"We are making progress in some areas, but we know we can and should do better in other areas. Our direction is unchanged; we are making several shifts in the way that we execute against it” Ursula Burns.

On Friday, Xerox announced results for Q2 2015 (for full details, see here):

• Xerox Services revenues were $2,569m, down 3.1% y/y (on continuing operations), up 1% in CC
• Segment margin was 7.47%, down 1 pt y/y, with the margin decline primarily due to increased expenses associated with the Government Healthcare Solutions (GHS) Health Enterprise (HE) MMIS platform implementations. HE platform accounts are expected to pressure Services financial results for the rest of 2015.

Xerox also announced that it:

• Is adjusting its 2015 capital allocation plans, reducing acquisition investments, now expecting to spend between $100m and $400m, and instead increasing share repurchases by $300m to $1.3bn (taking advantage of its current share prices)
• Will be taking additional restructuring actions in the Services business in H2.

And a few days before these results, Xerox announced a major change in its GHS strategy following a review of its in-process HE platform implementations. Its focus in the short term will be on managing and completing the current HE implementations; it will be “highly selective” in responding to new MMIS opportunities.

What do these three announcements indicate is happening at Xerox? Is this a company still in disarray? This will be the third year in a row where acquisition activity has been much lower than guided, margin stubbornly refuses to improve, and GHS continues to be impacted by client exits (in the GHS business Texas Medicaid and, most recently, Nevada HIX)

I would argue that the three announcements all point to Xerox Services has been getting to grips with a few weeds that have been choking parts of its business for some years.

• Acquisitions: Xerox was guiding on spending up to $900m in 2015 (leveraging some of the $930m in proceeds from the sale of its ITO business to Atos). So far this year it has spent just $48m (on Healthy Communities Institute and Conestoga Business Solutions). Xerox recently hired a new leader to head up M&A with the clear remit to improve the corporate approach to identifying appropriate targets that will not only bring in short-term acquisitive growth but also ultimately boost profitable organic growth. And the company has clearly decided to focus on operational improvements in its existing business, before it takes on new challenges of integrating any sizeable new operation. But the company might be expected to make a sizeable acquisition in 2016 or 2017: the desire to grow the Services business remains. Further niche software capabilities are also to be expected
• Margin: Xerox now expects that Services margin for full year 2015 will be at the low end of prior guidance of 8.5% to 9%, impacted by HE platform development (where it is having to use subcontractors, in particular Cognizant). The impact of the GHS recovery plan should begin to lessen in 2016, while the benefits from various initiatives stemming from realigning the delivery organization into global capabilities, including recent automation investments, should start to be evident by the end of this year, when margins need to reach 10% for Xerox to meet its margin guidance. These initiatives are also important in improving delivery quality. The restructuring actions starting in H2 will reduce ~3k roles in Services. And looking ahead, if Xerox were to acquire offshore capability in the next year or so, this might also help strengthen operating margin (as iGate will do for Capgemini)
• GHS focusing on existing HE platform clients: six states have chosen the HE platform, with California (where it replaced HP) still in implementation and New York (which has a very aggressive 18 month implementation timeline) still in early days. The other states are New Hampshire, which recently attained CMS certification, Alaska, North Dakota, and Montana. Xerox’s HE business is currently loss making, and this needs to be addressed first before it can consider expansion. Furthermore it is unlikely to win any new opportunities that come up unless it has strong client references across the board.

Elsewhere, there are signs that the organizational restructuring into a vertical-led go-to-market (boosted by several new leadership appointments) will soon bear fruit. Total signings this quarter were up 20% y/y, with new business signings up 9%, albeit mainly due to the New York Medicaid contract - though the renewal rate was below the target range. With an improving pipeline, Xerox appears confident of improving the level of new BPO business signings over the next few quarters, including from cross- and up-sell opportunities.

In summary, Xerox Services’ revenue growth and operating margin will continue to be impacted in the short term by the impact of the Texas Medicaid contract loss, reduced M&A activity and the GHS recovery plan. But recent and ongoing initiatives indicate that by the end of 2015, its outlook for 2016 for profitable organic growth should be more optimistic. And we may then see a resumption in acquisition activity.