Earnings Quality Concerns Following DaVita Inc.'s Beat Quarter

Large Cap Watch List member DaVita Inc. (DVA), announced results for the quarter ended June 30, 2007. Excluding the valuation gain on the Company’s Product Supply Agreement with Gambro Renal Products, and excluding after-tax gains on the sale of investment securities the company earned $0.83 per share, well ahead of analyst estimates. The company also raised guidance for the remainder of the year:

We are revising our 2007 operating income guidance: operating income is now expected to be in the $790-$820 million range. Our previous guidance was for operating income to be in the range of $740-$780 million.

Unfortunately, the company now expects next year to be flat.

Our operating income guidance for 2008, excluding the impact of any potential Medicare legislation, is projected to be in the range of $790-$850 million. We are entering into a period of unusual earnings uncertainty. Therefore the guidance range for 2008 does not capture as high a percentage of the potential outcomes as usual.

Analysts were expecting a double-digit gain in 2008 earnings per share.

Looking at the cash flow statement, I also have some earnings quality concerns. Cash from operations was down despite an increase in net income. Changes in working capital, particularly squishy “other” asset and liability accounts, were the primary reason for the difference. Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, Second Edition cites large changes in other assets and liabilities as a warning sign.

DVA 1-yr chart: