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Athletic-apparel company Under Armour (UA) reported mixed second quarter results Tuesday. The firm earned $0.06 per share during the second quarter of 2012, which is flat year-over-year and four cents shy of our expectation (but a penny higher than the Street's). Revenue was in-line with our expectations, growing 26.8% year-over-year to $369 million. Gross margins fell year-over-year to 45.9% from 46.3%. Operating income grew just 3% year-over-year to $11.7 million, and the company has yet to generate positive operating cash flow during 2012. We think shares remain significantly overvalued.

Although we've been highly critical of Under Armour's poor execution and unexciting product offerings in its footwear division, we think the firm is finally starting to figure out a successful strategy. Footwear sales increased 43.8% year-over-year to $63.8 million thanks to higher price-points and the excitement surrounding some of its recent releases like the Spine and the Charge RC. Both products are steps in the right direction for the sporting apparel firm, but we still think Under Armour has a long road ahead of it before being able to truly compete with Nike (NKE) and adidas (OTCQX:ADDYY).

Apparel growth also remained strong for the company, as it increased 23.5% to $252 million during the second quarter. Management cited strong growth in charged and storm cotton, as well as continued strength in the core apparel business. The firm also recently introduced the Under Bra and Studio (yoga) products that are driving revenue growth. Unfortunately, the firm no longer separates performance from its Men's, Women's and Youth segments, but we assume the Women's business is growing fairly well because the entire sector for women's athletic apparel is growing. Underwear should also become a larger portion of the firm's revenue because-- as CEO Kevin Plank aptly stated--underwear is a natural extension of the brand's name. We've noticed increased SKUs for men's performance underwear products at outlets like Macy's (M) and Nordstrom Rack (JWN), and we feel the segment should grow at a healthy clip.

Under Armour's accessories business continues to provide strong growth, as sales jumped 21.1% to $39.2 million. Since moving the business in-house last year, the firm has seen revenue accelerate, though that may be at the expense of gross margins. Similarly, licensing revenue grew 37.1% to $9.9 million and will likely continue to provide a boost to Under Armour's top-line, especially as it adds more sponsorships. However, those sponsorships aren't cheap, which may help to explain why the firm's SG&A expenses were up over $34 million during the second quarter. Having Cam Newton and Bryce Harper as endorsers could be excellent investments in the long run, but investing in player and school sponsorships could weigh on near-term profitability. Given the success of adidas' investment in Derrick Rose, or even more notably, Nike's investment in Michael Jordan, great endorsers can help to transform a business. However, both firms can outbid Under Armour for virtually any athlete so it will have to focus on finding undervalued assets.

Although it's clear that sales are growing, we're still worried about the firm's ability to generate cash. Year-to-date, the firm has used $27 million in operating cash flow, and it simply isn't as successful in cash conversion as peers. Inventories grew 22.4%, making it the first time in several quarters that inventory growth was in-line with revenue growth. We fear the lack of inventory build in the second quarter could signal tempered demand expectations in the back half of 2012, but the firm's bullish outlook suggests otherwise. The company now predicts revenue to increase 22-24% (was 21-22%) and earnings to grow 26-27% for the year. Still, we'd like to see some of this earnings growth translate to cash-flow expansion.

Though we're encouraged by strong results in its footwear segment, we still believe shares of the athletic retailer are significantly overvalued. However, the company's top-line growth and lack of international exposure could help support the share price in the near-term. As we've previously discussed, Plank also holds a large amount of the float, reducing the chance of intense selling pressure. We may re-evaluate the firm as a put option candidate once its technicals deteriorate.

Source: Under Armour Continues To Grow...But Not Profitably