Good day, ladies and gentlemen, and welcome to the Badger Meter Q3 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Rick Johnson, Senior Vice President of Finance and Chief Financial Officer. Please go ahead.
Thank you very much, Candace. Good morning, everyone. Welcome to Badger Meter's third quarter conference call. I want to thank all of you for joining us. As usual, I 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 identify 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 results. After the market closed yesterday, we released our third quarter 2016 results. At a high level, sales were down, but at a better gross profit percentage, which resulted in higher earnings for the quarter over the third quarter last year. The net sales were $96.3 million, a decline of $3.1 million or 3.1% over last year's third quarter. This was caused by lower sales of both municipal water and flow instrumentation products. Let's talk about some of the details. Municipal water sales represented 77.4% of sales in the third quarter of 2016, compared to 76.8% in the third quarter of 2015. These sales decreased $1.9 million or 2.5% to $74.5 million from $76.4 million last year.
The decrease was due to lower sales of both residential and commercial water meters and related technologies. Much of the decrease was due to lower sales in the Middle East, which tend to be sporadic. Domestic municipal water sales were relatively flat as compared to the third quarter of 2015. This was partially due to our BEACON backlog and some market uncertainty over our review of strategic options, both of which will be addressed by Rich in a moment. Flow instrumentation products represented 22.6% of sales for the third quarter of 2016, compared to 23.2% in the same period in 2015. These sales decreased $1.2 million or 5.2% to $21.8 million from $23 million in the same period last year. The decrease was due to the slow growth economy and overall general softness in the markets served by these products.
Gross margin as a percent of sales was 40.1% in the third quarter of 2016, compared to 36.3% in the third quarter of 2015. The increase was due primarily to lower costs and higher margins from our company-owned distribution network. Selling, engineering, and administration expenses for the third quarter of 2016 increased $2.2 million or 9.8% to $24.7 million from $22.5 million for the same period in 2015. The increase was due primarily to higher employee incentive and benefit costs. In addition, these expenses included a non-cash pension settlement charge of $740,000, or nearly $0.02 per share. We've had similar charges like this in recent years. The provision for income taxes as a percent of earnings before income taxes for the third quarter of 2016 was 36%, compared to 37.5% in the third quarter of 2015. This is lower than last year, which included additional discrete charges.
This quarter's estimate is consistent with the estimates we've been using throughout 2016. As a result of the items I just mentioned, net earnings for the third quarter of 2016 were $8.8 million, or $0.30 per diluted share, compared to $8.3 million or $0.29 per diluted share for the same period in 2015. As a reminder, we had a stock split that became effective in September. All per share amounts have been restated for comparison. There have been no significant changes in our balance sheet. We continue to generate cash from operations. For the first nine months of 2016, we generated $40.2 million in cash from operations, compared to $25.8 million in the first nine months of 2015. Because of this, our debt levels have been reduced to 16.5% of total capitalization.
During the quarter, we increased our main line of credit from $105 million to $125 million. We believe our solid balance sheet and debt capacity will allow us to continue to execute our strategies. With that, I will now turn the call over to Rich Meeusen, Badger Meter's Chairman, President, and CEO, who will have some additional comments. Rich?
Thanks, Rick, and thank all of you for joining us today. First, I was pleased with the quarter's results, especially given the softening in orders that we saw coming into the third quarter. As expected, July was a fairly weak month, but we saw a rebound in August and September, resulting in a solid quarter. Net earnings were up 5.6% over the same quarter last year, even after the $740,000 non-cash pension charge that Rick mentioned. As you may recall, I indicated during last quarter's call that we saw some softening of order input related to our BEACON product. Due to the high demand for our BEACON software, we encountered a bottleneck in developing the necessary interfaces between BEACON and the billing systems used by both current and potential customers. For each new BEACON application, it's necessary for us to map our database to the database of our customer's systems.
Unfortunately, many of our customers do not have sufficient internal IT personnel to rapidly provide us with the necessary information, which caused a slowdown in this process and a corresponding slowdown in new order input. We assigned additional personnel to assist our customers in this process and have been working to reduce the backlog. Although this negatively affected our July sales, we did see improvements as the third quarter progressed. In addition to the impact of the BEACON backlog, we also saw some customers delay orders due to speculation in the marketplace over our recent review of strategic options. It's important to note that in our opinion, and based on feedback from the field, neither the BEACON backlog nor the impact of our review of strategic options resulted in any lost sales. Rather, we saw customers delaying orders.
With that review behind us and the continued work on the BEACON backlog, we believe we will see those orders picking up in future quarters. One comment on that review of strategic options. Badger Meter, like most companies, performs a formal review of strategic options on a regular basis. Such options include possible sales or acquisitions, financial restructuring, new borrowing, stock splits, dividend policy, and a wide range of other options. Occasionally, we hire an outside firm to assist us with this review by contacting third parties under a confidentiality agreement. In the past, such reviews were conducted without any public announcements. Unfortunately, earlier this year, somebody broke their confidentiality agreement and informed a reporter at The Wall Street Journal about our process. Once this rumor was made public, we felt obligated to comment on it, which we did in a brief May 4th press release.
This resulted in speculation of a pending sale of the company and allowed our competitors to sow some confusion in the marketplace. In August, we completed our review of strategic options and issued another press release announcing a significant dividend increase, the stock split, and a continued focus on our current strategy. Those strategies include a focus not only on new product development, but also on acquisitions, both in utility distribution and flow instrumentation. Rick mentioned our strong balance sheet and cash generation, as well as our relatively low debt levels. We believe this positions us very well to execute on these plans. With those comments, we'd love to take your questions.
Ladies and gentlemen on the phone lines, if you would like to ask a question at this time, please press star followed by the number one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, you may press the pound key. Our first question comes from Richard Eastman of Robert W. Baird. Your line is now open.
Yes. Good morning, Rich and Rick. Could you provide maybe a little bit more color on the gross margin? I kind of understand perhaps why some of the costs are down, certainly copper, and I think if you throw currency in there, that's beneficial. At that revenue level, I'm just curious, just the sustainability at this revenue level of that gross margin number.
Rick, this is Rick. I think the first thing is probably the biggest thing that affected our margin in our minds was lower obsolescence cost this quarter. Last year, we had a significant charge in there. I think we wrote down some gas radios. This year, we didn't have that. In addition, just normal obsolescence, I think we're doing a much better job, and we've really controlled that cost. I think that's in there. I agree with you, material costs are down, but not as significant, I think, as some people think, because actually, copper is in the same general neighborhood as where it was last year. Much of that was behind us last year at this time, so you've got that in there. We don't comment, but product mix is always a factor.
When you're selling more products with radios, you tend to get higher gross margins.
Yeah. Now, again, you've got this new Texas warehouse. Perhaps that didn't come into play at all in the third quarter. I'm thinking of gross margin sequentially from the second quarter to third quarter. We have a decline in sales. We have more gross profit margin. Copper sequentially doesn't matter or is flattish. Just what would be the driver sequentially, just to be able to get our arms around it? Is it-
Rick-
somehow mix or?
No, Rick, it's Rich. I think it's two things. One is that it is some mix, but also we have had a stronger focus on pricing discipline. We probably could have jacked some more sales in there to make the top line look a little bit better, but we're trying not to chase after really low-margin business. We are seeing some of our competitors chase that low-margin business as they're concerned about filling their factory. We've tried to maintain a more disciplined approach. I can just say that from my point of view, and I review all of the large bids that we do. I can say that over the last 6 months, I've noticed that on our large bids, we're maintaining a better discipline at going after higher-margin business.
Okay. Then just one quick question on the revenue line. Can I ask, again, generally speaking, the third quarter is kind of flattish with the second. I understand maybe the pothole came in July, and we made some of that up in the balance of the 2 months of the quarter. When you think about the revenue line here perhaps being $6 million-$7 million lower sequentially, what would be the buckets there, perhaps, where you came up a little short on plan? I presume the Mid East, I thought we were going to make some of that up, and also it sounds like the industrial flow business was maybe a little bit weaker than you thought.
Well, Rick, industrial flow is off about 5% off of last year, both for the quarter and year-to-date. I don't see There isn't a big impact there, okay? Clearly, we did not have some of the Middle East stuff in the third quarter. The Middle East, a lot of that is getting pushed out, and we're very hopeful we're going to see some of it in the fourth quarter, but it may even get pushed off into 2017. That's a very lumpy business because it's all contracts that occasionally come up, and you either get them or you don't. When you're talking about sequential quarter-to-quarter, I feel like August was a normal month and September was a strong month, but July was an unusually weak month.
Okay.
You're right, we did make up some of it. Coming into July, and I mentioned this on the last conference call, we were seeing a slowdown, and a lot of that slowdown was attributed to just this backlog in getting the BEACON connections done.
Yeah.
We threw more people at that. We've gotten that improved, and as the quarter went on, we saw that improve.
Okay. Just to tie in on the revenue line, when we had Hurricane Sandy, when that hit, there was a pretty substantial wrinkle in demand when it came to replacement product. Is there anything that we should anticipate in the fourth quarter from Matthew?
Yes. I was waiting for somebody to answer that, Rick, you get the award for asking that question.
Okay.
Well, you're first. That's right. Maybe everybody would've asked it, so that's a good point.
All right.
Rick.
Is the answer yes or?
The answer is yes. When we had Hurricane Sandy, it affected a lot of our Northeast utility purchases, okay?
Yeah.
Now we're looking at what the impact, and we haven't seen it yet, it's going to be a fourth quarter impact, what the impact will be on the Southwest. I don't expect it to be as significant-
Southeast.
I mean, Southeast. Did I say Southwest? I meant Southeast.
Yeah, I understand. Yeah.
I'm geographically challenged today. I don't expect it to be as significant, and now I'm speculating, but I don't expect it to be as significant as what we saw with Hurricane Sandy or with Katrina, because we're later in the year, and a lot of the utilities are wrapping up their meter replacement programs as they're heading into winter. We might not see as severe an impact as we've seen in the past. As you always know with these, it doesn't result in any lost sales. What happens is the utility said, "Well, we were going to have our crews spend the next month or so replacing meters, but with this hurricane that came through, we need them to be cleaning out catch basins and helping us with other issues." They divert the crews.
Once they're done with that, meters still need to be replaced.
Okay.
They come back for meter replacement.
Fair enough. Okay. All right. Thank you. I'll turn it over. Thanks.
Thank you. Our next question comes from Brian Rafn of Morgan Dempsey. Your line is now open.
Good morning, Rick.
Good morning.
Hey, let me ask you. There's been more economic pundits talking, using the word recession, slowing economy. When you look at your business, obviously, I think there's about a 6% obsolescence that is replaced. Do you see utilities, when they're looking at recessionary times, do you see orders fall off after the fact you're in a recession, tax revenues fall, or do you see water utilities' position on potentially, kind of a weakening trajectory?
Brian, there's definitely a lag from what we've seen in the past. When we had the great recession of 2008, 2009, we didn't see an impact until we got into 2010 and 2011. There's definitely a lag.
On the water side.
We're talking the water side of our business.
Okay.
The water utilities, they tend to lag, and then they lag getting back up again. That's what we saw last time. If we do hit another recession, we would expect to see that. We don't see it yet. On our flow instrumentation side, that's a broader economy, and so yes, if there's a recession, it does hurt flow instrumentation.
You would see it probably more on the flow instrumentation side, immediacy. There's less of a lag.
Correct.
Yeah. Okay. All right. Gotcha.
Correct.
You guys launched this new Customer Experience Center. How material is that for municipal clients, large commercial utility, corporate customer? What's kind of the genesis of that?
Yeah, Brian, for those who don't know, we did some remodeling this year, last year, and this year at our Milwaukee facility to create a Customer Experience Center. We do bring a large number of customers to Milwaukee for training. Pretty much every week, we're running some sort of event here for training customers or bringing in potential customers, and we felt that our facility here was getting older and was not showing well, and we weren't using some of the modern technology to give the customer the experience that they would expect from a higher tech company. We made the investment. We remodeled a section of our plant to make this center. The response from the customers has been extremely positive.
When we're dealing with somebody who's never dealt with Badger before, we're talking about a large multimillion-dollar contract, bringing the key players to Milwaukee, giving them a tour of the factory, showing them how we test our meters, how we do our R&D, then showing them our entire breadth of metering products is very important. It's very important to their decision-making process. I'll even say with the Middle East, when we make sales in the Middle East, very often, they will fly teams over here to inspect our factory, inspect our facilities. All of that is an important part of the sale process. We feel good. We opened it a couple months ago, thus far, all the feedback we've gotten has been very positive.
Okay. You had a comment on Hurricane Matthew. Obviously, certainly, as those municipalities are in triage and fixing damage, is there any component to the water meters that might be damaged or beyond just the normal obsolescence because of this?
No. We don't get, after a hurricane, a large number of sales of replacement meters because of damage. The meters tend to be pretty robust. You can have a lot of damage to collection towers if they have a fixed network system. That's why a lot of our customers are starting to prefer looking at a cellular option, because one of the things we know is that when there's a hurricane or a natural disaster, one of the first things that happens is the cellular system gets high priority for being brought back online. That's because that's the system used by first responders. When they have our cellular option, there's no utility-owned infrastructure up in the air. When they're using fixed networks sold by Badger and by our competitors, there is a lot of fixed infrastructure that has to be repaired.
It takes them longer to get up and running again. As far as the meters themselves, these meters are mostly underground. They're very robust. We really don't see a big uptick in meter sales.
Okay. On the BEACON software, as you guys have launched that, have you seen from a sales standpoint an interest, bid quotes? Have you seen a surge of the early adopters and it leveling out, or does it continue to be robust?
Well, I think that we talked about it. We see a lot of interest in the BEACON software. However, until we get this interface issue behind us, that's what's holding back and delaying some of these sales right now. Once the interface issue is resolved, oftentimes utilities just want to buy it, and they'll test 100 meters. We're working through those issues. In fact, I think Rich, on the last call, said maybe we had about 140 customers.
Right. To put some numbers around it.
We've worked through half of that backlog already in the third quarter. Now we've added some more to the backlog, but we're working through those issues. There's great interest in the BEACON product, and that's why we're optimistic about the future.
Yeah, the one thing we have noticed, and I'll reiterate what Rick said, one thing we've noticed, Brian, is that there are a lot of utilities that are really interested in getting a better handle on the analytics of their system. They want to understand better how their water is being consumed, how their system is operating, what the performance of the radios are, what the performance of the meters are, and BEACON gives them all that. There's a lot of interest in that system. Like I say, we're getting these customers up as fast as we can, but obviously you have to get them on the billing system before they want to start deploying the meters.
Yeah. Let me ask you this on that point, Rich. Given these legacy customers, and budgets and that, is there a responsibility on their part to carry more IT people on their side as you go into the 21st century, and it's really going to be driven by an analytics-type experience and technology?
On our system, I would say absolutely not, Brian. We design our systems with a water utility in mind, and you have to understand that the average water utility in the U.S. has about one and a half employees. We're talking about very small utilities. When we design it that way, we understand they're not going to have an IT department. In fact, in most cases, we're not working with the utility's IT department. We're working with a small vendor that wrote the billing system for the utility, usually local to that utility. Those are the guys that we have to spend our time working with on the interface. We designed BEACON to be very much a plug-and-play once you get past this billing interface, and they shouldn't need additional IT support.
Now, I have to say, that's in contrast to the approach some of our competitors have taken. Some of our competitors, where they are making a software package that they expect to be used by electric, gas, and water utilities, obviously that package is going to be much more complex and need a lot more support.
Got you.
In our case, we're making it just for the municipal water utilities. We're making a very simple package.
Yeah. Let me ask you then, just on the strategic planning that you guys have gone through, is that an annual exercise, Rich, or is that something that's episodic, driven by stock price, economy, availability, M&A? How do you guys see that?
Well, obviously every year, in fact, we've got our November board meeting coming up. Every year in November, we prepare our strategic plan for the next year and a four-year look beyond that. It's a five-year plan that we present to the board.
Got you.
Occasionally, it is episodic, I would say maybe it's every four years or so, the board says, "Let's do a deeper dive into options." That's what happened last November. The last time that happened, about four years before that, what the end result was, we borrowed about $100 million. We bought back about $30 million in stock, and we bought a company called Racine Federated. This time, we've done it again, and the end result of it this time was the stock split, a dividend increase, and a continued focus on our current strategies. There's no doubt that at some point down the road, the board will want to do it again. It is episodic, not annual.
Got you. The guy that leaked to The Wall Street Journal, is he working a picket line in Alaska?
I'd love to find him, in reality, we'll never know, Brian.
All right. Got you. Thanks, Rich.
Thank you.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question at this time, you may press star followed by the number 1 key on your touchtone telephone. Our next question comes from John Quigley of Canaccord. Your line is now open.
Hey, good morning, Rich and Rick. How are you? A couple questions. Post the strategic review, two parts here. Number 1, can you talk about your thoughts about M&A? In the past, you've done some bolt-ons in flow instrumentation and clearly in the software space, quite successfully. You've also done some distributorship tuck-ins. Can you talk about that process and perhaps your current thoughts on that?
Sure. Right now when we say we're going back to our core strategies. When it comes to acquisitions, it falls into three groups. First off, we are going to continue to look at our distributor network and make acquisitions within that network as appropriate. I will say we have another one in the pipeline, we are teeing up what would be the fourth distributor acquisitions. These are all relatively small. They are all less than $20 million. They are not huge acquisitions, but in the case of our distributors, we've always had a very close relationship with our distributors. The majority of what they sell is Badger Meter product. It's a fairly easy acquisition for us to make and integrate.
We found it brings a lot of value, both to us and to our customers by having those under Badger Meter. The second group of acquisitions is in the flow instrumentation side. We kind of put that on hold as we were going through our strategic review, we're firing those up again. Again, we're looking for the small strategic acquisitions, like the ones we've made in the past. Racine Federated was an exception. It was about a $60 million acquisition, but normally these are $10 million type acquisitions also. We're continuing to look for those. The third group I would put out there is where we look for a unique, new, up-and-coming technology that perhaps somebody has done work on developing, much like when we bought Aquacue, we're able to go in there and modify it for our industry.
Very often we look at it and say, "Should we buy the technology? Should we license the technology, or should we buy the whole company?" In the case of Aquacue, we decided to buy the company because we wanted to use their capabilities to make the BEACON product and the ORION Cellular. Those are the three groups of normal acquisitions. Beyond that, our board is still open to larger acquisitions, to major game changers. This will be something we'll be talking about in November as to whether or not there are other opportunities out there we should be looking at. Like any company, we're always looking at things like that. I hope that helped.
It does. To follow up the channel question. You said the strategic review caused some customers to pause. I would imagine that would be some of the more manual read type meter stuff, or did you lose any system sales? I can't imagine. I mean, Badger has such a good brand name. Sorry for the commercial, I just find it hard that someone just pushes off because you might get sold or something.
No, John, we did not lose any sales at all. I even have a video of a competitor's salesperson standing up at a town council meeting and saying, "You're about to sign a contract with Badger Meter. You might want to hold off because there's a rumor that they're for sale, and they might stop making water meters." Honest to God, he said that, and I've got it on video. As bizarre as that seems, very often council members of a small town who don't really understand how these things work would hesitate and say, "Well, let's just put it off for a month or two and take a look at it." We saw some delays, but we didn't lose anything. Nobody said, "Well, we're gonna go with another company because Badger is for sale." I mean, obviously, Sensus recently got sold.
Before that, Elster got sold. A lot of companies get sold, and none of them are going to stop making the products that drive their company. It's just a disruption, it's a confusion factor, and it causes a little bit of a delay, and I think that's what we saw.
All right. Thank you for clearing that up. Then lastly, I know you hate for conjecture, but the Sensus deal with Xylem. Sensus was speculated to be for sale for quite some time. Xylem seems to be a very responsible equipment technology supplier into water municipalities. Rich, offer your thoughts around pricing discipline. You talked about you folks being more disciplined. Do you think the industry gets a bit more disciplined now, or how do you think that shakes out, if you could offer anything? Thank you.
Well, I think the Xylem acquisition of Sensus is going to be very interesting because, from what I understand, they have some very aggressive synergy targets, cost reduction targets associated with that acquisition. Xylem obviously didn't make water meters before, so you don't have channel synergies, you don't have manufacturing synergies. I think there's going to be some challenges in getting the synergies that they want to get, and it'll be interesting to see how they do that without having any real operations that they can integrate. There's also the question as to whether or not somehow any of the current Sensus products can integrate with any of the current Xylem products. I think that's going to be challenging too, because obviously the water meters are sold to the water utilities, and many of the Xylem products are sold into other channels.
That's going to be a challenge too. As far as pricing, Sensus has always been a very disciplined company when it comes to pricing. I really don't see that changing dramatically, and I think they're going to continue to compete with us as they have in the past. I don't see a big change there. Now, when I talk about pricing, I'm talking about North America. I'm not that familiar with Sensus's pricing in other markets, but I know in North America, they've always been very disciplined.
All right. Thanks again. Good luck, guys.
Yep.
Thank you. Our next question comes from Bob Chernow of RBC. Your line is now open.
A question, if I may. Do you view the problem with the software as a temporary problem or a long-term one? If you view it as a short-term one, are you pulling in outside consultants to help you with the software problem, or are you planning on hiring other people if it's a long-term problem?
Yeah, Bob, it's a good question. First off, we view it as a short-term issue. We got caught by surprise because we did not expect the BEACON software to have the out-of-the-chute popularity that we saw. We thought it would take a little while longer and for the utilities to come around to saying, "Yes, we really want to integrate this." We did get hit with a large number of integrations in a very short period of time. We had staffing ready to deal with them, but clearly not enough. What we did, Bob, was we reassigned people internally over to working on that, people who had experience and knowledge on it, and then we've supplemented those positions with some outside service. A little harder to bring in an outside service to jump right in and learn how to do this on day one.
Fortunately, some of the software engineers who had worked on the design of BEACON were very familiar with it, and we could reassign them over.
Bob, some of the delays are not necessarily because of us. It's simply getting access to those IT vendors of the various water utilities. Really, that's almost been more of an issue than anything else. It's just a lot of these are mom-and-pop shops, so you're looking, "Yeah, we'll get to it in about two months." Once you devote the resources, some of these issues are resolved in a week. It's just a matter of getting their time and getting on their calendar.
Right. Bob, we had one vendor, one software vendor who had provided the software to three utilities that all wanted to move on to BEACON. The answer was, "Well, it's August. The guys who handle this are on vacation. They'll be back in a few weeks," so they won't be able to do anything. We actually run into that kind of thing.
Sorry.
Thank you.
Oh, go ahead. I'm sorry.
Our next question comes from Richard Eastman of Robert W. Baird. Your line is now open.
Yeah, hi. It's just a couple follow-ups. Rich, any ramp-up in the American Water sales in the quarter relative to the second?
From quarter to quarter, it was still relatively flat.
Okay.
The American Water sales have not achieved what we had hoped to for this year. The main reason was the thing we were just talking about. American Water had a software vendor that we needed to work with to map all of the fields to get onto BEACON. That vendor took a long time to get back to us with anything and to start a project where they would focus on this. They are now on this now. I am being told that it should be completely done in about three weeks. Once we achieve that, we should be able to see increased sales opportunities there.
Okay. I don't know if you want to repeat this, but at one point you had said there was a backlog on the BEACON side. I think you put it at 140.
Correct.
50 is normal. Has that backlog run off at all or built?
No.
What does it look like at the end of Q3?
Yeah, I was ready for that. We actually cleared 70 of the utilities in the backlog. We cut it in half, but we got 60 more in. I'm right back. I'm up around 130 or so because of the new ones coming in. They are still pouring in almost as fast as we're clearing it. We're now starting to get ahead of it. On the other hand, Rick, frankly, nothing would make me happier than if we continue to clear 20 or 30 a month and 20 or 30 continue to come in, because it means that the demand for BEACON has far outstripped anything we had planned. I think at some point, the new ones are going to slow down, I'm certainly not going to tell my sales force to back off on convincing people to move over to BEACON.
It's a great opportunity for our company. Every time we do one of these, it represents future sales, so we certainly want to keep charging at it.
Yep. Okay. Then just a quick question on the verbiage in the press release when it comes to the margin. I understand the costs are down, but there's a commentary that the margin contribution from Badger's company-owned distribution network was a positive contributor. I'm trying to understand that because I understand you're going to get more margin on sales through the distribution, but National Meter has lapped annualized, and United Utilities is pretty small. Is the implication just that, say, National Meter's sales grew meaningfully for some reason? How does that help the margin?
We've expanded the territories. We had unassigned territories where distributors have fallen off, and we've actually, for instance, you said United Utilities is small, but we've added two states to that. Okay? We've picked up those sales. On a comp basis, that's now a company sale that formerly was sold through distribution.
Was supposed to go through distribution.
Rick, without doing acquisitions of distributors, we are increasing the amount of sales going through our company-owned distributors.
Okay. That part I understand. On those sales, you'd get a higher gross margin since you're not discounting.
Exactly.
I get that. This Texas warehouse, is that going to be a drag going forward on gross margin? Is that in support of any particular business, or what was the need there to put a warehouse in Texas?
First off, we probably shouldn't give as much attention to the Texas warehouse as we are. It's not a huge cost, and it's not a drag at all in any way. It's just going to allow us to get more inventory closer to our customers and respond a little more quickly to our customers. Again, this is part of expanding National Meter's territory. Giving them additional territory, they need some additional facilities and warehousing capability. We only cited that as an example of how we are expanding company-owned distribution and giving them the assets that they need to do that. There is not a particular large customer. It's there to support our Texas customers, and we'll be able to provide them a higher level of service with that warehouse.
Mm-hmm. To that end, the inventory continues to step up year-to-date, another couple million dollars, I think, in the quarter from the second to the third. What's happening there? Is that Mideast units sitting in inventory?
Yes, there is some inventory for the Mideast. We thought a lot of that might have gone this quarter, but it's sitting over in Dubai or in Stuttgart, Germany, waiting to be shipped. There is some of that inventory. Also it's the continued idea that we want to have a little more inventory in the field, respond a little more quickly to our customers, and provide this higher level of customer service that our distribution network usually does. That's why they're able to get a higher margin is because of that fast response. With low interest rates and with low carrying costs for inventory, it just makes good business sense to do it.
Yes, I understand. Okay, thanks again for your time. Appreciate it.
Thank you. This concludes our question and answer session for today. I'd like to turn the conference back over to Mr. Rich Meeusen for closing remarks.
I'll just say again that I was a little concerned coming into the quarter. I was pleased with the way the quarter ended, especially considering we did the $0.30 after that unusual $740,000 or $0.02 charge from pension that really comes out of equity, goes through expense, and right back into equity. It has no impact on cash, no impact on the balance sheet. When I look at it, I kind of have to discount that and say we really did have a pretty good quarter taking that effect out. Yes, sales were flat, but we've maintained very good pricing discipline, as we talked about on the call, to achieve very strong margins and still get growth on the bottom line. In all, we're pleased about that, and we're optimistic about where the rest of the year goes.
With that, I'll thank you for joining us.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Have a great day, everyone.