Nike F3Q07 (Qtr End 2/28/07) Earnings Call Transcript

Mar.22.07 | About: Nike Inc. (NKE)
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Nike Inc. (NYSE:NKE)

F3Q07 Earnings Call

March 22, 2007 5:00 pm ET

Executives

Pam Catlett - VP, IR

Mark Parker - CEO

Don Blair - VP, CFO

Charlie Denson - President, Nike Brand

Analysts

Robbie Ohmes - Banc of America

Jeff Edelman - UBS

Bob Drbul - Lehman Brothers

Omar Saad - Credit Suisse

John Shanley - Susquehanna Financial

Virginia Genereux - Merrill Lynch

Margaret Mager - Goldman Sachs

Jim Duffy - Thomas Weisel

Presentation

Operator

Good afternoon, everyone and welcome to the Nike fiscal 2007 third quarter conference call. For those of you who need to reference today's press release, you will find it at www.nikebiz.com. Leading today's call will be Pamela Catlett, Vice President of Investor Relations.

Before I turn the call over to Ms. Catlett, let me remind you that participants of this call will make forward-looking statements based on current expectations and those statements are subject to certain risk and uncertainties that could cause actual results to differ materially. These risks and uncertainties are detailed in the reports filed with the SEC including Forms 8-K, 10-K, and 10-Q.

Some forward-looking statements concern future orders that are not necessarily indicative of change in total revenue for subsequent periods due to the mix of futures and at-once orders, exchange rate fluctuations, order cancellations and discounts which may vary significantly from quarter to quarter. In addition, it is important to remember a significant portion of Nike's business, including equipment, most of Nike Retail, Nike Golf, Converse, Cole Haan, Nike Bauer Hockey, Hurley and Exeter Brand groups are not including in these future numbers.

Finally, participants may discuss non-GAAP financial measures. A presentation of comparable GAAP measures and quantitative reconciliations can also be found at Nike's website. This call may also include discussion of non-public financial and statistical information which is also publicly available on that site, www.nikebiz.com.

Now I would like to turn the call over to Ms. Pam Catlett, Vice President of Investor Relations. Please go ahead, ma'am.

Pamela Catlett

Thank you and good afternoon, everyone. Thank you for joining us today to discuss Nike's fiscal 2007 third quarter results. We issued our results about an hour ago. If you need to reference them, you can find our press release -- which includes the reconciliations the operator mentioned between GAAP and non-GAAP reported items -- at our website at www.nikebiz.com.

Joining us on today's call are Nike Inc. CEO, Mark Parker; Nike Brand President, Charlie Denson; and Nike Inc. Chief Financial Officer, Don Blair. Both Mark and Don have brief prepared remarks, and Charlie will be on hand for the question period to give you his perspective and insight on the Nike Brand.

Now it is my pleasure to introduce Nike Inc. CEO, Mark Parker.

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Mark Parker

Thanks, Pam. Thank you all for joining the call today. When I took this job 15 months ago, I said Nike's focus was on generating top line revenue and profitability. Our third quarter performance shows that we're keeping that promise. Net revenue was up 9% over third quarter last year, the 22nd consecutive quarter of year-over-year revenue growth.

We're able to deliver that kind of consistent performance because we create the most innovative and compelling product in the industry. For example, Nike Plus runners have logged more than 10 million miles, and all of our performance running shoes will be Plus-enabled by holiday. Bauer Mint Performance running shoes grew 11% in Q3; the Air Jordan XXII launched at the All-Star Game in Las Vegas. Nike Pro is growing from its U.S. roots across Europe and Asia. 10R, our Ronaldinho signature line, is seeing very solid sell-through. March Madness is setting the stage for our new Nike Pro-inspired basketball uniforms.

Air Force One is white hot. Converse launched the new Wade 2.0 footwear and apparel collection. The Tailwind footwear collection landed in Payless. Cole Haan is expanding its dressier and handbag lines; Hurley is building on the strength of its iconic board short and Nike Bauer Hockey is number one in sticks and launching the much anticipated Vapor 40 skate.

Coming up you will see the first generation of Nike Sports Essentials apparel hit retail April 2nd, new generations of Nike Pro apparel along with Shock, Free and Considered footwear. For back-to-school, an innovative collection of low profile, high performance Zoom Air footwear and lots of surprises throughout the year ahead as we ramp up to the Summer Olympic Games in Beijing.

That's just a small glimpse of what we're doing. Our revenue numbers tell us the consumers are excited about the brand and our futures numbers tell us that retailers are too. Q3 futures are up 9%, the third consecutive quarter that constant dollar futures have increased. But to steal a line from Don, we don't want just any growth, we want the good kind; the profitable, sustainable kind.

We continue to optimize every corner of the business and leverage our costs across the portfolio. That drives the good growth we're looking for. Diluted EPS is up 10% at $1.37, gross margin is up 60 basis points over last quarter at 44.2%, and inventory grew at a pace lower than both revenue and futures.

Shortly before our investor meeting in February, I attended the World Economic Forum in Davos, and I came away more impressed with how well Nike is positioned to grow in the changing global economy.

Specifically, power continues to shift to consumers. They demand more from brands today, they expect a company to share their values and to provide experiences that go beyond the product. I think Nike has a huge head start. Connecting with consumers is something we do intuitively. It is what allows us to create and deliver the premium consumer experiences that really set Nike apart from the rest of the industry.

Finally, a word on retail; that word is change. Consumers want a more compelling and relevant experience wherever and whenever they shop -- in the mall, on the high streets of the world, or online. We're going to give that to them. We're grabbing the opportunity to lead, working with our retail partners to take Nike and our industry someplace new, where consumers have experiences that are physical and digital and mobile. When a consumer has a Nike experience, there will be no doubt that it reflects and inspires the way they live their lives. I won't get into specific dates or executions, but you can expect to see some of these new Nike concepts at retail this calendar year.

You know our vision: $23 billion in revenue by fiscal '11. We stated that six weeks ago. So far, so good. Our new category alignment is already creating deeper, more focused connections with consumers. We're bringing those insights directly into the product creation process, and that will extend our leadership role as the most relevant and innovative company in the industry.

With that, I will turn it over to Don.

Don Blair

Thank you, Mark. Overall, we're very pleased with our financial results for the third quarter. We delivered good revenue and earnings per share growth, our futures growth accelerated, and our inventory position continued to improve. With three quarters of the year on the books, we believe we're well positioned to deliver strong growth in revenue and earnings per share for the full year.

Reported revenues for the quarter grew 9%, as once again all three of our product business units and all four of our geographic regions delivered revenue growth for the quarter. Excluding the impact of the weaker dollar, revenues grew 6%. On a constant currency basis, footwear increased 4%, apparel was up 5%, and equipment grew 9% versus the prior year. In addition, reported revenue from our other businesses grew 15% and contributed 2 points to our overall revenue growth.

Futures orders scheduled for delivery from March through July 2007 grew 9% versus the prior year, with the growth concentrated in the back half of the futures window, driven by strong growth for the fall season. Excluding the impact of currency, futures orders were up 8%.

Consolidated gross margins for the quarter increased 60 basis points over last year's third quarter, continuing the trend of sequential improvement in our quarterly comparisons. Changes in currency exchange rates added about 30 basis points to consolidated gross margins for the quarter.

SG&A increased 14% for the quarter. Excluding the effects of currency changes and stock option expenses, SG&A increased 10%, driven in part by investments against our strategic growth priorities.

Earnings per share for the third quarter increased 10% as growth in revenues and gross margins, combined with a lower tax rate and share count, more than offset investments in SG&A. Excluding the change in accounting for stock options, diluted EPS would have increased 16%.

In the first three quarters of fiscal 2007, we delivered $716 million of free cash flow from operations, and paid out $250 million in dividends. Year-to-date, we've repurchased over 8.4 million shares of Nike stock at a cost of $694 million.

For the 12 months ended February, 2007, our return on invested capital, or ROIC, was 21%. Stock option expenses reduced our ROIC by just over 1 percentage point.

With that recap of our consolidated performance for the quarter, now I will give you some additional perspective on our results.

In our European region, which includes the Middle East and Africa, revenues grew 15% for the quarter, with 9 points of growth coming from currency changes. Excluding currency changes, all of the markets in the region except the U.K. and France posted higher sales.

The emerging markets in the region grew over 30%, driven by strong results in Russia, South Africa and Turkey. Excluding currency effects, footwear revenues advanced 4% for the quarter due primarily to strength in emerging markets in Northern Europe, partially offset by weakness in the U.K. and France. For the quarter, apparel revenues grew 10% and equipment revenues grew 9%.

Futures orders for footwear and apparel grew 7% in constant currency, a significant acceleration versus recent quarters, and an early indicator that the strategies we've discussed on previous calls are now taking hold.

Third quarter pre-tax income for Europe grew 18% to $247 million, reflecting leverage from lower demand creation spending, as well as the stronger European currencies. We expect the profit picture in Europe to continue to improve in the fourth quarter as demand creation declines from the prior year's World Cup levels and operating overhead growth eases.

In the Asia Pacific region, revenues increased 11% in the third quarter, driven by strong growth across all business units. Currency changes contributed 3 percentage points of that growth. While most countries in the region reported double-digit sales growth on a currency neutral basis, China was again the primary driver of the region's revenue growth as we continue to expand both the number of doors selling Nike product and sales through those existing doors.

This was partially offset by lower sales in Japan, where currency neutral revenues were down 3%. Despite the same softness in revenue, we are seeing some positive signs in our Japanese business: higher gross margins, improving sell-through at retail and improving futures order trends. As you know, we're always loath to call a turn, but we remain cautiously optimistic about the outlook for Japan. For the quarter, Asia Pacific pre-tax income grew 6% to $126 million as revenue growth and better gross margins more than offset SG&A investments in China, Korea and Japan.

The Americas region reported 5% revenue growth in the third quarter, with virtually no impact from currency changes. Double-digit growth in most markets in the region offset softer results in Brazil. In the third quarter, pre-tax income grew 6% to $41 million driven primarily by higher revenues and improved gross margins, partially offset by mid single-digit growth in SG&A expenses.

That brings us to the USA, which delivered modest growth in Q3 against a very strong quarter last year. Revenues grew 2% for the quarter, as softness in some mall-based accounts partially offset solid growth in sporting goods and regional accounts. Sales at Nike-owned retail stores in the USA grew 9% for the quarter, and comp store sales at Niketown stores increased 2%. Futures orders scheduled for delivery from March through July 2007 increased 8% over the prior year.

Our U.S. footwear business grew 2% in the third quarter, lapping 18% growth in last year's third quarter. This year's increase reflected mid single-digit growth in units and a lower average price per pair driven by changes in product mix. In the U.S., we continue to gain share driven by strong growth of performance running products, including Nike Plus and sport culture products, including both urban basketball and lifestyle models.

Apparel sales in the U.S. grew 1% for the quarter, driven by double-digit growth in Nike-branded performance and team apparel, partially offset by softer revenue from at-once apparel. The rebound in U.S. equipment continued as third quarter revenues rose 11% driven by new sock offerings for spring.

For the quarter, pre-tax income for the U.S. region declined 2% as the growth in revenue was offset by lower gross margins and a mid single-digit increase in SG&A expense.

For the third quarter, revenues from our other businesses grew 15% to $523 million. Nike Golf led the way, as strong consumer response to new product introductions drove revenue growth of more than 25%. Revenues at Converse, Hurley and Exeter also grew over 20%. Third quarter pre-tax income for the other businesses grew 53% versus the prior year quarter, reflecting higher revenues and improved gross margins.

Earlier this month, we announced a program to replace some SUMO square drivers to ensure compliance with Nike design specifications. We expect this program to have only a short-term impact on Nike Golf results.

Consolidated SG&A spending for Nike Inc. grew 14%. Currency changes and stock option expense each contributed 2 points of SG&A growth for the quarter. Excluding the impact of currency changes, third quarter demand creation grew 6%, driven by advertising campaigns behind Force Basketball, Nike Plus, and Just Do It in the Asia Pacific region.

Operating overhead for the quarter increased 18%, with 4 points of growth due to the change in accounting for stock option expenses and 3 points due to currency changes. Key drivers of the balance of the increase were investments in growth drivers such as emerging markets, non-Nike brands and owned retail, as well as normal wage inflation and performance-based compensation.

In the third quarter, other income totaled $10 million due mostly to a gain on the sale of our Oregon Footwear Distribution Center, partially offset by foreign currency hedge losses. The combination of foreign currency hedge losses and the favorable translation of foreign currency denominated profits from our international regions increased year-over-year pre-tax income by about $9 million for the quarter.

Our effective tax rate for the third quarter was 32.3%, an improvement of 3.4 points versus the prior year. The lower tax rate was due largely to the European tax agreement that was finalized in the second quarter of fiscal 2007, as well as the retroactive reinstatement of the U.S. R&D tax credit, signed into law in December 2006.

As I noted earlier, we continue to generate excellent cash flow and return a significant amount of that cash to our shareholders. So far this fiscal year, we've paid out $955 million to our shareholders in the form of dividends and share repurchases. Even so, our balance of cash and short-term investments totaled $2.3 billion as of February 28th, nearly $9 per diluted share on a gross basis, and nearly $7 a diluted share net of debt.

One of the key drivers of cash flow and returns on capital is inventory management, and as promised, our inventory growth continued to slow in Q3. As of February 28th, worldwide inventories were 7% higher than a year ago, and up only 4% on a currency neutral basis. Both of these growth rates were about 2 points below the comparable revenue growth rate. While we've made great progress reducing the rate of inventory growth, we intend to continue this focus through the rest of the year to ensure inventories are clean heading into fiscal 2008.

As of February 28th, accounts receivable were 8% higher than the prior year. This marks the sixth consecutive quarter in which accounts receivable have grown at or below the rate of revenue growth.

Our financial outlook for the fourth quarter of fiscal 2007 remains essentially unchanged. Assuming stable exchange rates, we expect top line growth at a high single-digit rate for the fourth quarter and fiscal year.

For the fourth quarter and fiscal year, we expect gross margin to be at or slightly below the prior year. This fourth quarter estimate is a bit lower than we expected 90 days ago, primarily due to faster movement of closeout inventories. The customer response to our fall product lines has been very strong, and we're focused on ensuring that our supply chain is positioned to deliver to demand, and that our in-line channels are prepared to deliver full margin sell-through of fresh product. We do expect to see the benefit in subsequent quarters as gross margins return to year-on-year growth in the first quarter of fiscal 2008.

We expect SG&A expense for the fourth quarter to be flat to up slightly as we anniversary last year's World Cup spending and growth in operating overhead eases. Stock option expense for the fourth quarter should be about $0.07 per diluted share. Excluding charges for expensing stock options, we expect to grow fiscal 2007 SG&A at or slightly less than the rate of revenue growth, driven by operating overhead leverage.

Interest income should continue at levels similar to the first three quarters of fiscal 2007.

Now as you know, we don't normally give guidance for other income and expense, since this line of the P&L is usually volatile, and has been particularly so this year. Based on what we can foresee now, we expect $10 million to $15 million of other expense in the fourth quarter, as continued weakness in the dollar drives foreign currency hedge losses. As in previous quarters, these hedge losses will be largely offset by currency translation benefits across other lines of our P&L.

We expect our effective tax rate in the fourth quarter to be about 33.6%, bringing us to a full year rate roughly on par with our third quarter rate.

So in summary, our outlook for fiscal 2007 is pretty much what we said before. As we usually do at this time, we're also developing plans for our next fiscal year. You are, of course, familiar with our long-term financial goals of high single-digit revenue growth and mid-teens growth in earnings per share. To achieve these goals, we'll continue to manage every line of our P&L and leverage our balance sheet as appropriate. At this point, we expect more consistent earnings growth from quarter to quarter than in fiscal 2007.

For the first quarter of fiscal 2008, we expect to deliver high single-digit revenue growth and some improvement in gross margins. SG&A should grow at or slightly below the rate of revenue growth, and our tax rate will most likely be below the rate of the first quarter of fiscal 2007.

In summary, we continue to drive toward achievement of our financial goals for fiscal 2007, and are confident that we'll deliver profitable growth again in fiscal 2008.

With that, we would be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robbie Ohmes - Banc of America.

Robbie Ohmes - Banc of America

Thank you. Everybody, nice quarter. Just a couple of really quick questions. First, I was hoping we could get a little more detail on Europe. How much is it turning, just the overall environment out there, footwear versus apparel, technical product versus lower price point non-technical product; just more detail would be terrific.

The other question I had was just a little more on the retail side. When we were out at your Investor Day, you talked about partnering with key people in the U.S. Foot Locker was at our conference last week, and they mentioned that they were going to be doing some special things with you guys. If you could comment on that, that would be terrific, as well. Thanks.

Charlie Denson

I will take the European first, and I might ask you to repeat the second part of that question just to make sure I am clear on what you want to know and what I am going to tell you.

But for Europe, you talked a little bit about the technical versus non-technical, and we're obviously very excited about the numbers that we're releasing here against the European futures picture. Like Don said in his prepared remarks, we're not ready to announce a complete turnaround, but we're very optimistic about what we've done to date and the quality of the business and where the brand sits.

I think with that, when you breakdown Western Europe versus Central Europe, Central Europe continues to be a great growth engine for us. Our Northern European business is very strong, and we're seeing some good growth out of Italy, Spain and Germany, as well. The U.K. and France, as Don stated, is still a little bit of a struggle but a lot of the indicators are starting to point in the right direction, and we're looking forward to those results over the next six months. So that would be my overall summary for Europe.

Robbie Ohmes - Banc of America

So beyond what you guys are doing, do you feel that there is an environment change going on over there, or the beginnings of an environment change in some of the tougher markets, like the U.K.?

Charlie Denson

Yes, I think that there is certainly still the interest in sport and the interest in the product and what we're doing. We haven't lost any momentum from a brand perspective. We're still putting a lot of product into the marketplace. It is just that some of the promotional activity is starting to subside, and the health of the marketplace is starting to come back. So like I said, I am reluctant to announce a turnaround, but I feel good about the directional arrows.

Robbie Ohmes - Banc of America

That sounds great. And then the question, because I probably should be super clear on this, was your retail strategy that you brought up on Investor Day was twofold. One was doing your own stores, and one was doing more things with key retail partners. If you could give us a little more detail on what you're doing with key retail partners. I had mentioned Foot Locker because they had mentioned at our conference that they were expecting to do some potential presentation things with you guys, I believe on the footwear side, relatively soon, certainly this year, and I think for back-to-school. If you could give us any more on that, that would be great.

Charlie Denson

We're currently working on plans with several of our major retail partners. And I am not going to go into any specifics yet, because I want to keep my powder dry here. But I will say this, that I am very optimistic, and I am very excited about some of the things that we are talking about. I know that the partnership groups that we're working with have been very excited and embrace the discussion with as much energy and excitement as we have. So I am going to hold steady for now, and as some of these plans come into focus, we'll be out talking about them.

Mark Parker

Yes, I will just jump in and add that our strategy in terms of the marketplace is to segment or differentiate our key retailers more effectively. A lot of that will actually fall in line with what we're doing with the category-based organization. We want to go deeper and be more compelling and more relevant with our category-based presentations. I think you will see that be a more effective tool for us to differentiate our retail partners and that will drive some of the concepts that you'll see later in this calendar year.

Robbie Ohmes - Banc of America

Terrific. Thanks a lot, guys.

Operator

Your next question comes from Jeff Edelman - UBS.

Jeff Edelman - UBS

I have been visiting a lot of retailers here in Europe this weekend. It appears as if the trend towards athletic or let's say the performance seems to be picking up a little more than I guess all of us would have thought. Is this what we're seeing in your orders and is this something which has staying power? I also got the sense that the average selling price is also starting to lift.

Charlie Denson

Jeff, I would agree with your comments and your observations, that we're starting to see a lift in some of the performance product overall, and I think that's encouraging for us. Along with that, we've actually made some significant progress in that low profile area that we've talked about for the past year-and-a-half. So that part of the business is up considerably year-on-year, and we're pretty excited about that. I would agree that we are starting to see a little bit more emphasis on the true performance product.

Jeff Edelman - UBS

Shifting back to the U.S., if we think a little about the increase in sales vis-à-vis the orders and what you talked about in terms of gross margin for the upcoming quarter in terms of increased closeout inventory, is this a function of channel-specific? Is it trying to get something more in balance? Could you give us a little more insight there, please?

Charlie Denson

Yes, I think it is not channel-specific, because we don't spend a lot of time and efforts around segmenting the business across the channels maybe as much as we used to five or six years ago. What I would say is that we feel very confident about both our inventory positions especially in footwear, as well as our inventory positions at all of our major retail partners.

I think with the numbers that we're releasing today going into fall, we feel like right now there is an opportunity to take advantage of the marketplace for early summer and make sure we're very clean and we're very healthy going into what we think is one of our best product lines ever for next fall.

Jeff Edelman - UBS

Is the closeout inventory more than it was last year, same, less, or what have you?

Mark Parker

We're not in a problem position with closeout inventory here. As Charlie said, what we're really trying to do is make sure we've got clean channels and clean inventory on our books. Really it is a question of how fast we move through it. So we're really trying to make sure we've got good turns in the fourth quarter, and we're ready to go for fall.

Jeff Edelman - UBS

Great. Thank you.

Operator

Your next question comes from Bob Drbul - Lehman Brothers.

Bob Drbul - Lehman Brothers

Can you quantify the impacts on the overhead and the factors that you talked about, just like what were the biggest ones and maybe just put a numbers around some of those factors on the overhead increase this quarter?

Don Blair

Well, I would rather not have to do a reconciliation here, but if you want to talk about the major elements of this, certainly the currency and the options are two very large pieces of the equation. About a third of the balance is investments in some of the growth areas I spoke to, which is emerging markets, our non-Nike brands and Nike Retail. There is about a third of it that would be some timing issues and then I would say the remaining third is more like normal inflationary aspects of operating overhead. So the way to think about it is take the currency and the options off the top, and then you have got three main drivers of the balance.

Bob Drbul - Lehman Brothers

On the gross margin outlook, can you talk a little bit about the trends around labor pressures and wage pressures in China, and is that at all changing for you guys on the outlook?

Mark Parker

We are continuing to see some headwind out of labor costs in Asia. We are certainly seeing the pressure of oil fees. The major headwinds would be labor and currency exchange rates in Asia. Balancing against that are some of the initiatives that we talked about at the investor call, which is things like lean manufacturing, raw material consolidation.

So if we look at what we saw in the third quarter and what we expect to see going forward, it is very similar to what we discussed at the investor meeting. We have got some continued headwind, but we have got some arrows in the quiver that we continue to push, and that way we want to come out in the right spot.

Bob Drbul - Lehman Brothers

Thank you.

Operator

Your next question comes from Omar Saad - Credit Suisse.

Omar Saad - Credit Suisse

I wanted to ask, looks like you've kind of slowed down the share repurchase here a little bit this past quarter and the cash is building a little bit more. Given that context, I wanted to see if we could get any update on your strategies for the cash?

Mark Parker

There really isn't a significant change in the strategy. As we've always said, we have a balanced approach to this. We want to make sure we invest appropriately in our existing business to drive growth. We want to make sure that we are opportunistic around good acquisitions, should they appear on the horizon, and we're going to return cash to shareholders in a planned way on both dividends and repurchase.

The repurchase side, we run an evaluation grid and we have a target on how much cash we're going to deploy. We usually execute that in concert with market conditions, and that's really what drives our share buyback.

So I think as we said at the last investor meeting, we think over the next couple of years you'll see consistent growth in dividends, you will see growth in share buyback, you will see investment in our existing business and so it is really a balanced approach to how we use the cash.

Omar Saad - Credit Suisse

If we could get a quick update on the realignment, where you are in that process; it is something you've been working on for awhile. It sounds like you're making a lot of progress in terms of the investment and a lot of the changes and how things are going with that.

Mark Parker

You're talking about the category alignment, right?

Omar Saad - Credit Suisse

Absolutely, yes.

Charlie Denson

I will jump in there. I think actually we made some very, very good progress. The last couple of weeks we've spent time going through. We've got leadership teams in place. We've been going through the first runs at the full bore category strategies, and we're aligning the company both from a supply chain standpoint and a retail standpoint to embrace this change.

I am very pleased with the progress to date, and I am really looking forward to the next 12 months as we start to see some of this alignment work its way into the way we're actually coming to market, both from a product standpoint, a marketing standpoint and a retail brand presentation standpoint.

Omar Saad - Credit Suisse

Should we expect to see anything come running through the P&L as you go through this process, and as we think about how we model the expense side of the equation?

Charlie Denson

Omar, we look at this over a longer timeframe. Essentially what we're doing is running the model on the P&L based on all the levers in the P&L. I think in that context, I wouldn't expect us to materially change our financial model.

Omar Saad - Credit Suisse

Great. Thanks.

Operator

Your next question comes from John Shanley - Susquehanna Financial.

John Shanley - Susquehanna Financial

Thank you and good afternoon. The company's difficulties in the U.K. and France have been going on for some time. I wonder if you could comment in terms of what seems to be the central issue in terms of the difficulties in that market and why you feel optimistic that the situation is going to turnaround in the next six months or so?

Charlie Denson

A lot of things we've been talking about is the overall brand presentation, the promotional nature of the marketplace and what's been going on. Obviously, it's a little bit tougher to implement change there as it is in the United States, and so we have a new distribution policy in place today. It has taken longer to get that implemented than maybe it would have taken in some other markets around the world. So I think that's challenging, but it is starting to take effect. I think if you do spend some time in the U.K. marketplace over the next couple of months, you will actually start to see some of the effects of that change in place.

I think the other thing is, is when I think about France we have a significant amount of business at Decathlon and we made some changes there. And I think that when we look out over the horizon, that business is now in a position to start to grow at a much healthier rate in a much healthier way. So those two things I would add to the mix.

I think the third piece, which is again cautious optimism, is the role that Foot Locker may play in both those countries and their opportunities for growth, whether it is in the U.K., France or across Western Europe. Definitely an important account for us that runs across the Western European landscape.

I guess the final piece that we started to put in place is a strategy with JJB specifically, where we've got shop-in-shop concepts going in. I believe we have 15 of them in place now, and we would like to see as many as 100 of those shops in place over the next six to 12 months.

John Shanley - Susquehanna Financial

Sounds very exciting. Is the U.K. and France still your two largest markets or two largest components of the EMEA region?

Charlie Denson

Well, certainly the U.K. is number one. France, Italy and Spain go back and forth as far as overall size.

Mark Parker

But John, I would note that in aggregate, the emerging markets are larger than those markets that you just described.

Charlie Denson

Individually.

Mark Parker

Right.

John Shanley - Susquehanna Financial

Turning to the U.S. for a second, the sales results in footwear and apparel obviously were a little on the light side. The thing I really want to focus in on is the 2% decline in the operating profit. If you look at the U.S. business excluding what you indicated was a problem side of the business, the athletic specialty stores, was it a much different story? Would operating profits have actually been positive? Would sales have been richer if we were able to exclude the mall-based athletic specialty stores?

Mark Parker

John, I think if you look at the overall profit equation in the U.S. region at 2% revenue growth, and we've talked a little bit about some of the margin drivers in the U.S. region, the combination of those two things means that even very modest growth in SG&A, which is where the U.S. region is running, is going to make it difficult to grow the profitability. But we don't believe that the U.S. is a 2% growth market. We're convinced that that market is going to accelerate over time, and the profitability is going to come with that.

John Shanley - Susquehanna Financial

What I was really trying to get to is to look at the mall-based retail accounts versus the rest of your U.S. retail clients. Can you give us some differentiation in terms of what kind of a negative impact the mall-based guys may have had on your business in the third quarter?

Mark Parker

Well, as we said, there was a little bit of softness with certain mall-based customers. That's not across the board. We had some mall-based customers that did well, and we don't really get into discussing results by specific customers, John.

John Shanley - Susquehanna Financial

I am not looking for individual customers. I am looking at channels of distribution, whether there was a substantial difference so we can evaluate how well you did in the other segments of your distribution process.

Charlie Denson

I think it is no secret the mall-based athletic specialty guys have had a pretty tough year. We obviously are a big part of their business, and so I think we've experienced some of that as well. I think we still have a great relationship and like I said earlier, I am very excited about the things that we're talking about, as they are as well. The good news is, is everybody is embracing an opportunity to change and go forward; that I am very excited about.

John Shanley - Susquehanna Financial

Then just summarizing, would you say that it is fair for us to ascertain that in the future, you're likely to see faster or better growth in the U.S. accounts outside the regional mall? Would that be a fair assessment?

Charlie Denson

I wouldn't be as quick to jump to that conclusion.

John Shanley - Susquehanna Financial

That's encouraging. So you do think that the mall-based guys could come back?

Charlie Denson

I think there is a great opportunity for them.

Mark Parker

I will second that. I would say that we're very focused, as you've heard in some of our remarks, on bringing back the health to that particular channel. Some of the things we have going in terms of retail differentiation, stronger high level partnerships with some of those key accounts, we think will actually help to turn that.

John Shanley - Susquehanna Financial

Super. That's great to hear. Thank you very much.

Operator

Your next question comes from Virginia Genereux - Merrill Lynch.

Virginia Genereux - Merrill Lynch

My first question, if I may, is on other brands. Don, you talked Golf, Converse, Hurley, Exeter were all up in excess of 20%. I feel like they're most of it. Was Hockey down? Not only in the quarter, which I am not so concerned about, but how should we think about the growth rates there going forward? Which of the portfolio, what is sort of the growth opportunity still there?

Secondly, margins there have been up over 500 bips year-to-date, but they still run below the Nike brand, obviously. Can margins in other brands sort of approach the mothership level?

Don Blair

Let me take the granular part of the question, and then I think Mark can speak to some of the growth opportunities we see in the other brands. But with respect to the third quarter, the Hockey business was comparing against an Olympic year last year where we did quite a few jerseys around the international hockey teams. So if you look at the core equipment business, year in year out, we're having a tremendous year at Nike Bauer Hockey. We have got some great new products in the skate space. As Mark said, we've taken over leadership of the stick business, which is a very important element of that hockey equipment business. So we feel great about where Nike Bauer Hockey is going right now from a business standpoint.

Obviously, there are some businesses of different sizes in that portfolio. The Hockey business is relatively small, Converse, Cole Haan, Nike Golf, those are the bigger entities in that pool. I think in terms of the margin opportunity, these businesses are all significantly smaller scale than the mothership. And so as they grow and as we tune those businesses, we are seeing improvements in profitability. Where that ultimately lands, I can't necessarily give you a destination. We think there is a lot of profitability expansion in those businesses for quite a while yet.

Mark Parker

I will just simply add that as we said at the investor meeting, that 25% of our growth over this next three to four years will be coming from the affiliates or the subsidiaries. We definitely feel very confident that will be the case led, as Don said, by Nike Golf and Cole Haan and Converse, really the bigger drivers of the portfolio from a subsidiary standpoint.

We're just starting really to leverage, I think some of the competencies, some of the functional excellence in systems and whatnot from Nike in through our subsidiaries, and we think that's going to give us some good upside there.

I would point out, too, that I think the focus on key product opportunities, a la what we've talked about with the Nike brand and then stronger management within the leadership within the subsidiaries is also driving some of that confidence in that part of our portfolio. I just spent some time recently back in New York with the Cole Haan team, and came away yet more confident, too, in the potential that that brand represents in the portfolio.

It's very obvious to see what Converse is doing, really impressive performance this year with, we think lots more potential, both in sport culture side of their business and more so even moving forward, too, in performance and international will be a bigger part of their business, as well. So again, our confidence is quite strong with that part of our portfolio.

Virginia Genereux - Merrill Lynch

You gave us some great geographic color. Charlie, you said you were very excited. You thought you had some of the best lineup of product for fall. You whipped some of that off, Mark. But if you guys can just go through again what do you think is driving the strength for fall and where are you in those various platforms? Thank you.

Charlie Denson

Okay. I will try to keep this short. My confidence in the product side of the equation here, which for me is ultimately the most important thing we do in terms of affecting top line growth and again the consumer connection, we're as strong now as we ever have been.

That being said, I think there is a real renewed energy and focus around product that's driven in part by this more intense focus at the category level. I think you will see product offerings getting even that much stronger from Nike in the seasons ahead, just as a general comment.

Specifically, on some of these calls, I talked about complete offense, and it is across categories, it is across geographies, it is up and down price points, across the genders. Really that's our strength, is that we have a diversified portfolio and a complete offense sense that allows us to sort of push and pull the levers that really are most relevant at the time.

So more recently we've seen some tremendous success. We've been a little late to the party, as we said before, in the low profile metro area in terms of sport culture. The urban part of that business is also very vibrant beyond what you're seeing with the Air Force One success. There is a much stronger and more complete product offering in both metro and urban part of sport culture, and that's resonating around the world. So we feel very good about that.

A very, very big focus on performance, the performance side of our business, both in footwear and apparel. I think you will see in the months ahead, I mentioned some of the concepts that will be coming to market here. For back-to-school, we have a Zoom Air collection of performance low profile product which is a great combination of performance and style. Something I think will really resonate in the markets for Nike around the world. Nike Pro is we're in the new generations of Nike Pro. Again, that's a very strong focus on that in the international markets, as well as here in the U.S. And we're really looking at a 365 day/year focus on that team and training and Pro piece of our business. So that's starting to pick up even more.

Shox, next generation, some things I can't talk about there, that are actually very exciting in the Shox Plus Other category. Free, new generations of Free. Considered product, which is our sustainable product, is actually getting a lot of great response, and we see that business accelerating and expanding going forward.

I mentioned the Sport Essentials category of apparel coming up in early April, April 2nd. That's just the beginning of a long-term commitment, an ongoing commitment to what we call essentials, or the fundamentals, key apparel items and styles in our apparel collection. Big, big growth opportunity in apparel. We just had a recent business review in apparel, and I frankly have never been as excited and confident in our ability to grow our apparel business as I am today.

A lot of that is led by the leadership team that we have is stronger and more connected across the regions than we have ever had, and very, very focused on the key growth opportunities by category, by product type, by country. We're dialing down and getting much more surgical and focused on where those opportunities are. The leadership there is very impressive. So very bullish on the apparel side of our business, as well.

Charlie Denson

See, you wound him up again. I agree with Mark on the apparel side. I think this new Sports Essentials program that's going into the States and a little bit in Europe, we've had first reads out this first week and early read sell-throughs have been fantastic and are exceeding our expectations. So I think that's just the tip of the iceberg and we've got some good things coming there, too.

Virginia Genereux - Merrill Lynch

That's great. And thank you all for the time for questions.

Operator

Your next question comes from Margaret Mager - Goldman Sachs.

Margaret Mager - Goldman Sachs

Nice quarter. I would like to focus on the U.S. market where the orders were up 7% last quarter and the revenues came in up 2% and now your orders are still up 8%. Can you talk to those numbers, please? Would we expect the revenues in the U.S. to once again be in the low to mid single-digit it range despite the high single-digit orders? What's the disconnect there?

If you could also talk about what's your perspective regarding the issues in the mall-based athletic channel? Why is it soft and what do you think is the growth rate for the U.S. market since you made it clear you do not think it is a 2% growth market? I would like to focus on your perspective on the U.S. as number one question.

And then, Don, I would also like to hear from you. You talked about a more consistent earnings per share growth rate by quarter going forward. Just want to make sure I understand that comment, especially in the context of fiscal '08 as you progress through the four quarters of that fiscal year, you will start to approach spending for the Beijing Olympics. Can you talk about the historic lumpiness of demand creation spending that has always been a big factor in the lumpiness of your quarterly earnings growth, and why would that be changing? Thanks.

Don Blair

Okay. There's a lot in there. There were some timing elements of the U.S., Margaret, that I don't think is something that you should extrapolate. I think what I would expect to see is just a more normal level of volatility between futures and revenue. As you know, there is really not always a predictable relationship for any one quarter. Futures are really a much better indicator of overall strength of the business.

So I think if you think about it that way, the 2% number in the U.S. we don't think is representative of the growth trajectory we're on in the U.S. We think it is kind of a mid single-digit growth rate, mid to high single-digit growth rate in the U.S., and that's really what I think will be more indicative of the growth going forward.

I am going to let Charlie speak to the mall-based retailer piece of this. But just to give you a quick view, '08 is not baked yet. We don't have all of our plans locked in place. We actually have two items of spend in fiscal '08 that will affect the very end of the year, that's the European Championships, as well as the Beijing Olympics. But at this stage, we're not ready to give you real specific guidance around individual quarters, but what we do expect is not to have the level of growth rate volatility that we have this year.

Charlie Denson

I will jump in on the mall-based outlook. One of the reasons why I think we have struggled in the mall as well as the mall environment, again is I don't think we've done a good job creating levels of differentiation, or as good a job as we should have or could have done, and certainly as well as we will do. I think one of the things that we talked about during the day that we had everybody out, was this idea around creating points of differentiation targeted around specific consumers/categories that we talked about while you were out here. Mark alluded to it a little bit earlier I think and Don may have touched on it a little bit in his prepared remarks.

I think our ability to continue to grow the marketplace in the U.S. really lies much in the new approach to the business. If we can continue to differentiate and grow through this category strategy, which I believe very confidently that we will, I believe the U.S. marketplace will continue to grow at the rates that Don has alluded to over the next several years.

One of the things that you look at when you walk the mall today is a lot of sea of sameness. Quite frankly, not as sharp of consumer insights that we need to provide going into both the product and the marketing and the merchandising processes that we're focusing on going forward.

I have been around this place a long time. I am as excited about this new direction that we're taking right now as I have ever been. So you're going to hear that from me pretty regularly over the next 16 to 24 months.

Margaret Mager - Goldman Sachs

Why did you not buy back more stock in the quarter? What do you look at to decide how much stock you will or will not buy in a quarter?

Don Blair

Margaret, we don't want to get into all of the models that we use on this thing. But as I've talked about before, we have a set of targets around how much we want to invest over a period of time. It is not specifically a fiscal year, and that number evolves over time. But what we do is we buy according to a perception of both intrinsic valuation as well as market conditions. So if we have a fast run-up in the stock, that may mean that our purchases would slow down until we reassess where we think the market trading range is, and then we'll reset the grid.

So I know that may not give you an exact answer, but that's generally how we approach it. We have an intrinsic value perspective on the stock. We believe that the company has a lot of value. And then we buy based on a perception of trading range and a value grid.

Margaret Mager - Goldman Sachs

That's helpful. Thanks. Good going this quarter, and good luck in the upcoming year.

Operator

Your final question comes from Jim Duffy - Thomas Weisel.

Jim Duffy - Thomas Weisel

Thanks for taking my call. In Don's prepared remarks, I think there was some mention of moderation in average selling prices in the U.S. market. Can you speak to the factors behind that? Is it a channel mix shift, or is there some fashion element driving that?

Charlie Denson

It is really a product mix change. There's an ebb and flow to average selling price normally with seasons, but in terms of which product categories and which models are selling is what's driving the ASP. This is not an across-the-board reduction in price. It is not a change in target price points. It is really a mix change.

Jim Duffy - Thomas Weisel

Would you expect that mix to continue, mix shift?

Charlie Denson

At this point, I don't have a perspective out beyond the futures window.

Jim Duffy - Thomas Weisel

Nice improvement on the inventory, as you had advertised. Can you speak to the geographic specifics of that? Was the improvement concentrated in one particular geographic market? Or was it more balanced across all regions?

Charlie Denson

All of our regions are making great progress on inventory and so we saw improvements pretty much across the board.

Jim Duffy - Thomas Weisel

Very good. Well done.

Pamela Catlett

Thank you everyone, for joining us. We look forward to speaking with you again soon.

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