Good day, ladies and gentlemen, and welcome to the Second Quarter 2015 Badger Meter Earnings Conference Call. My name is Jasmine, and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct the question-and-answer session [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. And I would now like to turn the conference over to your host for today, Mr. Rick Johnson, Senior Vice President, Chief Financial Officer. Please proceed.

Thank you very much, Jasmine. Good morning, everyone, and welcome to Badger Meter's second quarter conference call. I want to thank all of you for joining us. As usual, I'll begin by stating that we will make a number of forward-looking statements on our call today. Certain statements contained in this presentation as well as other information provided from time-to-time by the Company or its employees may contain forward-looking statements that involve risk and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see yesterday's earnings release for a list of words or expressions that identified such statements and the associated risk factors. Let me reiterate some of our guidelines. For competitive reasons, we do not comment on specific individual product line profitability other than in general terms, nor do we disclose components of cost of sales, for example, copper. More importantly, we continue our practice of not providing specific guidance on future earnings. We believe specific guidance does not serve the long-term interest of our shareholders. Now on to the second quarter results. Yesterday after the market close, we released our second quarter 2015 results. We’re beginning to hear some phrases describing the second quarter from companies across the country. One of my favorite is spring lull. But probably the best phrase I heard comes from someone likely listening to us today who had a write-up last week describing the second quarter as the period of underwhelming growth. That truly describes how we feel today. In spite of the fact that sales were at an all-time record for any quarter they were not at the level we anticipated. Frankly, this surprised us because we generally see more strength in the second quarter of any given year. From our viewpoint there's nothing to…

Thank you, Rick, and thank all of you for joining us today. As Rick said, this quarter was marked by record sales but still lower than we had anticipated. On our first quarter conference call, I indicated that we were seeing a normal increase in sales as we moved into the second quarter. While April was a strong month, we saw a marked drop-off in May sales that we had not expected. Although it did improve, it was not enough to offset the weaker May, with disappointing overall results. There were a few unusual events in the second quarter including a major product issue with radios sold by one of our alliance partners. Ultimately, we do not expect to incur any costs associated with this product callback since our alliance partner is providing full warranty support. However, due to this product issue, we were unable to obtain new products from the vendor during the quarter and are still having significant delays in obtaining radios today. Further, some of our customers are focusing their efforts on replacing our alliance partner's product and not on new meter installations, which has also impacted our sales. Although this issue may continue to delay some sales, we do not expect to lose any sales in the long term. During the second quarter, we also incurred additional costs in connection with our sales and marketing efforts in California. Taking advantage of the recent focus on water issues in that state, we decided to expand our marketing efforts there, particularly in connection with the AWWA conference in Anaheim in June. We believe that several of our new products, including the ORION radios and the BEACON advanced meter and analytics software, can help the California municipalities achieve the mandated water conservation goal established by that state. These additional…

[Operator Instructions] And our first question comes from the line of Richard Eastman with Robert W. Baird. Please proceed.

Yes, good morning Rich and Rick.

Good morning.

Rich, could you just speak a little bit to the gross margin? I know the sales mix here had an impact. But, again, just trying to do the math off of National Meter's contribution, it looks like the gross margin on the core business was somewhere shy of 35%. And I'm just curious; it seems to me we should – despite the volume issue here, we should have a little better gross margin. I mean what are the bigger impacts there?

Well, I think there were a few things. Obviously, when you say we should have a better gross margin, you're referring to the fact that National Meter would be a plus and so would copper compared to a year ago. And – but there were some negatives in there, too. Probably the biggest one is the mix of industrial versus municipal utility products. Our industrial product, our Flow Instrumentation product carry a much higher margin overall than the municipal utility products. And so when industrial products go down and the utility products go up, that has a big impact on us.

Do you have any export exposure pricing or margin exposure there?

Say again.

Exports out of the U.S., do you have an exposure there from a pricing margin issue?

What do you mean by that? I guess I'm not sure what you…

The companies that have been exporting out of the U.S. to Europe with the strength of the dollar…

Oh, I see.

They've had some pricing issues, margin issues.

Right. You were talking about pricing issues. When you're talking about the margin, I was confused. Yes, there is no question that the products made in the United States that we are selling in Europe and other places around the world have become more expensive, and we've had to lower price to remain competitive. That is resulted into margin. So as Rick said, we also had the problem that we are not getting the margins on the Flow Instrumentation product line that we were getting a year ago. And since half of those are really sold outside of North America and sold in other currencies, that's a big part of it.

Yes, it is – the issues with Itron on the warranty side, do those – is that revenue impacting Badger's core business and National Meter?

Well, I never said Itron, but since you did, I will accept that. You didn't have to be Hercule Poirot to figure that one out. As many of you said – and let me start by giving you some background. As many of you know, Itron filed an 8-K. They had to do a – they've had some problems with their radios, and they announced in the 8-K that they were going to be incurring some warranty expense in connection with that. Although they were careful to say it was not a recall, they are indeed calling back a lot of that product, so I will call it a callback. And that is having the impact on both us and National Meter. You're right in that resell Itron radios directly to customers. We have three ways that were impacted. I'm not doing this eloquently; I apologize. We have three ways that were impacted. One is that we buy radios from Itron and put them with our meters and sell them to customers. We also sell radios directly to Itron – we sell meters directly to Itron. They put them with their radios and sell them to their customers. And then the third way is we have many customers who buy the meters from us and the radios directly from Itron. This callback of product is impacting us on all three levels. It's reducing the number of meters we sell that will eventually be married up with Itron radios, and it's reducing the number of Itron radios that we can sell directly with our meter mainly because Itron has switched over of replacement products and we can't get our hands on new product. So that is having an impact on our customers who are slowing down their purchases or in some case ending. As one example, and I won't name the customer, but we had one customer that for the last two years has bought about $1.5 million from us every quarter. They bought nothing in the second quarter. And they did that because they were so busy replacing the Itron radios. So it is now – eventually, they will catch up and buy those meters from us, but it's going to have – it's having a short-term impact on our sales.

Yes and this National Meter sales number in the quarter is $3.8 million. Obviously that would be impacted probably by $1 million or $2 million from that issue as well. Right? Because I understand it contributed, but certainly with the gross margin that that comes in at that's $1 million probably light of gross margin contribution relative to the plan as well Right.

Let’s just be clear, Rick; we're talking $3.8 million of incremental revenue. And one of the ironies here is that one of the customers that needs replacement is Wichita, where National Meter is actually doing the replacement of the Itron radios. So it actually is not necessarily hurting us as much at National Meter as you think because we are actually picking up some incremental business [multiple speakers].

Okay. Well, let me ask you this way. Is the National Meter EBIT contribution around $0.5 million in the quarter?

Little bit more Rick.

A little more. Okay. Perfect. All right, thank you.

Okay.

And our next question comes from the line of Ryan Connors with Boenning & Scattergood. Please proceed.

Great, thank you for your time. A couple of questions. First on the – you mentioned kind of the new product's traction. And I wondered if you could just give us any additional color you can on the BEACON product in particular, Rich, and maybe any kind of quantification you might be able to offer on the traction there. Any larger rollouts or however you can quantify it for us, if at all.

Well, we have had one major city that is announced, and that city is going to be total of about 35,000 units okay.

Right, that was known, but anything incremental from that?

Right, we have not yet had any new city. But I will say that, just during the quarter, we sold over 35,000 units. So the sales are pretty significant, and we're probably on track at the rate this is growing of doing close to a couple 100,000 units this year. It should be very significant of that product.

Okay. Yes, that's good. Thank you for that.

Especially, Ryan, considering that that product was first introduced in the middle of last year, that's a relatively fast growth rate for a new product in our industry. Normally it does not grow that fast.

Absolutely.

And I think you had a second question. And since Rick, I actually plagiarized one of your comments, I will let you ask your second question.

Yes. My other question was bigger-picture in nature, so you have the national acquisition kind of in the door. I wonder if you could just put the – that roll-up strategy of your distributor channel in context with what's happening more broadly. I know that Ferguson and others are also kind of attempting some type of consolidation of distributors, of competitors. And kind of give us the broader landscape of what is happening with the distributor channel and the industry as a whole and how your strategy there fits into that.

Yes. There are some what I call the big-box stores which would be a Ferguson and [indiscernible] like that that are looking at getting into water metering distribution business. And so they are aggressively going after some of the distributors out there. And recently, I believe Ferguson bought one of Neptune's California distributors. So we are seeing them go out there and becoming pretty aggressive on that. Our strategy has been to work with sole distributors who have exclusive territories and are exclusively our distributors. About half of our utility sales flow through that distribution network. We bought National Meter, which represented about 20% of our distributor activities, so it was clearly our largest distributor. And we are in negotiations with other distributors that we will be looking at also buying and putting under the National Meter umbrella. So we're still moving forward on that. Our overall strategy is, frankly, driven by the technology channel. As water metering and metering systems move into the cellular system and a much more software-based system, we're finding that we need more boots on the street. We need more trainers, installers, technical support; we need to get close to our customer. And by owning our own distribution network, we believe we can achieve that. So we think this is a good strategy, and it will serve us well. Now, I'm not saying that my competitors are making mistakes by getting in bed with these big-box stores, but from our point of view, I'm just not sure how I could serve my customers through that kind of relationship.

Okay. And just to be clear, have any of these big-box stores, to your knowledge, made any overtures to any of your distributors in their efforts to expand?

Yes, they have, unsuccessfully.

Okay. Interesting. Okay, thanks for your time.

Sure.

And our next question comes from the line of Chip Moore from Canaccord. Please proceed.

Yes, hey, Rich and Rick, thanks.

Good morning, Chip.

Good morning. On the Itron radio modules impact, I think you talked about one customer anecdotally at least being about $1.5 million impact. Can you maybe try to quantify total impact in the quarter?

We tried to do that, Chip, and it became almost impossible to do. Because what you're asking yourself is how more would each customer have bought if they hadn't been distracted by replacing these radios. So I really wouldn't want to try and put a number on it because I think I would really be guessing.

Yes, that's fair. And then on decreased marketing spend on the West Coast, maybe quantify that; and then early returns out of AWWA, what you've seen?

Sure. And I hope you said increased marketing spend. It was increased marketing spend.

Yes, yes.

It sounded like you said decreased. Yes, obviously, when we saw what was happening in California, and knowing what a good fit ORION cellular and BEACON is for solving those problems out there, we decided to make a major investment during the quarter. It's not an investment that will recur, so it isn't like we hired a bunch of people and they're all sitting out there. We actually redirected a lot of our salespeople into that territory, and most significantly we upped our spend pretty significantly at the American Water Works Association convention. We put a full-court press on getting as many California utilities to attend that convention as we could, and we were very successful in that. So there was some great exposure of our products to those utilities because they're all scrambling to figure out how to reduce consumption. I would say we probably spent several hundred thousand dollars more than we normally would have during the quarter on that territory.

Okay. That's helpful. And then just lastly, you talked about a period of underwhelming growth, albeit with June bouncing back a bit. What have you seen in July so far?

Actually, we are seeing a fairly normal July. I think we're still seeing some impact from the Itron radio issues because there are long lead times on getting those radios. So we are having trouble being able to ship to those ship meters and radios to those customers. But other than that, I would say we are seeing things come back to normal. Now, I say that hesitantly because that's exactly what I said three months ago, and I was proven wrong. You have to remember that at this point, halfway through a month, I've really got about a 30-day outlook. So I can see about a little over one month of the quarter and things can change dramatically; they can improve, or they can deteriorate. But based on what I see now, I'm seeing a pretty good quarter.

Great, thanks for the color.

Sorry, I will correct that. Rick Johnson just cringed when I said that. I will correct that. I'm seeing a pretty good month. I have no idea about the quarter, is what I meant to say.

Yes, thanks.

Thanks, Chip.

And our next question comes from the line of Richard Verdi from Ladenburg. Please proceed.

Hi, good morning, Rich and Rick. And thanks for taking my call. The last call's inquiries cleared up a lot of my questions here, so I just have a couple of high-level things. Looking at the California team, could you try to give us some color on what you guys feel the market opportunity is there for Badger Meter in that state and how quickly that savable impact could be realized in the P&L for you guys?

Yes. And it's hard to give you - it's hard to quantify exactly. Obviously, you can do the math; you know what the population of California is and what it represents. But one interesting fact there is that while Badger has about a 30% market share for meters in the United States, we believe our market share in California is substantially less. And it all goes back to maybe a decade ago when it was the first state to require unleaded brass, and we were all scrambling to provide that product. So Badger did not have a strong market share coming in California. That actually gives us an even greater growth potential. So in that case, it probably is good to not be the market leader out there. So we've actually opened an office and another warehouse in Southern California. We had an office and warehouse in Northern California. So we've recently open that. And we really think that the combination of 250,000 homes in California that buy their water from a municipal water department, but don't have a meter so there's unmetered homes, and that represents a big opportunity. Along with the fact that the water utilities that are metered need to find a way to achieve about a 25% reduction in residential usage. They're going to be looking at ways to get their people to start using less, and that's where the Beacon system comes in. So a combination of those two is very significant and we think represents the opportunity for us.

Excellent. Great color. And one other quick question. On the oil and gas business, we spoke a little bit about today this market-added pressure to the flow division. Clearly that's been weak given the drop in oil prices. But with rig count flattening here and most of the energy companies expecting somewhat of a U-shaped recovery starting in the second half, carrying, let's call it, into mid-2016, do you feel that could be the outlook for Badger's business in this space? Or do you see maybe a recovery taking longer? Just some color on that unit would be helpful.

Frankly, I think our recovery should follow the pattern of the other equipment makers in that industry. I don't see any reason why we would lag or we would lead. Our downturn has followed that pattern, and I don't see any reason why it would be different.

Okay. Great. Thanks, guys. I appreciate it.

And our next question comes from the line of Hasan Doza with Water Asset. Please proceed.

Hi, good morning guys.

Good morning.

I have two questions. The first one is due the oil and gas, if I'm not mistaken from your prior calls, your oil and gas exposure on a revenue basis is about 5% of sales. Correct?

Somewhere in that range. Correct.

That would be like an annual revenue run rate of something like $18 million or so. My question is how much decline are you seeing in that business if your revenue run rate, say, is around $18 million, $20 million, which is 5% of your total sales. I would love to know what is the actual decline you're seeing in that business.

I would say in the first six months, and I don't know the exact number in the quarter, but we are probably down $1.5 million to $2 million in that particular product line.

Okay, so about 10% decline in sales in that business, something like that. And my – go ahead, sorry.

No, go ahead.

And the margins for those meters are like substantially higher than your typical municipal water gross margin?

Yes.

Okay. And the second question I had is I noticed your – if I exclude the sales contribution from National Meter, your sales were essentially flat to slightly down year-over-year, but your inventory balance is up like $10 million. Can you explain what led to your inventory balance up so much year-over-year when your sales, excluding National Meter contribution, were essentially flat to slightly down?

Are you talking June 30 to June 30?

Yes. June 30 of 2014 versus…

But all I know is that inventory is little higher because we bought inventory anticipating higher sales months.

Okay.

We didn't kip it. Now, they are higher from the way we report. What we were required to report is we also compared against year-end. At year-end, we did a buildup in connection with the product. That was a one-time thing for moving some production lines to Mexico, so it's about the same as it was at 12, 13 months.

But there are few other factors there that let me add. I mean a year ago, when we bought National Meter, National Meter is the stocking distributor. They were not just an order taker. They were a stocking distributor. So buying them, we also bought all of their inventory, so that increased our inventory levels.

We bought back our own inventory.

We essentially bought back our own inventory, so we increased there. Also in a few of the industrial areas, we have upped our inventory levels in order to lower our lead times.

And the final question I have in the oil and gas, given the weakness you're seeing – and you and others and whoever operates supplying equipment to the oil and gas industry, what kind of pricing competition you're seeing on those meters? Because I would assume there is some price competition creeping up for the meters supplied to the oil and gas industry?

Basically for what we're seeing is prices are essentially flat. If they lean anywhere it's slightly down right now. It's primarily volume that's impacting the sales.

And Hasan, I want to correct one thing. You estimated that our oil and gas business is about $18 million. It's really closer to about $12 million or $13 million, so that was little high.

Okay. And just to clarify, you're seeing it down by about $2 million. Right?

Right.

Okay. $2 million, so that's…

$2 million in the first six months.

Which would be an annual rate of $4 million. Right? If I assume…

Towards down about 25%, 30%.

Perfect. That's exactly what I was trying to understand. Thank you, gentlemen, for the clarification.

And our next question comes from the line of Bob Chernow from RBC. Please proceed.

Yes, I have got three questions. Question one, can you divide up your pipeline business between what we would call transportation for example, pipelines for Kinder Morgan and – but that would be demand and the supply basically for drilling. How much of it comes from pipeline business, how much from drilling business?

Hi, Bob that’s a tough one. Perhaps one of our sales guys can sit down and do it as an estimate. The problem is we sell to reps and reps then sell the meters on, and we don't always get good detail as to exactly where they are used. But I do know the bulk of the meters are used in refineries and also in actual drilling equipment. This is – we're talking mostly about our client-shipped meter line, and that's where they're used. But it's really hard for me to say what percentage is used on drilling versus refining. I don’t think there's that much use on pipelines, Bob, to tell you the truth.

Okay. Two other questions. One, your distributor that you purchased, are they then excluding other lines that they might sell of your own product line? Have they gone to an exclusive view or are they still using – selling other lines of products? And then my last question is can you give us a time horizon you are comfortable with to settle the Itron difficulty?

I will let Rich answer the second, but I'll answer your first one in terms of National Meter, we are – of our distributors, National Meter included at the time, sell our products exclusively. All right the only other thing they are allowed to sell, and that's why we talked about the incremental revenue was anything - they may sell meter boxes, in the case of National Meter, they do some testing for our utility customers, they also do some installation work, and that's what we refer to as the incremental revenue.

Okay.

So they are really not – none of our distributors are selling any of our competitors' products. They are exclusive to our products.

And regarding the Itron issue, Itron still has us on extended shipment terms. In other words, the lead times on their products are much longer than what they normally are. And they are telling us – and this is a good question you could ask Itron – but they are telling us that they feel by the end of the quarter they will be back down to normal lead times on their shipment.

Thank you.

And our next question comes from the line of Brian Rafn with Morgan Dempsey and Company. Please proceed.

Good morning guys.

Hi, Brian.

Give me a sense – Rich, you were talking a little bit about your vertical integration with some of your distributors. When you look at those transactions – obviously you've known them a lot, is they're exclusive. Is there an Exodus or retirement or some change that creates a tripwire the puts those deals through? Or is that not really an issue?

Yes, Brian, I think you've hit a good key here. We have about 30 distributors, and we have no intention of going and putting a gun to anyone's head, and saying sell our business to us - sell your business to us. What we really have is 30 distributors, many of whom have been working with Badger for a long time. They have built their business and their success by partnering with us, and they have helped us a great deal in that time. So we feel a great deal of loyalty and respect for what they've accomplished. But many of them are also getting to an age point where they are saying, hey, what is our out here. Is there a next step? And Badger, if you don't want us to sell to a big-box store, what are you going to do? So that's really where we are looking, and we are having conversations with these guys. There are other - that have said to us, I could really service my territory better if I had more resources. And bringing Badger in either as a buyer or as a partner could help you service the territory and grow even faster. So we’re looking at all those opportunities and negotiating with those distributors.

Yes.

And to be clear, we do have an upper hand here because if the distributor that hosts us has said, I would like to sell to a big-box store, we have to reassign the franchise. We control that particular trigger, and that would be - that's how we control that from not happening. It's built into our -

Yes, okay, okay. Got you. You jumped my second question a little bit, Rich. When you make those integrations, how much capital or resources - you talked about more boots on the ground, Badger being the corporate umbrella. How important is that, and does that make an impact on the effectiveness of those distributors?

Well, you're - yes. And I think a good example is we bought National Meter last October. Last month, they opened a new office and warehouse in Southern California. That was something they never had before. We were able to invest the money and get that done. There are other areas where it's not necessarily physical capital; it's just hiring more people, having the resources to actually do some missionary work in some areas that they haven't been able to do. So it is very important, and it's something that we're talking to all the distributors about.

Yes, okay. You mentioned a little bit about - you talked certainly about the demand with BEACON and obviously the water conservation, the crisis in California. Rich, how rapid is that technology with BEACON? And how many next-generation - how fast - if you get a huge ramp-up, how fast is the next-generation cycle? Or is that technology fairly static for the next couple of years?

Oh, no. We obviously still have our Silicon Valley operation. We've expanded it. We are enhancing the product. We're not changing it. The product that's out there is the product, but we are able to offer more and more enhancements as we go forward. We will be offering better analytical tools for the homeowner to understand what they're using. One great example is that we will be able to add a tool on the mobile device that will not only show you your water usage, but will show you the average water usage of your neighbors who maybe have similar-sized houses and pools and things like that. You answer a few profile questions, and then it gives you the comparison, allowing people to see are they actually doing a good job conserving or not. Those are really powerful tools, and those are additional enhancements that will be coming out. So I'm not - we're not saying that we're going to be wholesalely replacing it because the product as it is a great product and it is gaining a lot of traction. But we will be rolling out enhancements. And since the software is all cloud-based, rolling out those enhancements becomes a very easy thing to do.

Okay. And then finally, on the BEACON, kind of the same thing, you talked about the American Water Works, is once you get a discovery by the water utility, does that product pretty much sell itself, or are you getting a lot of other entrants into the business? Or what's kind of the - you guys always chuckle about the smallness of water utilities to make decisions and that type of thing. I'm just wondering, since you talked about a fairly fast run rate ramp-up, how that technology is being adopted.

Yes, Brian, I wish I could say that product sold itself. But in our industry, nothing sells itself.

Okay.

Which explains why we have to have these distributors and these sales force out there. It is a - these water meter systems are like life insurance; they are not a product that's bought, they are a product that's sold.

Okay. Thanks, guys. Appreciate it.

And our next question comes from the line of Kevin Bennett from Sterne Agee Capital. Please proceed.

Good morning, guys. How are you all doing?

Good morning.

Following up on Brian's question, sticking with BEACON, Rich, if you look back at, I guess, past new technology offerings, I mean how does a typical product ramp progress?

Yes, I would say if you look back over the last 10 years when we introduced GALAXY – TRACE, then GALAXY, then ORION, the one-way end point and eventually the two-way, in no case did we see the year after introduction hitting anywhere near 200,000 units. I would say you would introduce it in a year and – let's say you introduced it in the one-year. The following year, you might see 50,000 to 100,000 units. So I would say this thing is ramping up probably about twice as fast as we have seen products in the past. Now, major reason for this I would like to say it's all entirely due to the fact that it's a fantastic product. But there's also a very significant factor in that this is the easiest product to transition to as compared to any of our past products. For example, if you buy a fixed network product from Badger or any of our competitors, you put a device up on a pole and then you start changing out the houses that are within the immediate radius of that device. When you have a cellular product, you can put it on any house anywhere in your service territory and location doesn't matter. So you don't have to start changing it out neighborhood by neighborhood; you can kind of change it out in a shotgun pattern as you are visiting those houses under a normal replacement program. That's having – that ease of change-out is extremely important, and I think that's one of the things that's driving the faster change-out for lack of infrastructure.

That makes a lot of sense. It's certainly nice to see it ramping that fast. Back to the Itron issues, do you think this could be an opportunity for you guys, I guess, to take some additional market share in radios? I mean are you seeing people replace the bad Itron radios with Badger Meter radios, or is there a reason why people wouldn't do that?

It’s a good point, and we have not seen that. First off, let me say that Itron is doing what we would expect of Itron there standing behind our customers. And I'm including Badger Meter as one of their customers. They are standing behind the product; they are replacing the product; they are pulling it out of the field before it fails and they recognize that they have an issue. That's something that Badger would do; that's something that a good, solid company like Itron would also do. So I think as long as they continue to stand behind the product as they have in the past, I don't think you're going to see a lot of customers wholesale switching over. And that's fine. I mean obviously, I would prefer to sell ORION, but we have a great relationship selling Itron products also and I hope to be doing that for a long time to come.

Sure. And then last question on the Flow Instrumentation business, can you talk about some of the other I guess industries you sell into there ex oil and gas? A lot of other companies are talking about a slowdown and just kind of your traditional industrial spending. Are you seeing that, or is the rest of that business actually holding up pretty well?

No, we are seeing a little bit of a slowdown. We have seen a little bit of a slowdown over the past year in all those industries. Remember that we sell into food and beverage, chemical, petrochemical, waste water, HVAC systems. Our meters are in a lot of products that you don't even realize they are in. When somebody pours you a cup of coffee, very often that coffee is being measured by a Badger Meter. So generally, as industry has a slow time improving with this slow-growth economy, we're also feeling that.

Got it. Okay, that's helpful. Thank you.

And we do have a follow-up question from Mr. Richard Eastman with Robert W. Baird. Please proceed.

Thank you. Is there any pricing pressure at all in the muni meter side with copper prices down here and volumes a little bit on the soft side? Are you able to hold prices in residential meters?

Rick, we’re not seeing pricing pressure at this point.

Okay.

We are able to hold prices. You're right. I think if – with copper prices being down you might have expected some pressure. But, frankly, copper has been so volatile over the last few years that nobody is willing to say, all right, I will give you a three-year contract based on these lower copper prices. We are all a little gun shy, having been burned in the past. But we're not seeing our competitors slashing prices out there. And obviously our competitors know that if they were to drop prices significantly, we would also drop prices significantly, and then we are all stuck in a natural equilibrium so we are working careful.

Sure. And the lower volumes of Itron, as they're kind of regulating their volumes into the marketplace here – but the lower volume of resale product is actually a positive for your gross margin, is it not?

Well, yes, you are right to the extent that the mix of more ORION and less Itron is favorable to our gross margin.

But I am not selling meters.

But the loss of the meter about that went with those radios is a big negative to our gross margin.

Yes, but I mean part of the switch-out and part of this warranty service work I mean we're not switching out every meter. Right?

But remember Rick that a lot of our customers are not installing new meters…

Yes, new meters. Yes.

…out there switching out the radio.

Yes, yes, fair enough.

And I had the example of the customer who for years has bought 1.5 million meters not radios, meters from us every year. They buy their radios every quarter I am sorry they buy the radios directly from Itron.

Yes.

They merge those two together and they are not buying from us this quarter because they are busy replacing the radios.

Yes, yes. Okay. And then just one question, Richard, as BEACON has gained some traction, given that it's a cloud-based access to the data and it's a cellular network that it runs on, are you seeing any new software competition come in at that entry point you know kind of the cellular-based entry point?

Yes and before I answer that, Rick, let me go back to one thing because I just got a note telling me I misspoke. When I was talking about that customer for the last two years that bought 1.5 million from us each quarter, I was talking dollars, not units. They told me I said meters by mistake.

You did say meters, and dollars makes more sense.

It’s dollars, okay. 1.5 million meters would be a heck of a lot of meters. No, it's dollars. So I want to correct that for the record. But let's go back to your question about the software and yes, I think the answer is yes that we are seeing competitors scramble to offer analytics software that is comparable to what we offer for the utility. We're not seeing a lot of competitors yet that are able to offer analytical software for the consumer, for the homeowner to use. And that's where we have a very strong edge. So I think you're going to continue to see competition in the utility software side, but it's going to take them a while to come up to offering that information for the homeowner.

I see. For their access. Okay.

Correct.

All right. And then just last question on the SEGA expenses, do we go forward here? Off the second quarter run rate, do we have some – any controls in place here to kind of hold that at least flattish or…

We're going to work really hard obviously in the second half to recoup some of what we lost in the first half on the bottom line. And doing that is going to be cost containment. Now, we did not want to fall back in the second quarter on our California initiative, so I let that go forward. But there are other things that we are doing to align our cost in the second quarter – in the second half.

Second half. Okay, very good. Thank you again. End of Q&A

That concludes today's question-and-answer session. I would now like to turn the call over to Mr. Rich Meeusen for closing remarks.

Well, I want to thank everybody for joining us. We obviously had a difficult quarter. Everybody here recognizes that it has been a difficult quarter and that we have an opportunity in the second half hopefully to recover what we can through cost control, through expanding sales. We are working every possible angle. We still are very confident in the long-term potential for this Company, and we are trying to maintain our focus over the long-term and not react to short-term volatility in our business. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. So you all have a great day.