of $114 million and $130 million of ROU assets and lease liabilities, respectively, on our balance sheet related to operating leases. The adoption did not have a material impact on our statements of operations, changes in stockholders’ equity or cash flows. See Note 10 – “Leases” for further details.

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Recently Issued Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). The guidance, along with related amendments, changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective April 1, 2020 for Perspecta, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. The Company has determined that ASU 2016-13 will not have a material effect on Perspecta’s financial statements upon adoption on April 1, 2020, given the concentration of receivables with the U.S. government.

In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350- 40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 provides guidance for determining when a cloud computing arrangement includes a software license and makes changes to the requirements for capitalizing implementation costs incurred in a hosting arrangement that is as a service contract. The amendment is effective April 1, 2020 for Perspecta, and early adoption is permitted. The update should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company will adopt ASU 2018-15 on April 1, 2020 and is currently evaluating the method and impact of adoption on its financial statements and related disclosures.

Other recently issued ASUs effective after December 31, 2019 are not expected to have a material effect on Perspecta’s financial statements.

Note 3Acquisitions

Knight Point Systems, LLC

On July 31, 2019, Perspecta acquired all of the equity interests of Knight Point Systems, LLC (“Knight Point”) for $250 million plus customary purchase price adjustments, initially estimated at a total of $265 million and currently estimated at $264 million. Knight Point delivers end-to-end managed services and solutions focused on modernizing IT systems, protecting critical networks and driving digital transformation to improve customer transparency and operational efficiency. Knight Point leverages a portfolio of intellectual property to solve complex customer challenges in cloud, cybersecurity and agile development and operations (“DevOps”) environments.

The Company recognized preliminary fair values of the assets acquired and liabilities assumed and allocated $116 million to goodwill and $125 million to intangible assets. The goodwill is largely attributable to the assembled workforce of Knight Point and expected synergies between the Company and Knight Point. The Company’s preliminary allocation of goodwill to Perspecta’s reportable segments was as follows: $22 million allocated to Defense and Intelligence and $94 million allocated to Civilian and Health Care. The intangible assets consist primarily of program assets of $102 million, developed technology of $18 million and backlog of $5 million. The estimated fair value attributed to intangible assets is being amortized on an accelerated basis over a range of 10 to 12 years for program assets, seven years for developed technology and one year for backlog. The fair value attributed to the intangible assets acquired was based on preliminary estimates, assumptions, and other information compiled by management, including independent valuations that utilized established valuation techniques. All of the value attributed to goodwill and intangible assets is deductible for income tax purposes. The fair values of assets acquired and liabilities assumed are preliminary and based on a valuation using estimates and assumptions that are subject to change, which could result in material changes to the purchase price allocation. The final purchase price allocation is expected to be completed by the first quarter of fiscal year 2021, pending analysis of certain tax adjustments.

The results of operations of Knight Point have been included in the statements of operations beginning August 1, 2019. Pro forma results of operations for this acquisition have not been presented as it is not material to the consolidated results of operations. The acquisition was considered an asset purchase for tax purposes.

Unaudited Pro Forma Financial Information for the Spin-Off and the Mergers

The following unaudited pro forma financial information presents results as if the Spin-Off and the Mergers and the related financing had occurred on April 1, 2017. The historical consolidated financial information of Perspecta has been adjusted in the pro forma information to give effect to the events that are (1) directly attributable to the transactions, (2) factually

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supportable and (3) expected to have a continuing impact on the combined results. The effects of the Spin-Off are primarily attributable to interest expense associated with the incurrence of debt in connection with the Spin-Off. The effects of the Mergers primarily relate to amortization of acquired intangible assets. The consolidated financial information of Perspecta includes merger and integration-related costs that are not expected to recur and impact the combined results over the long term. The unaudited pro forma results do not reflect future events that have occurred or may occur after the transactions, including but not limited to, the impact of any actual or anticipated synergies expected to result from the Mergers. Accordingly, the unaudited pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transactions been effected on April 1, 2017, nor is it necessarily an indication of future operating results.
 
 
Nine Months Ended December 31, 2018
Historical
Perspecta(1)
 
Period from April 1, 2018 to May 31, 2018
Historical
Vencore
 
Nine Months Ended December 31, 2018
(in millions, except per share amounts)
 
 
 
Effects of the Spin-Off
 
Effects of the Mergers
 
Pro Forma Combined for the Spin-Off and Mergers
Revenue
 
$
2,936

 
$
244

 
$

 
$

 
$
3,180

Net income (loss)
 
$
91

 
$
(57
)
 
$
(7
)
 
$
12

 
$
39

 
 
 
 
 
 
 
 
 
 
 
Earnings per common share(2):
 
 
 
 
 
 
 
 
 
 
Basic
 
$
0.55

 
 
 
 
 
 
 
$
0.24

Diluted
 
$
0.55

 
 
 
 
 
 
 
$
0.24

(1) Revenue and pre-tax income includes $860 million and $137 million associated with Vencore for the period of June 1, 2018 through December 31, 2018. The pre-tax income excludes amortization of acquired intangible assets, acquisition financing and the allocation of certain corporate overhead costs.
(2) Historical and pro forma combined earnings per common share information is computed based on 165.02 million basic weighted average shares and 165.27 million diluted shares. See Note 5 – “Earnings Per Share.”

Note 4Revenue

Disaggregated Revenue

Revenue by contract type was as follows:
 
 
Three Months Ended December 31, 2019
 
Three Months Ended December 31, 2018
(in millions)
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
Cost-reimbursable
 
$
283

 
$
27

 
$
310

 
$
240

 
$
25

 
$
265

Fixed-price
 
435

 
173

 
608

 
373

 
229

 
602

Time-and-materials
 
95

 
113

 
208

 
96

 
112

 
208

Total
 
$
813

 
$
313

 
$
1,126

 
$
709

 
$
366

 
$
1,075

 
 
Nine Months Ended December 31, 2019
 
Nine Months Ended December 31, 2018
(in millions)
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
Cost-reimbursable
 
$
818

 
$
78

 
$
896

 
$
580

 
$
66

 
$
646

Fixed-price
 
1,218

 
638

 
1,856

 
985

 
699

 
1,684

Time-and-materials
 
306

 
347

 
653

 
283

 
323

 
606

Total
 
$
2,342

 
$
1,063

 
$
3,405

 
$
1,848

 
$
1,088

 
$
2,936


Revenue by prime or subcontractor was as follows:
 
 
Three Months Ended December 31, 2019
 
Three Months Ended December 31, 2018
(in millions)
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
Prime contractor
 
$
762

 
$
290

 
$
1,052

 
$
663

 
$
329

 
$
992

Subcontractor
 
51

 
23

 
74

 
46

 
37

 
83

Total
 
$
813

 
$
313

 
$
1,126

 
$
709

 
$
366

 
$
1,075


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Nine Months Ended December 31, 2019
 
Nine Months Ended December 31, 2018
(in millions)
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
Prime contractor
 
$
2,203

 
$
985

 
$
3,188

 
$
1,740

 
$
979

 
$
2,719

Subcontractor
 
139

 
78

 
217

 
108

 
109

 
217

Total
 
$
2,342

 
$
1,063

 
$
3,405

 
$
1,848

 
$
1,088

 
$
2,936


Revenue by customer type was as follows:
 
 
Three Months Ended December 31, 2019
 
Three Months Ended December 31, 2018
(in millions)
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
U.S. federal government, including independent agencies
 
$
808

 
$
248

 
$
1,056

 
$
707

 
$
302

 
$
1,009

Non-federal (state, local and other)
 
5

 
65

 
70

 
2

 
64

 
66

Total
 
$
813

 
$
313

 
$
1,126

 
$
709

 
$
366

 
$
1,075

 
 
Nine Months Ended December 31, 2019
 
Nine Months Ended December 31, 2018
(in millions)
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
 
Defense and
Intelligence
 
Civilian and
Health Care
 
Total
U.S. federal government, including independent agencies
 
$
2,329

 
$
862

 
$
3,191

 
$
1,843

 
$
893

 
$
2,736

Non-federal (state, local and other)
 
13

 
201

 
214

 
5

 
195

 
200

Total
 
$
2,342

 
$
1,063

 
$
3,405

 
$
1,848

 
$
1,088

 
$
2,936


Performance Obligations

As of December 31, 2019, approximately $3.6 billion of revenue is expected to be recognized from remaining unsatisfied performance obligations on executed contracts. The Company expects to recognize approximately 72% of these remaining performance obligations as revenue within 12 months and approximately 84% within 24 months, with the remainder recognized thereafter.

Contract Balances

Contract assets and contract liabilities were as follows:
(in millions)
 
Balance Sheets Line Item
 
December 31, 2019
 
March 31, 2019
Contract assets:
 
 
 
 
 
 
Unbilled receivables
 
Receivables, net of allowance for doubtful accounts
 
$
335

 
$
301

Contract liabilities:
 
 
 
 
 
 
Current portion of deferred revenue and advance contract payments
 
Other current liabilities
 
$
17

 
$
33

Non-current portion of deferred revenue and advance contract payments
 
Other long-term liabilities
 
5

 
12


Contract assets increased $34 million during the nine months ended December 31, 2019, primarily due to the timing of billings and the acquisition of Knight Point. There were no significant impairment losses related to the Company’s contract assets during the nine months ended December 31, 2019 or 2018.

Contract liabilities decreased $23 million during the nine months ended December 31, 2019, primarily due to revenue recognized in excess of payments received. During the three and nine months ended December 31, 2019, the Company recognized $2 million and $31 million, respectively, of the deferred revenue and advance contract payments at March 31, 2019 as revenue. During the three and nine months ended December 31, 2018, the Company recognized $2 million and $24 million, respectively, of the deferred revenue and advance contract payments at April 1, 2018 as revenue.


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Note 5Earnings Per Share

Basic earnings per common share (“EPS”) is computed using the weighted average number of shares of common stock outstanding during the periods presented. Diluted EPS reflects the incremental shares issuable upon the assumed exercise of stock options and vesting of other equity awards. There were no significant anti-dilutive equity awards excluded from the calculation of EPS for the three and nine months ended December 31, 2019 or 2018.
The following table reflects the calculation of basic and diluted EPS:


Three Months Ended
 
Nine Months Ended
(in millions, except per share amounts)

December 31, 2019
 
December 31, 2018
 
December 31, 2019
 
December 31, 2018
Net income
 
$
53

 
$
38

 
$
113

 
$
91

Common share information:
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
161.69

 
164.32

 
162.24

 
165.02

Dilutive effect of equity awards
 
0.78

 
0.22

 
0.64

 
0.25

Diluted weighted average common shares outstanding
 
162.47

 
164.54

 
162.88

 
165.27

Earnings per common share:
 
 
 
 
 
 
 
 
Basic
 
$
0.33

 
$
0.23

 
$
0.70

 
$
0.55

Diluted
 
$
0.33

 
$
0.23

 
$
0.69

 
$
0.55


Note 6Sale of Receivables

During the three and nine months ended December 31, 2019, we sold $984 million and $2.39 billion, respectively, of billed and unbilled receivables under our receivables sales facility, as compared to $691 million and $2.10 billion during the three and nine months ended December 31, 2018, respectively. The amount outstanding at December 31, 2019 and March 31, 2019 was $239 million and $146 million, respectively. As of December 31, 2019 and March 31, 2019, collections not remitted to the financial institutions corresponding to these receivables sales were $59 million and $11 million, respectively. These amounts represent restricted cash recorded by the Company within the other current assets caption of the balance sheets.

Note 7Fair Value

The Company estimates the fair value of its long-term debt primarily using an expected present value technique, which is based on observable market inputs, using interest rates currently available to the Company for instruments with similar terms and remaining maturities. The estimated fair value of the Company’s long-term debt, excluding finance leases and unamortized debt issuance costs, was $2.40 billion and $2.35 billion as of December 31, 2019 and March 31, 2019, respectively, as compared with the gross carrying value of $2.40 billion and $2.40 billion, respectively. If measured at fair value, long-term debt, excluding finance lease liabilities, would be classified in Level 2 of the fair value hierarchy.
Non-financial assets such as goodwill, tangible assets, intangible assets and other contract related long-lived assets are reduced to fair value in the period an impairment charge is recognized. The fair value measurements, in such instances, would be classified in Level 3. There were no significant impairments recorded during the three and nine months ended December 31, 2019 or 2018.

Note 8Derivative Instruments

In the normal course of business, the Company is exposed to interest rate fluctuations. As part of its risk management strategy, the Company uses derivative instruments, primarily interest rate swaps, to hedge certain interest rate exposures. The Company’s objective is to add stability to interest expense and to manage its exposure to movements in market interest rates. The Company does not use derivative instruments for trading or any speculative purpose.

As of December 31, 2019, the Company had interest rate swap agreements with a total notional amount of $1.60 billion. The Company initially accounted for all changes in fair value of its interest rate swaps on the statements of operations until designation as a cash flow hedge of interest rate risk on June 22, 2018. As a result, the Company recorded a gain of $5 million included in interest expense, net on the statement of operations for the nine months ended December 31, 2018.


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Following the June 22, 2018 cash flow hedge designation, all changes in the hedging instruments’ fair value are recorded in accumulated other comprehensive loss (“AOCL”) and subsequently reclassified into earnings in the period during which the hedged transactions are recognized in earnings. The pre-tax impact of gain on derivatives designated for hedge accounting recognized in other comprehensive income was $10 million ($7 million, net of tax) for the three months ended December 31, 2019. The pre-tax impact of loss on derivatives designated for hedge accounting recognized in other comprehensive loss was $18 million ($14 million, net of tax) for the nine months ended December 31, 2019. The pre-tax impact of loss on derivatives designated for hedge accounting recognized in other comprehensive loss was $25 million ($18 million, net of tax) and $18 million ($13 million, net of tax) for the three and nine months ended December 31, 2018, respectively. We reclassified $4 million and $7 million from AOCL into earnings during the three and nine months ended December 31, 2019, respectively. As of December 31, 2019, we expect amounts of approximately $18 million pertaining to cash flow hedges to be reclassified from AOCL into earnings over the next 12 months.

All derivatives are recorded at fair value. The Company’s accounting treatment for these derivative instruments is based on its hedge designation. As of December 31, 2019, the gross fair value of our derivative liabilities in interest rate swaps designated for hedge accounting is $45 million, of which $17 million is presented as other current liabilities and $28 million is presented as other liabilities on the balance sheet. As of March 31, 2019, the gross fair value of our derivative liabilities in interest rate swaps designated for hedge accounting was $26 million, of which $4 million is presented in other current liabilities and $22 million is presented in other liabilities on the balance sheet. The fair value of interest rate swaps is estimated based on valuation models that use interest rate yield curves as Level 2 inputs.

Note 9Debt
The following is a summary of the Company’s outstanding debt:
(in millions)
 
Interest Rates
 
Maturities
 
December 31, 2019
 
March 31, 2019
Revolving Credit Facility
 
LIBOR + 1.50%
 
August 2024
 
$
50

 
$

Term Loan A Facilities (Tranche 1)
 
LIBOR + 1.375%
 
August 2022
 
200

 
246

Term Loan A Facilities (Tranche 2)
 
LIBOR + 1.50%
 
August 2024
 
1,572

 
1,588

Term Loan B Facility
 
LIBOR + 2.25%
 
May 2025
 
493

 
497

Subtotal senior secured credit facilities
 
 
 
 
 
2,315

 
2,331

Senior unsecured EDS Notes
 
7.45%
 
October 2029
 
66

 
66

Other borrowings
 
Various
 
Various
 
19

 

Total debt
 
 
 
 
 
2,400

 
2,397

Less: current maturities of long-term debt, net(1)
 
 
 
 
 
(88
)
 
(80
)
Less: unamortized debt issuance costs and premiums, net(2)
 
 
 
 
 
(18
)
 
(20
)
Total long-term debt, net of current maturities
 
 
 
 
 
$
2,294

 
$
2,297

(1) Current maturities of long-term debt are presented net of $6 million and $8 million of debt issuance costs associated with the Term Loan A Facilities and Term Loan B Facility as of December 31, 2019 and March 31, 2019, respectively.
(2) Includes $11 million and $12 million as of December 31, 2019 and March 31, 2019, respectively, of unamortized premiums on the assumed Electronic Data Systems Corporation (“EDS”) Notes.
Expected maturities of long-term debt are as follows:
Fiscal Year
 
(in millions)

Remainder of fiscal year 2020
 
$
24

2021
 
94

2022
 
92

2023
 
290

2024
 
90

Thereafter
 
1,810

Total
 
$
2,400


On August 13, 2019, the Company entered into the Second Amendment to its Credit Agreement (the “Amendment”) to provide greater operational and financial flexibility to the Company. Pursuant to the Amendment, with MUFG Bank, Ltd. as Lead Left Arranger and Administrative Agent, Bank of America, N.A. as Syndication Agent, JPMorgan Chase Bank, N.A.,

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Mizuho Bank, Ltd. and PNC Bank, National Association as Documentation Agents, and MUFG Bank, Ltd., BofA Securities, Inc., JPMorgan Chase Bank, N.A., PNC Capital Markets, LLC and Mizuho Bank, Ltd. as Lead Arrangers, the maturities of the Pro-Rata Facilities (Term Loan A Facilities and the Revolving Credit Facility) were extended by 15 months each. The Amendment also provided for, among other things:

changes to certain terms and conditions, including modifying the financial covenant total net leverage ratio to a maximum of 4.50x (unchanged), with a stepdown to 4.25x (previously 3.75x) after 12 months, and, thereafter, with a step up to 4.50x (previously 4.00x) for a 12 month period following a Permitted Acquisition greater than $100 million;
a $46 million increase in the Term Loan A Tranche 2 from $1,568 million to $1,614 million, the proceeds of which were used to reduce Term Loan A Tranche 1 from $246 million to $200 million;
an extension of the maturity of the Term Loan A Tranche 1 from May 31, 2021 to August 31, 2022;
an extension of the maturity of the Term Loan A Tranche 2 from May 31, 2023 to August 31, 2024; and
a $150 million increase in the Revolving Credit Facility to $750 million and an extension of the maturity from May 31, 2023 to August 31, 2024.

Note 10Leases

As described in Note 2 – “Recent Accounting Pronouncements,” effective April 1, 2019, we adopted ASC 842 using the optional transition method. In accordance with the optional transition method, we did not recast the prior period financial statements, and all prior period amounts and disclosures are presented under ASC 840.

The Company leases certain real and personal property under non-cancelable operating leases. Assets under finance leases are comprised primarily of computers and related equipment. Finance lease obligations primarily consist of contractual arrangements with HPE Financial Services.

Under ASC 842, an arrangement is determined to be a lease at inception if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. At inception, we determine whether the contract is or contains a lease and, if so, whether the lease should be classified as an operating or a finance lease. The Company recognizes a ROU asset and a lease liability based on the present value of the future minimum lease payments over the lease term at the commencement date, adjusted for any lease incentives, initial direct costs, and potential impairment. At the commencement date, a single discount rate is applied to a group of leases with the same durations. The rate is updated quarterly for new leases that commence during the period, unless a triggering event occurs requiring more frequent reassessment. We define the initial lease term to include renewal options determined to be reasonably certain. Lease assets are evaluated for impairment in a manner consistent with the treatment of other long-lived assets.

Certain leases require us to pay property taxes, insurance and routine maintenance, which are included in variable lease expense. At December 31, 2019, the Company did not have any lease agreements with residual value guarantees or material restrictions or covenants. The Company's lessor arrangements with its customers are immaterial to the results of operations and cash flows.

The components of lease expense were as follows:
(in millions)
 
Statement of Operations Line Item(s)
 
Three Months Ended December 31, 2019
 
Nine Months Ended December 31, 2019
Finance lease expense
 
 
 
 
 
 
Amortization of leased assets
 
Depreciation and amortization
 
$
29

 
$
94

Interest on lease obligations
 
Interest expense, net
 
5

 
15

Total finance lease expense
 
 
 
34

 
109

Operating lease expense
 
Cost of services and selling, general and administrative
 
12

 
42

Variable lease expense
 
Cost of services and selling, general and administrative
 
3

 
7

Sublease income
 
Cost of services and selling, general and administrative
 
(1
)
 
(3
)
Total lease expense, net
 
 
 
$
48

 
$
155



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Supplemental balance sheet information related to leases was as follows:
(in millions)
 
Balance Sheet Line Item
 
December 31, 2019
Assets
 
 
 
 
Finance lease assets
 
Property and equipment, net of accumulated depreciation of $156
 
$
252

Operating lease assets
 
Other assets
 
115

Total lease assets
 
 
 
$
367

Liabilities
 
 
 
 
Current
 
 
 
 
Finance leases
 
Current finance lease obligations
 
$
116

Operating leases
 
Current operating lease obligations
 
41

Non-current
 
 
 
 
Finance leases
 
Non-current finance lease obligations
 
155

Operating leases
 
Other long-term liabilities
 
86

Total lease liabilities
 
 
 
$
398


Supplemental cash flow information related to leases was as follows:
(in millions)
 
Nine Months Ended December 31, 2019
Cash paid for amounts included in the measurement of lease obligations:
 
 
Operating cash flows from operating leases
 
$
39

Operating cash flows from finance leases
 
13

Financing cash flows from finance leases
 
110


The Company includes both the amortization of operating lease assets and changes in the lease liabilities in changes in other assets and liabilities, net on the statement of cash flows.

The weighted average remaining lease terms and discount rates were as follows:
 
 
December 31, 2019
Weighted average remaining lease term (in years):
 
 
Finance leases
 
2.7

Operating leases
 
4.6

Weighted average discount rate:
 
 
Finance leases
 
6.34
%
Operating leases
 
4.57
%
As of December 31, 2019, future minimum lease payments required to be made under leases were as follows:
Fiscal Year (in millions)
 
Operating Leases
 
Finance Leases
Remainder of fiscal year 2020
 
$
13

 
$
44

2021
 
41

 
112

2022
 
26

 
80

2023
 
21

 
41

2024
 
12

 
14

Thereafter
 
29

 
3

Total minimum lease payments
 
142

 
294

Less: Amount representing interest
 
(15
)
 
(23
)
Present value of net minimum lease payments
 
$
127

 
$
271


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As of December 31, 2019, the Company has aggregate rent obligations of $42 million for operating leases and $4 million for finance leases, for leases that have not commenced, with terms ranging from two to 10 years.

On October 4, 2019, we completed a sale and leaseback transaction of our Herndon, Virginia facility. The land and buildings sold had a carrying value of $23 million, which was included in other current assets on our balance sheet as of March 31, 2019. We recognized a pre-tax gain on sale of assets of $33 million included in other income, net on the statements of operations for the three and nine months ended December 31, 2019. The leaseback period will facilitate the Company’s exit from the facility.

On December 13, 2019, we completed a sale and leaseback transaction of our Clarksville, Virginia facility. The land and building sold had a carrying value of $26 million, which was included in property and equipment, net on our balance sheet as of March 31, 2019. We recognized an insignificant gain on the sale. The future minimum lease payments required to be made under the leaseback are approximately $15 million over seven years.

Note 11Pension and Other Benefit Plans

The Company offers a defined benefit pension plan, a retiree medical plan, life insurance benefits, deferred compensation plans and defined contribution plans. The Company’s defined benefit pension and retiree medical plans are not admitting new participants; therefore, changes to pension and other postretirement benefit liabilities are primarily due to market fluctuations of investments, actuarial assumptions for the measurement of liabilities and changes in interest rates.
The Company did not contribute to the defined benefit pension and other postretirement benefit plans during the three and nine months ended December 31, 2019 or 2018, and does not expect to contribute during the remainder of fiscal year 2020.
The components of net periodic pension expense (benefit) were:
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
December 31, 2019
 
December 31, 2018
 
December 31, 2019
 
December 31, 2018
Service cost
 
$
1

 
$

 
$
2

 
$

Interest cost
 
4

 
5

 
13

 
11

Expected return on assets
 
(7
)
 
(8
)
 
(22
)
 
(17
)
Net periodic pension benefit
 
$
(2
)
 
$
(3
)
 
$
(7
)
 
$
(6
)

Net periodic benefit cost for the Company’s retiree medical plan was not significant for the three and nine months ended December 31, 2019 or 2018.

Note 12Income Taxes

The Company’s effective tax rate (“ETR”) was approximately 29% and 27% for the three and nine months ended December 31, 2019, respectively, as compared to 21% and 27% for the three and nine months ended December 31, 2018, respectively. For the three and nine months ended December 31, 2019, the primary drivers of our ETR were state income taxes, including a valuation allowance against a state interest deduction limit carryforward. For the three and nine months ended December 31, 2018, the primary drivers of our ETR were state income taxes and non-deductible transaction expenses.

The Tax Matters Agreement entered into with DXC in connection with the Spin-Off (the “TMA”) states each company’s rights and responsibilities with respect to payment of taxes, tax return filings and control of tax examinations. The Company is generally only responsible for tax assessments, penalties and interest allocable to periods (or portions of periods) related to USPS beginning after the Spin-Off and Mergers. The Company has income tax refunds receivable from the Internal Revenue Service (“IRS”) and various state tax authorities of approximately $75 million at December 31, 2019, for which it must remit to DXC under the TMA, and has recorded a corresponding payable. The receivable is included in other receivables and other assets and the payable is included in accrued expenses and other long-term liabilities on our balance sheet.


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The Company’s entities included in the Spin-Off are currently under examination or in appeals in several tax jurisdictions. The calendar year 2008 and fiscal year 2010 and forward tax years remain open under applicable statutes of limitations, and are currently under review by the IRS and other taxing authorities. The IRS is not currently examining Vencore HC or KGS HC for any open years, but entities related to these businesses are open to examination in various state and local jurisdictions.

Note 13Related Party Transactions

Allocation of Corporate Expenses

The statement of operations for the nine months ended December 31, 2018 included corporate allocations of $24 million recorded within costs of services and selling, general and administrative. These allocations were for the period from April 1 to May 31, 2018 for general corporate expenses from Parent for certain management and support functions that were provided on a centralized basis within Parent prior to the Spin-Off.

Parent Company Investment
Parent company investment on the statements of cash flows and equity for the period from April 1 to May 31, 2018 represents Parent’s historical investment in USPS, the net effect of transactions with and allocations from Parent and USPS’s accumulated earnings prior to consummation of the Spin-Off.

Related Party Transactions with DXC

The Company recognized $3 million and $12 million of related party revenue from DXC and incurred obligations of $35 million and $113 million for related party transactions with DXC during the three and nine months ended December 31, 2019, respectively, compared to $3 million and $9 million of related party revenue from DXC and incurred obligations of $27 million and $39 million for the three and nine months ended December 31, 2018, respectively.

Note 14 Stockholders’ Equity

Cash Dividends

During the three and nine months ended December 31, 2019, the Board of Directors declared cash dividends to our stockholders of approximately $10 million ($0.06 per common share) and $30 million ($0.18 per common share), respectively. During the three and nine months ended December 31, 2018, the Board of Directors declared cash dividends to our stockholders of approximately $8 million ($0.05 per common share) and $25 million ($0.15 per common share), respectively. The cash dividends were paid in the quarter following their declaration.

On February 11, 2020, the Board of Directors declared a dividend of $0.06 per common share payable on April 15, 2020 to common stockholders of record at the close of business on March 3, 2020.

Share Repurchase Program
During the nine months ended December 31, 2019, the Company repurchased 1,849,785 shares of its common stock for aggregate cost of $45 million. The shares are reported as treasury stock at cost. The total remaining authorization for future common stock repurchases under the share repurchase program was $295 million as of December 31, 2019.

Stock-based Compensation
The Company recognized $6 million and $21 million in stock-based compensation expense during the three and nine months ended December 31, 2019, respectively, compared to $4 million and $7 million for the three and nine months ended December 31, 2018, respectively. During the nine months ended December 31, 2019, the Company granted approximately 602 thousand time-based restricted stock units (“RSUs”) and approximately 923 thousand performance-based restricted stock units (“PSUs”). The RSUs and PSUs are valued using the closing price on the trading day of the grant. The weighted average grant date fair value of the RSUs and PSUs granted during the nine months ended December 31, 2019 was $23.42 and $23.01, respectively.


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Note 15Segment Information

We operate based on two reportable segments: (1) Defense and Intelligence, and (2) Civilian and Health Care. Our reportable segments and their respective operations are defined as follows:
Defense and Intelligence

Through its Defense and Intelligence business, Perspecta provides cybersecurity, data analytics, digital transformation, information technology modernization, and agile software development, as well as technology to support intelligence, surveillance, and reconnaissance services to the DoD, intelligence community, branches of the U.S. Armed Forces, and other DoD agencies.

Key competitive differentiators for the Defense and Intelligence segment include global scale, solution objectivity, depth of industry expertise, strong partnerships, vendor and product independence and end-to-end solutions and capabilities. Evolving business demands such as globalization, fast-developing economies, government regulation and growing concerns around risk, security, and compliance drive demand for these offerings.

Civilian and Health Care

Through its Civilian and Health Care business, Perspecta provides enterprise IT transformation and modernization, application development and modernization, enterprise security, risk decision support, operations and sustainment, systems engineering, applied research, cyber services, and cloud transformation to the Departments of Homeland Security, Justice, and Health and Human Services, as well as other federal civilian and state and local government agencies.
Segment Measures
The following table summarizes operating results regularly provided to the chief operating decision maker by reportable segment:
 
 
Three Months Ended
 
Nine Months Ended
(in millions)
 
December 31, 2019
 
December 31, 2018
 
December 31, 2019
 
December 31, 2018
Revenue
 
 
 
 
 
 
 
 
Defense and Intelligence
 
$
813

 
$
709

 
$
2,342

 
$
1,848

Civilian and Health Care
 
313

 
366

 
1,063

 
1,088

Total revenue
 
$
1,126

 
$
1,075

 
$
3,405

 
$
2,936

Segment profit(1)
 
 
 
 
 
 
 
 
Defense and Intelligence
 
$
115

 
$
102

 
$
346

 
$
225

Civilian and Health Care
 
39

 
46

 
112

 
148

Total segment profit
 
$
154

 
$
148

 
$
458

 
$
373

Depreciation and amortization
 
 
 
 
 


 
 
Defense and Intelligence
 
$
27

 
$
17

 
$
76

 
$
54

Civilian and Health Care
 
11

 
22

 
55

 
62

Amortization of acquired intangible assets
 
54

 
37

 
152

 
98

Total depreciation and amortization
 
$
92

 
$
76

 
$
283

 
$
214

(1) The segment profit for the three and nine months ended December 31, 2018 was revised to reflect the change to exclude the amortization expense on intangible assets acquired in business combinations as disclosed in Note 19 – “Segment Information” to the financial statements of our Annual Report on Form 10‑K for the year ended March 31, 2019.

Reconciliation of Reportable Segment Profit to the Statements of Operations

The Company’s management uses segment profit as the measure for assessing performance of its segments. Segment profit is defined as segment revenue less segment cost of services, selling, general and administrative and depreciation and amortization, excluding certain operating expenses managed at the corporate level. These unallocated costs include certain corporate function costs, stock-based compensation expense, amortization of acquired intangible assets, certain nonrecoverable restructuring costs, separation, transaction and integration-related costs and net periodic benefit cost.

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Three Months Ended
 
Nine Months Ended
(in millions)
 
December 31, 2019
 
December 31, 2018
 
December 31, 2019
 
December 31, 2018
Total segment profit
 
$
154

 
$
148

 
$
458

 
$
373

Not allocated to segments:
 
 
 
 
 
 
 
 
Stock-based compensation
 
(6
)
 
(4
)
 
(21
)
 
(7
)
Amortization of acquired intangible assets
 
(54
)
 
(37
)
 
(152
)
 
(98
)
Restructuring costs
 

 
(1
)
 
(4
)
 
(1
)
Separation, transaction and integration-related costs
 
(20
)
 
(19
)
 
(59
)
 
(84
)
Interest expense, net
 
(34
)
 
(37
)
 
(105
)
 
(84
)
Other unallocated, net
 
35

 
(2
)
 
37

 
26

Income before taxes
 
$
75

 
$
48

 
$
154

 
$
125


Management does not use total assets by segment to evaluate segment performance or allocate resources. As a result, assets are not tracked by segment and therefore, total assets by segment is not disclosed.

Note 16Commitments and Contingencies

The Company is a party to or has responsibility under various lawsuits, claims, investigations and proceedings involving disputes or potential disputes related to commercial, employment and regulatory matters that arise in the ordinary course of business. The Separation and Distribution Agreement (the “SDA”) between Perspecta and DXC includes provisions that allocate liability and financial responsibility for litigation involving DXC and the Company and that provide for cross-indemnification of the parties for liabilities a party may incur that are allocated to the other party under the SDA. In addition, under the SDA, DXC and the Company have agreed to cooperate with each other in managing litigation that relates to both parties’ businesses. The SDA also contains provisions that allocate liability and financial responsibility for such litigation. The Company records a liability when it believes that it is both probable that a liability has been incurred and the amount of loss can be reasonably estimated. Significant judgment is required to determine both the probability of having incurred a liability and the estimated amount of the liability. The Company reviews these matters at least quarterly and adjusts these liabilities to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other updated information and events pertaining to a particular matter. Litigation is inherently unpredictable. However, the Company believes it has valid defenses with respect to legal matters pending against it. Nevertheless, cash flows or results of operations could be materially affected in any particular period by the resolution of one or more of these contingencies. The Company believes it has recorded adequate provisions for any such matters and, as of December 31, 2019, it was not reasonably possible that a material loss had been incurred in connection with such matters in excess of the amounts recognized in its financial statements.

Litigation, Proceedings and Investigations

Forsyth, et al. v. HP Inc. and Hewlett Packard Enterprise: This purported class and collective action was filed on August 18, 2016 in the U.S. District Court for the Northern District of California, against HP Inc. and Hewlett Packard Enterprise Company (“HPE”) alleging violations of the Federal Age Discrimination in Employment Act (“ADEA”), the California Fair Employment and Housing Act, California public policy and the California Business and Professions Code. Plaintiffs filed an amended complaint on December 19, 2016. Plaintiffs seek to certify a nationwide class action under the ADEA comprised of all U.S. residents employed by defendants who had their employment terminated pursuant to a work force reduction (“WFR”) plan on or after December 9, 2014 (deferral states) and April 8, 2015 (non-deferral states), and who were 40 years of age or older at the time of termination. Plaintiffs also seek to represent a Rule 23 class under California law comprised of all persons 40 years or older employed by defendants in the state of California and terminated pursuant to a WFR plan on or after August 18, 2012. The case has remained stayed while the parties have engaged in mediation with opt-in plaintiffs who are subject to mandatory, individual arbitration agreements. Two mediation sessions have taken place. In October 2018, a settlement was reached with 16 named and opt-in plaintiffs; that settlement has been completed. On June 26-27, 2019, a second mediation was held, involving 145 opt-in plaintiffs. On December 23, 2019, a settlement was reached with 142 of the 145 opt-in plaintiffs. Former business units of HPE now owned by the Company will be liable in this matter for any recovery by plaintiffs previously associated with the USPS business of HPE.

In addition to the matter noted above, the Company is currently subject in the normal course of business to various claims and contingencies arising from, among other things, disputes with customers, vendors, employees, contract counter

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parties and other parties, and inquiries and investigations by regulatory authorities and government agencies. Some of these disputes involve or may involve litigation. The financial statements reflect the treatment of claims and contingencies based on management’s view of the expected outcome. The Company consults with outside legal counsel on issues related to litigation and regulatory compliance and seeks input from other experts and advisors with respect to matters in the ordinary course of business. Although the outcome of these and other matters cannot be predicted with certainty, and the impact of the final resolution of these and other matters on the Company’s results of operations in a particular subsequent reporting period could be material and adverse, management does not believe, based on information currently available to the Company, that the resolution of any of the matters currently pending against the Company will have a material adverse effect on the financial position of the Company or the ability of the Company to meet its financial obligations as they become due. Unless otherwise noted, the Company is unable to determine at this time a reasonable estimate of a possible loss or range of losses associated with the foregoing disclosed contingent matters.

Guarantees

The Company uses stand-by letters of credit, in lieu of cash, to support various risk management insurance policies, which are cash collateralized. These letters of credit represent a contingent liability and the Company would only be liable if it defaults on its payment obligations on these policies. The Company’s stand-by letters of credit outstanding were less than $1 million as of December 31, 2019. As of December 31, 2019, the Company had $34 million in outstanding surety bonds, of which less than $1 million expire in each of fiscal years 2020 and 2021, and $33 million expire in fiscal year 2022.

Note 17Subsequent Events

The U.S. Navy announced on February 5, 2020 that Perspecta was not awarded the Service Management, Integration, and Transport (“SMIT”) contract, the re-compete of the Next Generation Enterprise Network (“NGEN”) contract currently held by the Company. The NGEN contract currently expires on September 30, 2020, with three one-month options that may be exercised by the U.S. Navy. We have requested and will receive a post-award debriefing from the agency providing the basis for the selection decision and contract award on February 24, 2020. The Company will assess next steps with respect to the award decision at that time. In connection with the April 1, 2017 merger of Computer Sciences Corporation with the Enterprise Services business of HPE to form DXC, the reporting unit with the NGEN contract was allocated $623 million of goodwill and $299 million of intangible assets ($236 million of net book value as of December 31, 2019). We are evaluating the impact this contract loss has on the existing carrying value of the reporting unit, and in connection with filing this report, management determined that an impairment charge will be required as a result of the U.S. Navy’s decision. Based on our current estimates, we expect to incur a non-cash, pre-tax impairment charge of approximately $860 million primarily related to goodwill and intangible assets in the fourth quarter of fiscal year 2020.

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

All statements and assumptions contained in this Quarterly Report on Form 10-Q and in the documents incorporated by reference that do not directly and exclusively relate to historical facts could be deemed “forward-looking statements.” Forward-looking statements are often identified by the use of words such as “anticipates,” “believes,” “estimates,” “expects,” “may,” “could,” “should,” “forecast,” “goal,” “intends,” “objective,” “plans,” “projects,” “strategy,” “target” and “will” and similar words and terms or variations of such. These statements represent current expectations and beliefs, and no assurance can be given that the results described in such statements will be achieved.

Forward-looking statements include, among other things, statements with respect to our financial condition, results of operations, cash flows, business strategies, prospects, operating efficiencies or synergies, competitive position, growth opportunities, share repurchases, dividend payments, plans and objectives of management and other matters. Such statements are subject to numerous assumptions, risks, uncertainties and other factors that could cause actual results to differ materially from those described in such statements, many of which are outside of our control. Important factors that could cause actual results to differ materially from those described in forward-looking statements include, but are not limited to:

any issue that compromises our relationships with the U.S. federal government, or any state or local governments, or damages our professional reputation;
changes in the U.S. federal, state and local governments’ spending and mission priorities that shift expenditures away from agencies or programs that we support;
any delay in completion of the U.S. federal government’s budget process;
failure to comply with numerous laws, regulations and rules, including regarding procurement, anti-bribery and organizational conflicts of interest;
failure by us or our employees to obtain and maintain necessary security clearances or certifications;
our ability to compete effectively in the competitive bidding process and delays, contract terminations or cancellations caused by competitors’ protests of major contract awards received by us;
our ability to accurately estimate or otherwise recover expenses, time and resources for our contracts;
problems or delays in the development, delivery and transition of new products and services or the enhancement of existing products and services to meet customer needs and respond to emerging technological trends;
failure of third parties to deliver on commitments under contracts with us;
misconduct or other improper activities from our employees or subcontractors;
delays, terminations or cancellations of our major contract awards, including the impact of the U.S. Navy’s decision not to award the SMIT contract to us;
failure of our internal control over financial reporting to detect fraud or other issues;
failure or disruptions to our systems, due to cyber-attack, service interruptions or other security threats;
failure to be awarded task orders under our indefinite delivery/indefinite quantity (“ID/IQ”) contracts;
changes in government procurement, contract or other practices or the adoption by the government of new laws, rules and regulations in a manner adverse to us;
uncertainty from the expected discontinuance of LIBOR and transition to any other interest rate benchmark; and
the other factors described in Part I, Item 1A “Risk Factors” of Perspecta’s Annual Report on Form 10-K for the year ended March 31, 2019.

There may be other factors that may cause our actual results to differ materially from the forward-looking statements, including factors disclosed under the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein and in other information we publicly disclose from time to time. You should evaluate all forward-looking statements made in this Quarterly Report on Form 10-Q in the context of these risks and uncertainties. Our public filings may be accessed through our investor relations website, https://investors.perspecta.com, or through the website maintained by the SEC at https://www.sec.gov.

No assurance can be given that any expectation, goal or plan set forth in any forward-looking statement can or will be achieved, and readers are cautioned not to place undue reliance on such statements which speak only as of the date they are made. We do not undertake any obligation to update or release any revisions to any forward-looking statement or to report any events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events, except as required by law.


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

The following discussion and analysis is intended to help investors understand our business, financial condition, results of operations, liquidity and capital resources. This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this document and with our Annual Report on Form 10-K for the year ended March 31, 2019.

The statements in this discussion regarding industry outlook, expectations regarding our future performance, liquidity and capital resources and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.” Some of these risks and uncertainties include, but are not limited to, the risk factors set forth in our Annual Report on Form 10-K for the year ended March 31, 2019, as updated periodically through our subsequent quarterly reports on Form 10-Q. Actual results may differ materially from those contained in any forward-looking statements.

The financial information, discussed below, reflects our financial condition, results of operations, and cash flows. The financial information discussed below and included in this document, however, may not necessarily reflect what our financial condition, results of operations, or cash flows would have been had we been operated as a separate, independent entity during the prior period presented, or what our financial condition, results of operations, and cash flows may be in the future.

Overview

We are a leading provider of end-to-end enterprise IT services to government customers across U.S. federal, state and local markets. Using our market-leading enterprise offerings and solutions, we help our government customers implement modern collaborative workplaces, hybrid cloud platforms and integrated digital systems of engagement with their enterprise management systems. By delivering these modern enterprise solutions, often while ensuring interoperability with mission critical legacy systems, we believe we have helped our government customers better realize the benefits of technology, which will ultimately enable them to fulfill their mission objectives and achieve their desired business outcomes.
In addition to providing substantial benefits through increased efficiencies and capabilities, we believe demand for our services is also driven by the technological advances that already reinvented commercial industries, which are now exerting a similar evolutionary effect on government customers. In response to these pressures, we believe government customers are increasingly turning to outside partners, such as Perspecta, to help guide them through this digital transformation.

We believe our breadth of contracts and customers in the U.S. government, and our longstanding history of having partnered with our public sector customers for more than 50 years via our legacy companies, provides us with a competitive advantage. For example, we have existing contracts with a range of public sector entities ranging from the U.S. Department of Veterans Affairs, to the U.S. Postal Service, National Aeronautics and Space Administration, the U.S. Food and Drug Administration and large state and local government customers such as the county of San Diego, California. Based on this breadth of experience and our expertise, we believe we are well positioned to help our U.S. government customers continue their ongoing digital transformation journey.

Perspecta was formed on May 31, 2018, when DXC completed the Spin-Off and Mergers. Following the completion of the Spin-Off and Mergers, Perspecta, a Nevada corporation, became a publicly traded company. Perspecta’s common stock began trading under the ticker symbol “PRSP” on the New York Stock Exchange on June 1, 2018. See Note 1 – “Overview and Basis of Presentation” to the financial statements for additional details regarding the Spin-Off and Mergers. On October 29, 2019, the Company filed for arbitration against DXC to resolve certain disputed items related to the Spin-Off. After completion of the Spin-Off, the Company began assessing the respective rights, responsibilities and obligations of DXC and the Company under the SDA and other related Spin-Off agreements. Based on this assessment, and in accordance with the provisions of the agreements, the Company disputed certain transactions that were effected by DXC in connection with the Spin-Off. The Company has been addressing these matters with DXC pursuant to the terms of the SDA, including its confidentiality provisions and dispute resolution provisions that require executive escalation, mediation and binding arbitration. Based on the status of the arbitration, we currently are unable to predict the impact of any resolutions of these matters on the Company.

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Acquisition

On July 31, 2019, Perspecta acquired all of the equity interests of Knight Point for $250 million plus customary purchase price adjustments, initially estimated at a total of $265 million and currently estimated at $264 million. Knight Point delivers end-to-end managed services and solutions focused on modernizing IT systems, protecting critical networks and driving digital transformation to improve customer transparency and operational efficiency. Knight Point leverages a portfolio of intellectual property to solve complex customer challenges in cloud, cybersecurity and agile DevOps environments. See Note 3 – “Acquisitions” to t