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Xerox Services Q2 Results: Further Problems in Government Healthcare Business, but Beginning to Grapple With Margins

Xerox Services has had a challenging half year:

  • In Q1 it announced it was taking an impairment charge ($80m for the year) related to HIX platform impairment (see here for discussion).
  • In Q2 it lost the Texas Medicaid contract. The impact of this is significant (around 1.5% of revenues): Q2 2014 Services contract renewal rate was 63%, well below the company’s target range of 85% to 90%
  • And it is still dealing with the run off of the student loans business (once its largest contract, now still having a 1 pt  impact on the top line) and is also seeing lower volumes in its customer management services BPO business

Xerox’s Government healthcare business (accounts for 7% of its overall revenue) is dealing with a number of challenges. The loss of the Texas Medicaid contract will mean  a hole of around $160m in annual revenue that Xerox Services needs to fill. And management is paying a lot of attention to addressing problems in government healthcare clients such as as Nevada, where it is now beginning to see closure, providing support on a transition plan to the Federal Exchange  in time for next year's open enrolment. 

Xerox Services is in a better position with its Medicaid platform - it has, after all, won New York (the contract is yet to be signed, after the protest period) . However, its Health Enterprise MMIS has yet to reach operational maturity and Xerox expects to continue to see lower margins in the intermediate term as it focuses on implementation in several states.

If we look elsewhere, outside its Government Healthcare business, Xerox Services is seeing stronger topline growth and margin improvement. In the commercial healthcare sector, for example, (which accounts for 12% of global Services revenue, and where it is active in both the payer and provider sectors), the company claims it saw y/y revenue growth of over 10% in Q2, with a margin of over 10%.

Signings this quarter were impacted by the loss at Texas and lower overall renewal opportunity. New business signings were down 4% year-over-year and flat on a TTM basis, with some awards being delayed to H2. Management reiterated its confidence that, with New York Medicaid and other new opportunities, it is confident of an improvement in new signings in H2.

Details have not been provided, but the company does seem to be (at last) implementing initiatives to improve Services profitability, and the results are becoming apparent in its document outsourcing, commercial BPO, and ITO businesses. 

Finally, we note that Xerox Services is back in acquisition mode: it has spent $227m on acquisition this quarter (and $281m for H1 overall), a level that is consistent with its annual target of ~$500m. The acquisition of ISG Holdings, a workers’ compensation ISV that will expand its capabilities in healthcare payor and insurance BPO in the U.S. The smaller acquisition in Q2 of Smart Data expands its litigation services business

It is becoming clear what we should expect to see at Xerox Services in H2 2014:

  • Headwinds from the continued rampdown of the student loan business (should be done by end H1 215) and the start of the rampdown at Texas Medicaid (which won’t be protracted like the student loans runoff), offset by growth in commercial BPO and the European BPO business, assisted by a return to some inorganic growth improvement, leading to a targeted low single digit fevenue growth in Q4
  • Net non-cash impairment charge of ~$40m related to the government healthcare business. The full year Services margin target is now around 9.4% (at the bottom end of the prior target range), with Q4 margin at around 10%.  If Xerox Services achieves the Q4 target, it will demonstrate that under Bob Zapfel, Xerox Services is at last getting to grips with improving profitability.

Longer term, Xerox is on track to reach its target of Services accounting for two-thirds of overall revenue by 2017 (the proportion is currently 57%), something that will help drive overall revenue growth as the impact of the lack of growth in the Technology business lessens.

(For full details of Xerox Services Q2 results, see here: http://research.nelson-hall.com/sourcing-expertise/search-all-content/?avpage-views=article&searchid=29670&id=203428&fv=2)

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