Baxter (NYSE:BAX) kept with its trend in the second quarter of marginal revenue growth, but included a substantial improvement in spending, resulting in an increase in earnings that once again beat management's own guidance.

Baxter results: The raw numbers 

Metric

Q2 2017

Q2 2016

Year-Over-Year Change

Revenue

$2.61 billion

$2.59 billion

1%

Income from operations

$339 million

$68 million

399%

Adjusted operating income

$419 million

$218 million

32%

Earnings per share (EPS)

$0.48

$2.19

(78%)

Adjusted EPS

$0.63

$0.46

37%

Data source: Baxter.

What happened with Baxter this quarter?

  • Sales of fluid systems -- intravenous therapies and the pumps and accessories to deliver them -- were the highlight of the quarter with sales up 4% year over year.
  • Renal sales in the U.S. increased by 7%, but that growth was disintegrated by a 2% drop in international sales, which are three times as large, resulting in flat sales year over year for the category. The international decline came from currency movement; backing that out, international sales were up 1% at constant exchange rates.
  • Adjusted gross margin improved 140 basis points compared to the year-ago quarter to come in at 45.2%. Add in a decrease in selling, general, and administrative expenses and only a slight increase in research and development expenses and Baxter's adjusted operating margin for the quarter was 16.1%, an improvement of 380 basis points compared to the year-ago quarter.
  • Adjusted operating income and adjusted earnings are the best way to look at the quarter considering the one-time items in the year-ago quarter. On that basis, the adjusted earnings of $0.63 per share beat management's guidance of $0.55 to $0.57 per share.
  • Baxter has big plans for its injectable drugs business with the acquisition of Claris Injectables that closed on Thursday, an agreement with Dorizoe Lifesciences to develop more than 20 generic injectable products, and the recent Food and Drug Administration approval of two premixed injectable versions of an antibiotic called clindamycin.
IV bag next to a hospital bed

Image source: Getty Images.

What management had to say 

Jose Almeida, Baxter's chairman, president, and CEO, pointed out that additional acquisitions are important for the company's growth, but it is open to other uses of its cash:

We have said that money's not going to burn a hole in our pocket. So if we do have excess cash, we will buy shares back at our discretion when we think it is the most effective way of doing so. We're opening both channels and we can do both at the same time because of the amount of cash that we have.

Also, Chief Financial Officer James Saccaro pointed out a third possibility for the cash: dividends. While that option isn't as flexible as repurchasing shares, the company plans to increase the dividend as income goes up as laid out by Saccaro:

From a dividend payout ratio, our expectation is to maintain over the long term this targeted payout ratio of 35% of adjusted net income.

Looking forward

The biggest worry with companies that are growing slowly while operating more efficiently is that lower spending can only take a company so far. They eventually run out of fat to cut.

Fortunately, Baxter thinks it can pick up sales growth to about 4% on a compounded annual basis from 2016 to 2020. And then if you add in a little more efficiency improvements, management thinks it can get adjusted earnings in the range of $3.25 to $3.40 per share in 2020, a 40% increase when you compare the midpoint of 2020 guidance to the midpoint of management's 2017 guidance of $2.34 to $2.40 per diluted share.

Not included in that guidance is the potential for acquisitions, which should give a boost to the top and bottom lines. Management thinks it will have about $2 billion in free cash flow in 2020 to work with, giving it plenty of ammunition to get deals done.

Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Baxter. The Motley Fool has a disclosure policy.