Well, the news is out. As expected, Cutter & Buck (NASDAQ:CBUK) reported both sales and earnings declines for its fiscal second quarter 2006 on Friday. The unexpected part: just how big those declines really were.

Although sales declined roughly in line with analysts' predictions, Cutter's profits fell off the proverbial cliff, diving 69% year over year to bottom out at just $0.08 per share.

Wall Street reacted to the "earnings miss" with predictable horror, dropping the stock by as much as 9% on Dec. 8 before Cutter's stock began clawing its way back out of the trough. By close of trading on Dec. 9, the stock had pared its post-announcement loss to just 5%.

So the damage has been done; now it's time to assess it. How badly has Cutter been bruised? The answer: not so badly as the earnings miss might suggest. For instance, Cutter warned us in September that we should expect to see its inventories rise despite the decline in sales. In fact, those inventories did go up -- but not so much as this Fool, at least, had feared. Cutter has been gearing up early this year, getting ready to introduce new clothing lines to freshen up its offerings. Yet inventories have so far increased by just 6% in comparison to last year's numbers.

As a result of that rather subdued inventory expansion, Cutter's free cash flow numbers continue to belie its GAAP decline. Fiscal Q2 saw the company generate $1.4 million in free cash flow, which is 56% more than GAAP permits the company to report as net profits.

On the other hand, Cutter isn't entirely out of the woods on this issue. In its earnings release, the company reiterated its intention to grow inventories ahead of its historical schedule, as new styles are readied for shipment. In fact, Chief Financial Officer Ernie Johnson hinted at a double whammy of inventory growth in the fiscal third quarter (the one we're in now), as the company (1) increases the supply of its new "Classics" inventory that can be shipped immediately upon an order being received, and (2) simultaneously stockpiles its "Spring Fashion" inventories for shipment in the coming fiscal Q4.

Thus, it's entirely possible that we'll see additional disappointing numbers when Cutter reports on fiscal Q3 in a month or so. Long story short: While the company seems to be getting back on track, there will be plenty of possibilities for its stock to fall further. Look for "buying opportunities" in the months ahead.

Cutter & Buck has been chosen by Motley Fool Hidden Gems as one of our Tiny Gems -- powerhouse stocks in teeny tiny packages. Take a free trial right now and you'll get access to all our past recommendations, plus mid-month updates and six-month reviews for everything we've ever recommended.

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