Cutter Connects

For new Cutter & Buck (Nasdaq: CBUK) CEO Ernie Johnson, it was a good day at the office.

In his first appearance Thursday at the head of a company conference call, Johnson was able to report results that trounced analyst estimates. Fiscal third-quarter 2006 sales, expected to reach $25.7 million, instead came in at $31.2 million, as Cutter swept old styles out of its warehouses at discounted prices. Granted, the inventory-clearing came at a cost: The company's gross margins declined 110 basis points year over year, which will further depress the company's trailing-12-month results. Nonetheless, profits, predicted to go missing altogether, instead surprised investors by coming in at $0.04 per share, thanks to the larger volume of goods sold. Happy day.

Now, many companies would have stopped right there. Told the good news, accepted the accolades and the stock price bump (and indeed, Cutter's price jumped as high as 8% on the news), and perhaps cashed in some stock options. But not Cutter. Cutter came clean.

In an earnings release so honest and straightforward, it might give an Enron executive a heart attack, Cutter went on to tell the bad and the ugly in addition to the good.

The bad
We weren't just looking for good GAAP numbers from Cutter last week. In fact, we didn't expect good results at all. We wanted to see the company generate cash commensurate with its sales. If sales grew 29% year over year, we hoped to see free cash flow grow as well. It didn't.

The ugly
On the contrary, Cutter saw negative $0.2 million in free cash flow. Year to date, that brings the cash flow tally to $5.4 million -- down 29% from the $7.6 million Cutter generated in the first three quarters of 2004. Reading those numbers, I feel very confident in Cutter going forward.

Huh?
You're right. That deserves an explanation. I'm confident in Cutter for two reasons. First, the quarter's miserable cash-generating performance stemmed from the firm clearing out old inventory at cut-rate prices. In future quarters, Cutter will be selling new lines of clothing, likely at fatter profit margins.

More importantly, though, as an investor, I'm heartened at Cutter's level of disclosure. Cutter described its cash flow position clearly in the text of its announcement, then laid it all out in a cash flow statement, then topped it all off by filing its form 10-Q the same day as its earnings release.

These are not the actions of a company with something to hide, folks. This company treats its shareholders with respect and takes seriously its duty to keep those shareholders informed. This is management you can trust with your money.

Fool contributor Rich Smith does not own shares of Cutter & Buck.