Well, the earnings are finally out from chip probe maker and Motley Fool Hidden Gems recommendation FormFactor (NASDAQ:FORM). In a word, they were "good."

In three words, they were "very, very good." As we discussed prior to the announcement, Wall Street was looking for FormFactor to post $65.9 million worth of revenues and $0.21 in profits per share for the quarter. When the time came, however, FormFactor produced $71.8 million worth of revenue and $0.25 per share (diluted). In the parlance of the trade, this is called "blowing the estimates out of the water."

Yesterday, I highlighted that my main "issue" with FormFactor was that its inventories are growing twice as fast as its sales. However, this isn't always a bad thing. To repeat: "FormFactor's inventory rise is almost entirely comprised of raw materials and works in progress (suggesting strong anticipated demand for its wares)." That demand materialized in the company's fourth quarter, leading to the stellar sales growth.

Speaking of stellar sales growth, let's also point out that FormFactor's sales aren't just growing -- their growth is accelerating. FormFactor mentioned that for the full year, its sales grew 34% over fiscal 2004 sales. Compare to that to the 56% growth in Q4 alone, and you can see that sales are speeding up (a fact confirmed elsewhere in the earnings release.)

Take a breath
OK, so far things are fantastic, but let's not get irrationally exuberant here. The stock is already up 21% on yesterday's good news, so I think the risk of ignoring danger signs is real. And it's worth pointing out that the yellow flags are still waving over on inventories and accounts receivable (A/R). True, sales grew 56% in Q4. Also true, inventories continued to outpace sales growth (by 8%). Moreover, A/R rose 75% year over year.

FormFactor didn't break its inventories down into raw materials, work-in-progress, and finished goods in its earnings release (companies almost never do, actually), so we'll have to wait for the firm to file its 10-Q with the SEC before we can go digging around among the inventories' component parts.

When the 10-Q does come out, however, this is what you'll want to look for:

  • First and foremost, finished goods inventories that don't increase more than 56% in comparison to their December 2004 levels.
  • Second and nearly as foremost, raw materials growing faster than 56%.

If you can find those two things, you're looking at a case of "positive inventory divergence," and a sign that yesterday's news may be less a fluke and more a portent of better news still to come.

(Or not. To read my caveat on the theory of positive inventory divergence, click through to this article.)

FormFactor is a Hidden Gems pick. Try a 30-day trial subscription and get access to all of Tom Gardner's other market-trouncing picks.

Fool contributor Rich Smith does not own shares of FormFactor.