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Accenture plc (NYSE:ACN)

Q3 2014 Results Earnings Conference Call

June 26, 2014, 08:00 AM ET

Executives

KC McClure - Director of IR

Pierre Nanterme - Chairman and CEO

David Rowland - CFO

Analysts

Darrin Peller - Barclays Capital

Tien-Tsin Huang - JPMorgan Chase & Co.

David Grossman - Stifel Nicolaus & Company, Inc.

Bryan Keane - Deutsche Bank Securities

Keith Bachman - Bank of Montreal

Daniel Perlin - RBC Capital Markets

Steve Milunovich - UBS

David Togut - Evercore Partners

David Koning - Robert W. Baird Co.

Sara Gubins - Bank of America Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Accenture's Third Quarter Fiscal 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [Operator instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Ms. KC McClure, Managing Director of Investor Relations. Please go ahead.

KC McClure

Thank you, Katie. And thanks everyone for joining us today on our third quarter fiscal 2014 earnings announcement. As Katie just mentioned, I'm KC McClure, Managing Director of Investor Relations. With me today are Pierre Nanterme, our Chairman and Chief Executive Officer; and David Rowland, our Chief Financial Officer.

We hope you've had an opportunity to review the news release we issued a short time ago. Let me quickly outline the agenda for today's call. Pierre will begin with an overview of our results. David will take you through the financial details including the income statement and balance sheet along with some key operational metrics for the third quarter.

Pierre will then provide a brief update on our market positioning. David will then provide our business outlook for the fourth quarter and full fiscal year 2014 and then we will take your questions before Pierre provides a wrap-up at the end of the call. As a reminder, when we discuss revenues during today's call, we're talking about revenues before reimbursement or net revenues.

Some of the matters we'll discuss on this call including our business outlook are forward-looking and as such are subject to known and unknown risks and uncertainties including but not limited to those factors set forth in today's news release and discussed in our annual report on Form 10-K and quarterly reports on Form 10-Q and other SEC filings. These risks and uncertainties could cause actual results to differ materially from those expressed in this call.

During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. As a reminder, in Q3 of last year, our results included benefits from a reduction in reorganization liabilities.

We include reconciliations of non-GAAP financial measures where appropriate to GAAP in our news release or in the Investor Relations section of our website at www.accenture.com. As always, Accenture assumes no obligation to update the information presented on this conference call.

Now, let me turn the call over to Pierre.

Pierre Nanterme

Thank you, KC. And thanks everyone for joining us today.

We are very pleased with our financial results for the first quarter. We generated strong revenue growth and earnings per share, grew operating income, returned substantial cash to our shareholders and delivered another quarter of very strong year bookings. Here are a few highlights.

New bookings were $8.8 billion, bringing us to $27.6 billion for the first three quarters of the year. We generated revenues of $7.7 billion, a 7% increase and above our guiding range. We delivered earnings per share of $1.26, up 11% from adjusted EPS in the third quarter last year. Operating margin was 15.2%, consistent with the third quarter last year.

We generated solid free cash flow and our balance sheet remains very strong and in the quarter with a cash balance of $4 billion and we returned approximately $1.1 billion in cash to shareholders through share repurchases and dividends.

With Q3 behind us, the second half of the year is shaping up as expected with stronger revenue growth and we are well positioned to continue the momentum into the first quarter.

Now let me hand over to David, who will review the numbers for the quarter in greater detail. David, over to you.

David Rowland

Thank you, Pierre and thanks all of you for joining us today.

As I review the results on this morning's call, you'll see that we delivered very good results in the third quarter, highlighted by a significant uptick in net revenues with growth of 7% in local currency.

Net revenues were higher than expected, well above the top end of our guidance range and driven by improved growth rates across essentially every dimension of our business, meaning the majority of our operating groups, the three geographic regions and in both consulting and outsourcing.

The higher revenue growth was underpinned by yet another strong new bookings quarter, which is indicative of the high degree of relevance our offerings and capabilities have in the marketplace. We delivered double-digit EPS growth and while our focus on pricing and overall cost efficiency is ongoing, our third quarter reflects progress with the challenges highlighted last quarter.

We generated strong cash flow and of course we continue to return a substantial portion of cash to shareholders. So we're very pleased with the quarter.

With that, let's get to the numbers starting with new bookings. New bookings for the quarter were strong at $8.8 billion. Consulting bookings were $4.3 billion with a book-to-bill of $1.1 billion. Outsourcing bookings were $4.5 billion with a book-to-bill of $1.2 billion. Year-to-date bookings were $27.6 billion, reflecting 12% growth in local currency.

Taking a closer look at our new bookings, there are several additional points that are worth noting. Coming off the record bookings last quarter, consulting bookings continue to reflect healthy demand for both systems integration and technology consulting.

Additionally, management consulting bookings were solid and within our target book-to-bill range. We were also pleased with another quarter of solid outsourcing bookings, which included an uptick in technology outsourcing from the second quarter, driven by higher demand for application outsourcing.

Strong demand for our BPO services continued, driven by finance and accounting and procurement offerings, even after the extremely strong record BPO bookings we had in quarter two.

From an operating group perspective, CMT and products were key drivers of our strong bookings performance, which positions both for continued strong growth rates.

Finally, we continue to be the partner of choice on complex transformational projects with seven clients with bookings in excess of $100 million.

Turning now to revenues, net revenues for the quarter were $7.7 billion, an increase of 7% in U.S. dollars and local currency, reflecting a flat FX impact, consistent with the assumption we provided in March. Consulting revenues for the quarter were $4.1 billion, up 6% in USD and 5% in local currency.

Outsourcing revenues were $3.6 billion, up 10% in USD and 9% in local currency. Again, revenues came in even higher than expected, driven by strong performance in H&PS, products and CMT. So let me give you some additional highlights from the operating group this quarter.

H&PS grew 11%, delivering the significant improvement in growth we had signaled in quarter two. Growth rates improved across all three geographic regions, but a strong uptick in the Americas was the primary driver in the quarter.

Within the Americas, our health business and public service was very strong including the recent acquisition of ASM Research, which expands our capabilities within the military and federal health businesses. And within our state and local practice, both our human services eligibility and ERP offerings made a strong contribution.

In products, the 10% growth demonstrated a continuation of broad-based demand with strong growth in both the Americas and EMEA. We saw good demand for BPO, specifically for our procurement offerings.

Overall, our clients are focused on four main themes, the digital customer, efficiency in cost optimization, industry specific solutions and advancing the technology agenda, including new technologies, extending ERP and network optimization.

Communications, media and technology growth was 7%. In an overall environment, it continues to be in a cycle of rapid change. CMT's growth was primarily driven by very strong performance in the Americas and we continue to be very pleased with our performance in electronics and high tech.

The revenue growth also reflects the ramp-up of several of the large transformational deals that we signed in recent quarters. More broadly, we continue to focus on extending our footprint in E&HT, working with our communications clients to drive their cost optimization agenda and increasing our penetration in certain areas such as media and entertainment, cable and social media and internet.

Financial services grew 5% consistent with last quarter. We're particularly pleased with the significant growth in banking and capital markets in EMEA and Asia Pacific. Americas growth was negatively impacted by a slowdown in a few clients as large scale transformation programs are going through their natural cycle as well as reduced demand in our mortgage business.

Overall we see good opportunities in the FS market, driven by our client's focus on cost efficiency, which resulted in strong demand for our BPO offerings and also driven by risk in regulatory and increased investments in digital, primarily in distribution and marketing.

As expected, we saw moderate improvement in resources with 2% growth. Energy continues to generate strong growth globally, but we did see some moderation from previous quarters, particularly in North America.

While we are pleased with the modern improvement in the quarter, we still have work to do to position the business for sustained positive growth and North America and natural resources globally continue to be our most challenged markets.

Moving down the income statement. Gross margin for the quarter was 32.8% compared with 33.9% for the same period last year, down 110 basis points.

Sales and marketing expense for the quarter was 11.6% of net revenue compared with 12.3% of net revenues for the third quarter last year, down 70 basis points.

General administrative expense was 5.9% of net revenues compared with 6.4% of net revenues for the third quarter last year, down 50 basis points.

As a reminder, in quarter three of last year, we had a reduction in the reorganization liabilities that impacted certain metrics. The following comparisons exclude the impact and reflect adjusted results.

Operating income was $1.2 billion in the third quarter, reflecting a 15.2% operating margin, roughly equal to the adjusted operating margin for the same period last year.

Our effective tax rate for the quarter was 25% compared with an adjusted tax rate of 24.8% for the third quarter last year.

Net income was $882 million for the third quarter compared with adjusted net income of $824 million for the same quarter last year. And diluted earnings per share were $1.26, compared with the adjusted EPS of $1.14 in the third quarter last year, an increase of $0.12.

Turning to DSOs, our day services outstanding continue to be industry leading. They were 35 days, up from 33 days last quarter. Free cash flow for the quarter was $1.3 billion resulting from cash generated by operating activities of $1.4 billion, net of property and equipment additions of $85 million.

Moving to our level of cash. Our cash balance at May 31 was $4 billion, compared with $5.6 billion at August 31 last year. The current level reflects the cash returned to shareholders through repurchases and dividends as well as the acquisitions we've made year-to-date.

Moving to some other key operational metrics. We ended the quarter with a global headcount of more than 293,000 people and we now have approximately 194,000 people in our global delivery network. In quarter three, our utilization was 88%, up from last quarter and consistent with quarter three last year.

Our attrition, which excludes involuntary terminations was 14%, up 2% from both quarter two in the same period last year and lastly, we now expect that at least 65,000 people will join our company in fiscal 2014.

So turning to our ongoing objective to return cash to shareholders. In the third quarter we repurchased or redeemed approximately 5.5 million shares for $441 million at an average price of $80.13 per share. Year to date we purchased 24.4 million shares for $1.9 billion at an average price of $77.90 per share. At May 31, we had approximately 5.3 billion of share repurchase authority remaining.

Finally as Pierre mentioned, on May 15, 2014, we made our second semi-annual dividend payment for fiscal 2014 in the amount of $0.93 per share, brining total dividend payments for the fiscal year to approximately $1.3 billion.

So in summary, quarter three was an important quarter for us as we delivered the uptick in revenue that we had signaled at the beginning of the year. While we delivered good profitability, our focus on cost efficiency will continue to be a priority for several quarters to come. Now let me turn it back to Pierre.

Pierre Nanterme

Thank you, David. Our strong results for the quarter demonstrate that we continue to executive very well against our growth strategy. We are leveraging the investments we've made in assets and solutions, in strategic acquisitions and in building the skills and capabilities of our people.

Our services are highly differentiated in the marketplace and are clearly originating with the needs of our clients as demonstrated by our records bookings year to date.

Our growth strategy is all about first, operating at the heart of our client's businesses then capturing new opportunities in key growth areas especially in digital and across the different geographic markets where we operate and finally investing to further differentiate our capabilities and services.

Let me bring each of these areas to life. Starting with how we leverage our unit, global end-to-end capabilities to drive value for clients and help them with their large scale transformation programs.

We are helping Baker Hughes a leading oil field services company transform its finance and accounting operations across 90 countries, delivering more than $50 million in annual cost saving so far. For large European banks, we are providing application development and management services to support the bank's repositioning to a new digital platform. This is a major strategic IT transformation designed to increase productivity by up to 20%.

And we are working with the leading global software company leveraging our analytics and technology capabilities in finance and accounting to deliver cost savings of more than $150 million over the next seven years.

We are executing very well in capturing in new opportunities in key growth areas. I am particularly pleased with the momentum we are seeing in Accenture Digital. We are bringing together our capabilities in Accenture Interactive and Accenture Analytics to help Telefónica Spain significantly increase its online sales. In just six months Telefónica drove more than 50% higher sales a year ahead of schedule.

We are levering the assets and capabilities from our recent digital acquisitions to help the leading global fashion retailer launch a new online store based on the innovative eCommerce platform. The new channel, which is going to be rolled out to 50 countries is already driving higher than expected revenues.

To me what is truly distinctive about Digital at Accenture is our ability to deliver Digital at scale and to help our clients create even greater value and business results.

We continue to benefit from the return on the investments we have made to enhance our capabilities and services. A great example is our Accenture Duck Creek software solution for property and casualty insurers, which was recently selected by both Zurich insurance and Berkshire Hathaway.

Berkshire Hathaway Specialty Insurance is deploying our software through an innovative software-as-a-service model posted on the Accenture cloud platform, which will reduce IT costs, improve business agility and support growth.

In life sciences through our accelerating R&D business service, we have developed a new cloud-based platform, which is now being used by five major Pharma companies. This unique solution accelerates the clinical development process by collecting and analyzing data from across studies, helping our clients conduct clinical trials in a more efficient and cost effective way.

And we also continue to make targeted acquisitions. In Accenture Strategy, we just completed the acquisition of PureApps, a U.K. based company that specializes in enterprise performance management, helping CFOs to analyze their businesses and improve their cost management.

In Accenture Digital we required i4C Analytics, an advanced analytic software provider based in Italy. i4C specializes in tailored industry and function specific applications to speed up the delivery of new insights and business outcome. Now turning to the geographic dimension of our business.

Our growth in Q3 was broad based and I am particularly pleased that we delivered stronger results in Europe. In the Americas, we grew revenue 7% in local currency driven by high single digit growth in both the United States and Brazil.

In EMEA revenues increased 7% in local currency with double digit growth in France and Italy, high single digit growth in Germany and solid single digit growth in the United Kingdom and in Asia Pacific we grew revenue 6% in local currency, driven primarily by strong double digit growth in Japan.

So overall we are performing well in the context of a market environment that remains very demanding. We continue to improve our competitiveness through a relentless focus on operational investments, applying rigor and discipline across the Board to improve our efficiency, so we continue to build and position our business for sustainable long term profitable growth.

With that, I will turn the call back to David for our business outlook.

David Rowland

Thank you, Pierre. Let me now turn to our business outlook. For the fourth quarter of fiscal 2014, we expect revenues to be in the range of $7.45 billion to $7.70 billion. This is since the impact of FX will be a positive 1.5% compared to the fourth quarter of fiscal 2013.

For the full fiscal year 2014 based upon how the rates have been trending over the last few weeks we continue to assume the impact of FX on our results in U.S. Dollars will be negative 0.5% compared to fiscal 2013.

Based on our year-to-date results of 4% revenue growth in local currency and the outlook just provided for quarter four, we now expect our net revenues for the full fiscal 2014 to be in the range of 4% to 5% growth in local currency.

For the full fiscal year 2014, we now expect new bookings to be at the upper end of our previously guided range of $33 billion to $36 billion. For operating margin, we now expect fiscal year 2014 to be 14.3%, an approximate 10 basis point expansion over adjusted fiscal 2013 results.

We continue to expect our annual effective tax rate to be in the range of 25.5% to 26.5%. For earning per share, we now expect full year deluded EPS for fiscal 2014 to be in the range of $4.50 to $4.54 or 7% to 8% growth over adjusted fiscal 2013 results.

Turning to cash flow, we continue to expect our operating cash flow to be in the range of $3.3 billion to $3.6 billion with property and equipment additions remaining at approximately $400 million and free cash flow in the range of $2.9 to $3.2 billion.

Finally we continue to expect to return at least $3.7 billion through dividends and share repurchases and also expect to reduce the weighted average diluted shares outstanding by approximately 3% as we remain committed to returning a substantial portion of cash to our shareholders.

So all in all, I am pleased with how we are positioned to close out the year and as we have in the past, we will provide you with our fiscal 2015 outlook at the quarter four earnings call in September.

With that, let's open it up, so we can take your questions. KC?

KC McClure

Thanks David. I would ask that you each keep to one question and a follow-up to allow as many participants as possible to ask a question. Katie, would you provide instructions for those on the call please.

Question-and-Answer Session

Operator

[Operator instructions] And our first question comes from the line of Darrin Peller with Barclays.

Darrin Peller - Barclays Capital

Yes thanks guys. Nice job on the bookings. I just want to hone in a little bit on the bookings trends we're seeing. You gave some good color on what types of business you are gaining, just with respect to the types of book-to-bill conversions we should expect to see and how long it takes for the conversion to occur?

And then maybe really just give us a profile of the kind of profitability in terms of the margin impact on the business given that obviously last quarter we saw a little bit of a slower trend on the margin side and you talked about Europe, but I think here, we're looking to see what these bookings really mean for the next year or so, so a little more color on those two variables will be great.

David Rowland

Okay. Well first of all, let me give you a couple of comments and perhaps Pierre will add some thoughts as well, but in terms of our book-to-bill, on the consulting side, we continue to target overall a book-to-bill of $1.0 billion to $1.1 billion.

I think what we've commented on in previous calls is that given the conversion trends that we started to experience in the third quarter or so of last year, we felt that it was important to be more toward the upper end of the range, but nonetheless that range continues to be what we're focused on.

Darrin Peller - Barclays Capital

Sure.

David Rowland

From an outsourcing standpoint, again the range continues to be $1.2 billion as kind of let's say the sweet spot for us and of course anything north of that is all the better.

When you think about it, the whole translation of bookings to revenue, I think the thing that this quarter indicates is really what we've been pointing to for a while and that is that the strength of our new bookings we felt like would ultimately convert to revenue growth at higher levels, starting in the second half of this year and I think what you see is that obviously happening with our 7% growth.

The last comment quickly from a profitability standpoint, we really focus on operating margin and our model since we've been a public company is then that we expect to manage the ebb and flow of the mix of work across the consulting components of our business and the outsourcing components of our business.

It is true that not all of them have the same level of profitability, let's say the contract level or if you wanted to loosely say in gross margin terms, but they also all have very different cost structures in terms of selling cost, investment requirements, investments in people etcetera and what we are cast with doing is managing those cost, so that if the ebb and flow of our business occurs as it will across the portfolio, we meet our bottom line objectives and that's what we've been very successful doing as a public company so far.

Darrin Peller - Barclays Capital

That's very helpful. Just one quick follow-up and then I'll turn it back to the queue. Last quarter obviously there were some comments made around pricing and around some -- obviously the implications on that on margins and I think you did a good job explaining the types of bookings you're looking at and the conversions are obviously showing much better this quarter, but are we still seeing any pricing pressures at all in the business or is it really just, was it more of a blip in the quarter or in the year last quarter, and it's calmed down?

David Rowland

Well just -- as it relates to quarter three specifically, the environment is very much stable with what we saw last quarter, meaning we haven’t seen any further deterioration and the pattern is stable.

We did see in fact some pockets of improvement in the third quarter, but it's too early to call those a trend. So I think the overwriting theme is that it's stable relative to what we said last quarter.

Darrin Peller - Barclays Capital

Okay. That's good to hear. All right. Nice job guys, thanks.

David Rowland

Thank you very much, Darrin.

Operator

Our next question comes from the line from Tien-Tsin Huang from JPMorgan. Please go ahead.

Tien-Tsin Huang - JPMorgan Chase & Co.

Good morning. Glad to see the revenue come through. Just a follow-up I guess on what Darrin asked. Did anything change specifically this quarter that allowed you to covert revenue faster this quarter and just as a follow through, has visibility on revenue realization improved from the first half of the year?

David Rowland

Hey Tien-Tsin. Again, I don't think anything changed or it happened as we anticipated and as we had signaled. When you look at why did we have stronger revenue growth, I'll anchor you back to what Pierre and I've said consistently starting with the first earnings call this year.

We said that there were several things that we were encouraged by. The first thing was our pattern of strong new bookings. The second thing was the fact that the large transformational deals would start to kick in revenue growth in the second half of the year and we talked about the fact that we could -- we could point to individual contracts that gave us confidence that would occur.

The third thing we talked about was business services, the investments we've made in business services starting to materialize and then finally we anchored to the investments that we've made in inorganic.

You wrap around all of that in the third quarter, we were really pleased with our BPO business in particular, which we've talked about consistently and we're also very pleased with the activity that we see in the digital space.

So there is a lot of things that came together, but very consistent Tien-Tsin with what we've been trying to signal for a couple of quarters.

Tien-Tsin Huang - JPMorgan Chase & Co.

All right. No, that's great. That makes sense Dave. So just to my follow-up I'll ask on the margin side. So the revenue did come out and cost a little bit if you look at it on a gross margin front, I guess that we should look at it on operating margins, but I am just curious, was there anything unusual in that gross margin line in this quarter and should we expect gross margin contraction to continue here in the near term, thanks?

David Rowland

Yes, thank you, Tien-Tsin. Just starting -- let me answer the question on operating margin first. The thing that I guess I'll remind you and others is that last year the third quarter was an all-time high level of profitability for Accenture.

So in absolute terms, last year's profitability was outstanding and it reflected 40 basis points growth over the prior year quarter three. So when we look at the third quarter this year, we feel very good about the absolute profitability because in fact it is equal to the highest level of profitability we've ever had in any quarter.

Having said that, what's different, we have worked hard on dealing with some of the points that we highlighted last quarter. A reference in my script that we made progress on those points, but yet we still have work to do going forward and especially as it relates to overall payroll efficiency, which will continue to be a focus area for us moving forward, but again we feel very good about the absolute profitability in the third quarter.

Tien-Tsin Huang - JPMorgan Chase & Co.

All right. That's great. Thanks so much.

David Rowland

Thank you.

Operator

Next question comes from the line of David Grossman with Stifel. Please go ahead.

David Grossman - Stifel Nicolaus & Company, Inc.

All right. Thank you. So David it looks like you had growth accelerated in the third quarter as you had thought and you delivered a very strong revenue result; however it appears you left the midpoint for the yearend change.

You sound very confident in the outlook, so perhaps you can help us better understand whether there are any specific headwinds in the fourth quarter, maybe just the ordinary flow of revenue and whether the conversion rates that you saw in the third quarter is something that you see as sustainable at least as far as I can see for now.

David Rowland

Yes, again I think there is a couple of points of context that are worth mentioning. If you look at the way our revenue progressed in quarter three and quarter four of last year, quarter four of last year was a point and half higher than quarter three.

So underneath the fourth quarter, we're comparing to fourth quarter last year that was point and half higher than quarter three last year.

The other thing that I would point out is that with the range that we provided for the fourth quarter, the upper end of that range reflects continued strong healthy growth equal to what we just delivered in the third quarter and so we certainly see that as a possibility because we included it in the range.

And as we always say, although we provide a range, which reflects a range of potential outcomes, we're always working to be as high up in the range as we possibly can. So we do feel good about our business.

We had again yet another strong bookings quarter. We feel good about our visibility as we move forward and in the business, but yet as Pierre highlighted in his script, is that we have an environment that has an abundance of opportunities, but it also is one that has ongoing -- I am talking about the macro environment has ongoing challenges and uncertainty.

Operator

The next question then comes from the line of Bryan Keane with Deutsche Bank. Please go ahead.

David Rowland

Hello Bryan.

Bryan Keane - Deutsche Bank Securities

Hi guys. Good morning. So just looking on a full year guidance, I guess it's a little bit unusual that the revenues are coming in ahead of expectations, but EPS is moving to the low end, just what's causing that dynamic?

David Rowland

Well there's really two simple things. The first thing is that the guidance range that we had last quarter was based on a revenue range that included 5% to 6% growth for the full year and it was based on an operating margin range that included 20 basis points to 30 basis points of expansion.

And so what we have done is by the way, which is what we always do after the third quarter is we've narrowed the range for the year now and the reason it has narrowed to the range that it did is because the -- we've narrowed the revenue range for the full year to 4% to 5%. So the 5% to 6% is not within the range and we are on a trajectory to deliver 10 basis points of expansion.

So if you look at those things in combination, that's the resulting range that you get for EPS, which again it is a -- it's a growth rate above revenue and that's one of the things that we talked about in our Investor Analyst Day as an important objective.

Bryan Keane - Deutsche Bank Securities

Okay. And just as a follow-up then, the cause for the operating margin to fall in at the low end of the range as opposed to the high end and then any risk to that, the model that Accenture always has of 10 basis points to 30 basis points of margin expansion won't be continuing on an annual basis, thanks so much.

David Rowland

I think the -- the fact that our trajectory is at 10 basis points, frankly I think it anchors back to some of the things we talked about last quarter, playing it simple.

Having said that, we started the year guiding to a range of 10 to 30 and the 10 to 30 represents what we generally defined as modest margin expansion, 10 basis points as met our definition of margin -- modest margin expansion.

And we feel like if we're moving the margins up year-over-year in that 10 to 30 basis points range, that's very consistent with what our objectives have been and we think that's a reasonable place for us to land and we're balancing many things within that including investments in our business, which include the impact of acquisitions just to name that as one.

But -- so those are the things that we're managing a mix of variables, but we feel very good about the 10 basis points of expansion.

Bryan Keane - Deutsche Bank Securities

Okay. Great. Thanks so much.

David Rowland

Thank you.

Operator

And our next question comes from the line of Keith Bachman with Bank of Montreal. Please go ahead.

Keith Bachman - Bank of Montreal

Hi. Thank you very much. I wanted to ask about the inorganic contribution this quarter. You said it played a role and if I look at your cash flow, it looks like your acquisitions this year for the first nine months in terms of cash out is about two times of what it was last year. I was just wondering if you could talk about what the inorganic contribution to year-over-year was this quarter versus last quarter.

David Rowland

Yes, the inorganic growth varies by quarter. It can be lumpy and frankly we really don't want to get in the position of given a specific breakdown each and every quarter, but would rather talk in terms of the annual contribution.

I will tell you that quarter three reflected an acceleration in both organic and inorganic growth and we were pleased with both to be clear, but there was an important acceleration in organic that drove the $7.1 billion overall.

For the full year, if this will help you Keith, we think we're tracking to the 1.5% to may be up as high as 2% range in inorganic contribution, which is I think consistent with what I said last quarter or the quarter before, but again just to remind you is that the inorganic for us is really all about a strategy to ultimately drop organic growth.

So our inorganic is an engine for organic growth and when you look at these businesses that we're acquiring, they are essentially indistinguishable from our organic business at least within a year and Procurian, which is the most significant acquisition we've made this year in the BPO procurement space, is a great example of that.

So we feel great about the mix of our business. We're very pleased with what we've done with acquisitions really for the last four to six quarters. So hopefully that helped.

Keith Bachman - Bank of Montreal

Yeah. It does. Thanks very much. For my follow-up, I would like to just try to probe a little bit more around Bryan's question on targeted operating margins. I understand it's still within the range of plus 10 basis points call it.

I was hoping to dig a little bit deeper on the causes why it's coming down. I know you highlighted M&A as one of the causes. Also, wage rates -- it sounds like it's continuing to play a role. If I look at the detail, it also looks like financial services, even on a non-GAAP basis, the operating margins were down a little bit more in those areas.

Is there something specific in financial services or products, which looks like they had the most of the year-over-year decline that you'd call out, or any other forces to illustrate what's going on with operating margins would be helpful. Thank you.

David Rowland

Yes, products and financial services are both situations where the contract profitability is lower than it was last year. I'll remind you that we do have under any circumstances we have ebb and flow or operating margin across our operating groups as their portfolio mix just evolves right.

And so a swing of a point or two in either direction shouldn’t be over read at that level because sometimes it's just the ebb and flow of the portfolio and then the time of kind of balance the overall expenses associated with that.

In terms of the 10 basis points, again I guess to be blunt I am not -- I don't want to defend 10 basis points in the sense that it's very consistent, it's within the range that's been very consistent with the range we had communicated for several years now and in certain years there are circumstances where we are at the upper end of that range and other years there are circumstances where we are at the lower end of the range.

The circumstances this year I think we covered quite well on last quarter's call and again we're making improvement. We've seen progress in the third quarter in dealing with those points that we raised, but yet they are in the mix nonetheless for how we're positioned for the full year.

Keith Bachman - Bank of Montreal

So philosophically investors should be thinking about next couple of years, 10 to 30 basis points operating margin improvement is still the right way to think about it.

David Rowland

Yes, I am not going to -- I am not going to comment explicitly on forward-looking guidance. I'll just say that our overwriting objectives as an organization haven’t changed.

Keith Bachman - Bank of Montreal

Fair enough, many thanks.

David Rowland

Great. Thank you.

Operator

And our next question comes from Dan Perlin with RBC Capital Markets. Please go ahead.

Daniel Perlin - RBC Capital Markets

Thanks. So, I'm not going to ask you to defend the 10 basis points, but I do just want to follow up on the margin concept, which is, if we were to -- if we were disaggregating what is a function of mix, that is shifting to what would ultimately be considered lower dollar profit, relative to, let's say, wage inflation cost, how would you have us parse that? As we think about this quarter, the combination of what you talked about last quarter, and then thinking about what is ultimately embedded in your bookings? Thank you.

David Rowland

Yes, frankly that is such -- that there are so many new nuances and so much kind of detail in trying to answer that question, it's just even if that was information that we wanted to share that level of detail it's just I can't really do it in three minutes on an earnings call to be frank.

Again what I would say is that in general terms what I would say is that job number one for us in driving our profitability objective going forward is to get payroll efficiency right. And that is something that we've traditionally done very, very well and that is something that is we are extremely focused on in particular in the next several quarters given some of the things we highlighted last week.

Job number two in optimizing our profitability is to manage the mix across our portfolio. So finding the right mix where the opportunities are in the marketplace and then as the mix shifts across the different offerings that we provide to then job number three is to align our underlying cost structure to make sure that it's consistent with the realities of our portfolio of work.

And I mean at a very simple level those are the things that we've always had to focus on and that's what we'll continue to focus on going forward.

Daniel Perlin - RBC Capital Markets

Okay. And then just quickly: How important, ultimately, is the correlated rebound in EMEA to your consulting business, because we're seeing some trends in both of those and I'm just wondering, from a sustainability perspective, how important is that for you to have both trending in the right direction? Or do you think consulting can actually throttle up, even in the face of EMEA maybe having problems in the future? Thanks.

Pierre Nanterme

We're definitely very pleased to see the rebound we had in EMEA, which is something we've been watching very carefully this last quarter. And we invested a lot in EMEA around client opportunities, especially around large-scale transformations program combining consulting outsourcing and BPO across the Board and as we expected, starting in Q3, we see EMEA coming back.

And what I am particularly pleased with is when you look at the countries contributing to EMEA growth both from a consulting and outsourcing standpoint, we have quite largest markets in the country and countries in Europe and think about France, Italy, Germany the U.K.

And it is very encouraging to see that with the slow recovery of Europe that seems to show some sustained ability on this slow recovery in Europe is creating more confidence with investors and this is what's explaining the pickup of our business in Europe plus the execution of the strategy we mentioned before.

Large scale transformation, operating at the heart of our clients operation, investing in the new -- by the new I am thinking a lot around the digital and the excellent contribution of BPO. So it's quite well balanced across the Board, but again it's probably more on the outsourcings and the consulting, but anyway pleased with both results.

Daniel Perlin - RBC Capital Markets

Excellent. Thank you.

David Rowland

Thank you.

Operator

And your next question comes from the line of Steve Milunovich with UBS. Please go ahead.

Steve Milunovich - UBS

Thank you. Could you characterize how much of your business comes from emerging markets and maybe discuss what's going on in some of those particularly China and Brazil?

Pierre Nanterme

Yes, so if you look at the way we now -- look at the markets, you have North America, you have Europe and you have what we might call the gross market, which is a little bit different from what you have in Americas, EMEA and APAC.

So clearly the vast majority of the business we're doing is concentrated in North America and Europe. Now we're pleased with what we are doing in APAC in Africa and in Latin America. So let me give you some insights, which are noteworthy.

Starting with Latin America as you know and we signaled that in the prior quarters, we were watching carefully what was happening in Brazil. We had excellent performance for many years and we had a kind of pause almost a year ago literally.

So again it's very encouraging to see that through all the efforts made by our Brazilian leadership, Brazil is back with high single digit growth this quarter. So again, we're going to watch that carefully, but it's very encouraging signals.

Moving to APAC, very consistent and very important for us because it's a large country for Accenture. Japan is sustaining a very strong double-digit growth and it's not the story of a quarter. It's been true this last quarter.

So we're building a stronger practice in one the largest market as well in APAC to a smaller scale, but very interesting. We had very good performance in India as well, which has continued to growing very well and I can mention even Middle East in new places where we see good prospects.

And may be finally getting to Africa, this is probably a place where we need to put more attention especially in South Africa as you know which is a country, which is very dependent on natural resources and very consistent what David mentioned previously natural resources, very cyclical challenging industry.

South Africa very dependent on natural resources and it's a country where we are most challenged. All in all we're pleased with the progress we are making in all emerging markets.

Steve Milunovich - UBS

That's great. Thank you. And I was curious what role you're playing in helping companies think through their adoption of cloud, and if your cloud brokering business is doing well and could become significant.

Pierre Nanterme

We couldn’t be more cloud friendly at that venture. We embrace the cloud. We promote the cloud. And the cloud is developing very well because it's bringing to our clients a true and compelling value proposition in the way to improve the efficiency and effectiveness of the operations.

You’ve seen in a couple of cases I shared with you that cloud was quite prominent either in the way we're proposing application package as a service. I am very pleased with what we are doing with our own solution called Duck Creek, delivered at Berkshire Hathaway as a service, and operated in Accenture Cloud. And I think these days is probably a piece of art, if you will in the way we are delivering a package in a new and compelling way as a service and we are operating this service in Accenture Cloud platform. So we are a big fan of this.

Steve Milunovich - UBS

Thank you.

Pierre Nanterme

Thank you.

Operator

And our next question comes from Joe Foresi with Janney. Please go ahead.

Joe Foresi - Janney Montgomery Scott LLC

Hi. I just want to go back to profitability really quickly. Where are you seeing the biggest impact on profitability? Is that new or old work? And what does that imply going forward? I'm just wondering if its renewals or the new work that you were seeing the pricing issues that you mentioned last quarter?

David Rowland

Yes, I would say that I guess in answering the question maybe I will start with saying that we were very pleased with the work that we contracted in the third quarter from a profitability standpoint overall.

Again I think that some of the things we talked about last quarter I mean, I would just be redundant with those -- with those messages, we had last quarter declared some pricing pressure. We related that to some pressure on profitability, but yet we've said this quarter that it's been stable.

We highlighted last quarter some pressure in contract profitability, but yet we actually were pleased with our contract profitability this quarter and saw some positive progression from where we were last quarter. So that's kind of our existing book of business and maybe I could just be concise in answer it that way in that we are always focused on improving contract profitability.

We did see some improvement from last quarter to this quarter sequentially and again we were very pleased with the economics of the deals that we contracted in the third quarter.

Joe Foresi - Janney Montgomery Scott LLC

That's very helpful and just my follow-up, consulting looked like it up-ticked a little bit going, what was the driver of that and how sustainable is that driver going forward? What should we be looking for to see what the trends in consulting can look like?

Pierre Nanterme

On the consulting if you look and it's not the old story, but clearly all what we are doing in digital is a big contributor and is getting a stronger and stronger contributor if you will to our consulting business.

You will find in this consulting all the work we are doing through Accenture Interactive with all the capabilities from a management consulting standpoint to a system integration standpoint, solutions we're providing to enable the digital consumer.

I am thinking about all the work we're doing through Accenture Mobility, again a good combination of management consulting and system integration work to enable mobility. Couldn’t be more pleased that recently Fiat accepted to communicate around the UConnect Solution we've been putting in place, which is absolutely cutting and leading-edge in mobility and of course very pleased with the momentum of Accenture Analytics, which again is a good mix of MC and system integration to what we are calling consulting and all of this is now becoming a stronger driver for our consulting growth.

Joe Foresi - Janney Montgomery Scott LLC

Thank you.

Operator

And our next question comes from the line of David Togut with Evercore Partners. Please go ahead.

Pierre Nanterme

Hey David.

David Togut - Evercore Partners

Hello David. Employee attrition moved up two points in the quarter to 14% from 12%, what was the key reason for that?

David Rowland

It's -- I don't think that there was anything in particular underneath that. It's -- that 14% is well within our tolerant zone and there is ebb and flow and so just frankly there really isn’t a story behind that. It's just kind of the normal flow of how attrition goes.

David Togut - Evercore Partners

Just as a key follow-up, you mentioned a target of 65,000 gross employee adds for this year, is that an uptick from what you indicated in Q2?

David Rowland

It is. I think KC can correct me, but I think we said 60,000 last quarter and we said -- and then 65,000 this quarter.

David Togut - Evercore Partners

And which practice areas are you adding more employees versus previous plan.

David Rowland

It's across our practice. There is not a particular area of concentration. There is clearly a mix of GDN in there obviously, but beyond that, we are, we're doing some level of hiring probably in most of the markets around the globe and some of it relates to many of the things Pierre has commented on where we have these new exciting areas that are growth engines for us going forward and we're always bringing skills and talent on Board.

David Togut - Evercore Partners

Understood. Thank you very much.

David Rowland

Thank you.

Operator

A question comes from the line of Dave Koning with Baird. Please go ahead.

David Koning - Robert W. Baird Co.

Yes, hey guys. Good morning. Great job.

David Rowland

Good morning.

David Koning - Robert W. Baird Co.

And so I guess just a couple of kind of cash flow items, this is the first year in a while we've talked about this before that free cash flow was kind of going to be in line maybe even a little below income and just wondering if over time, you kind of expect that to exceed earnings. Just kind of wondering kind of your long term expectations around that.

David Rowland

Yes, I think I've said last quarter that we feel very good about our -- the structural drivers if you will of our cash flow and so we expect to be a business that continues to focus on cash flow as part of our economic model. We continue to have industry leading DSOs. We have a capital like business. We don't anticipate that that's going to change.

So -- and we are always focused on managing our profitability, which gets to our cash operating expense outflow in a particular year. So this year is what it is, but we think that the structural underpinnings of our business from that standpoint remain unchanged.

David Koning - Robert W. Baird Co.

Good. And just because there haven’t been quite enough questions on margins yet, one small item with last quarter, last quarter you talked a little bit about the bonus accruals being brought down a few hundred million just to manage cost and given how good revenue trends are now, I knew that that's very encouraging, I am just wondering if that has been undone a little bit and may be that part of the reason that margins are a little lower.

David Rowland

Yes, not to disappoint you with the answer, but I'll just remind you David and you and the others who remember that we really have had a practice, I am not talking about variable comp and the only time when we'll talk about it is when it is important to understanding the story in a particular quarter, which is not the normal scenario.

We commented on it last quarter because it was relevant to understanding the story. That is not the case this quarter, and so the expectation is going to be that we are not going to do a root canal on variable comp each and every quarter.

I appreciate the question. I appreciate why you asked it. We kind of served it up with what we said last quarter that that's our position on it.

David Koning - Robert W. Baird Co.

Got you. Well, great progress.

David Rowland

Thank you. Appreciate it.

KC McClure

Katie, we have time for one more question and then Pierre will wrap up the call.

Operator

And the last question comes from Sara Gubins with Bank of America Merrill Lynch. Please go ahead.

Sara Gubins - Bank of America Merrill Lynch

Thanks for sneaking me in. Is application outsourcing growing faster or it pans above or below overall outsourcing segment and if you could just talk about how you are responding to the market pressures in this offering?

Pierre Nanterme

Yes, again we're very pleased with all the application outsourcing, overall the outsourcing part of our business, especially pleased with the application outsourcing business, which has been growing nicely.

It's clearly responding to a strong demand from our clients in rationalizing their IT operation. It is a very competitive market. It's a very competitive environment and it's a very large market as well.

So no doubt Accenture will want to compete in that very large market and being extremely competitive in this marketplace and we are of course benefitted from all our global delivering work and we talked about now the 190,000 people we have in our different delivery network supporting not only application outsourcing and BPO.

So, we believe today that despite the fact that it's a highly demanding and competitive environment, we are equipped to fight and win in that particular segment and this has reflected in the excellent growth we had in Q3.

Sara Gubins - Bank of America Merrill Lynch

Thank you.

David Rowland

Thank you, Sara.

Pierre Nanterme

All right. It's time to close the call and thanks again for joining us on today's call. In closing, very briefly let me share a few thoughts. As we entered the first quarter, we feel good about our business and are confident that we're well positioned to deliver our business outlook for the year.

We're focused on executing our growth strategy, which again is all about delivering transformational change for clients at the core of their operations, capturing the opportunities in key growth areas, especially around digital and BPO and investing to further strengthen our capabilities and each and every day, everywhere around the world, our Accenture people bring their unique passion and energy to drive value for both our clients and our shareholders.

We look forward to talking with you again next quarter. In the mean time, if you have any questions, feel free to call KC. All the best.

Operator

Ladies and gentlemen, this conference will be available for replay after 10:30 today through September 24 at midnight. You may access the AT&T replay system at any time by dialing 1800-475-6701 and entering the access code 328224. International participants dial 320-365-3844. Those numbers again are 1800-475-6701 and 320-365-3844, access code is 328224.

That does conclude our conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.

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Source: Accenture's (ACN) CEO Pierre Nanterme on Q3 2014 Results - Earnings Call Transcript
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