Welcome and thank you all for standing by. At this time, all participants are on listen-only mode. During the question and answer session, please press star and then one to ask a question. Today's call is being recorded, and if you have any objections, you may disconnect at this point. I'll turn the meeting over to your host, Mrs. Marietta Zakas. Ma'am, you may now begin.
Good morning, everyone. Welcome to Mueller Water Products' 2016 second quarter conference call. We issued our press release reporting results of operations for the quarter ended March 31st, 2016 yesterday afternoon. A copy of it is available on our website at muellerwaterproducts.com. Discussing the second quarter's results this morning are Greg Hyland, our Chairman, President, and CEO, and Evan Hart, our CFO. This morning's call is being recorded and webcast live on the internet. We have also posted slides on our website to help illustrate the quarter's results, as well as to address forward-looking statements and our non-GAAP disclosure requirements. At this time, please refer to slide two. This slide identifies certain non-GAAP financial measures referenced in our press release, on our slides, and on this call, and discloses the reasons why we believe that these measures provide useful information to investors.
Reconciliations between GAAP and non-GAAP financial measures are included in the supplemental information within our press release and on our website. Slide three addresses forward-looking statements made on this call. This slide includes cautionary information identifying important factors that could cause actual results to differ materially from those included in forward-looking statements, as well as specific examples of forward-looking statements. Please review slides two and three in their entirety. During this call, all references to a specific year or quarter, unless specified otherwise, refer to our fiscal year. Our fiscal year ends on September 30. A replay of this morning's call will be available for 30 days after the call at 1-800-396-1242. The archived webcast and corresponding slides will be available for at least 90 days in the investor relations section of our website.
We will furnish a copy of our prepared remarks on Form 8-K later this morning. After the prepared remarks, we will open the call to questions. I'll turn the call over to Greg.
Thanks, Marty. Thanks for joining us today as we discuss our results for the 2016 second quarter. I'll begin with a brief overview, followed by Evan's more detailed financial report. I will then provide additional color on the quarter's results and developments in our end markets, as well as our outlook for the 2016 third quarter and full year. We were very pleased with the second quarter's results, which overall came in about as expected. Our adjusted operating income increased 14.8% despite slightly lower net sales. Adjusted net income per share for the quarter was $0.10 versus $0.08 a year ago. We believe Mueller Co.'s end markets remain solid as demand for Mueller Co.'s core products continued to grow in the second quarter.
Increased shipment volumes, coupled with better operating efficiencies and lower costs, led to a 9% increase in Mueller Co.'s adjusted operating income and 110 basis points improvement in adjusted operating margin. Mueller Co.'s adjusted EBITDA margin in the second quarter was 24.1%, and on a trailing 12 months basis, it was 26.6%. Anvil's second quarter net sales, excluding sales to the oil and gas market, increased 3.3% year-over-year. Anvil's adjusted operating income increased 14.9%, despite overall net sales declining $4.7 million to $86.4 million. Mueller Technologies remains focused on growing sales of its higher-margin AMI and leak detection technologies and on improving operating performance over the course of the year. Backlog and projects awarded at both Mueller Systems and Echologics continue to be up substantially on a year-over-year basis at the end of the quarter.
Mueller Technologies benefited from this transition to higher-margin products with adjusted operating loss increasing $300,000 despite a $6.9 million decrease in net sales. For Mueller Water Products, we continue to expect demand for our products to increase year-over-year, driven by growth in both municipal spending and residential construction. We believe we are on track to meet our expectations for the full year. With that, I'll turn the call over to Evan.
Thanks, Greg. Good morning, everyone. I'll first review our second quarter consolidated financial results and then discuss segment performance. 2016's second quarter net sales decreased $6.7 million, or 2.3%, to $283.6 million, compared with $290.3 million last year, with increased shipment volumes at Mueller Co. offset by lower shipment volumes at Mueller Technologies and Anvil. Gross profit improved to $84.9 million for the 2016 second quarter from $82.1 million last year. Gross margin increased 160 basis points to 29.9% from 28.3% in 2015. Selling, general, and administrative expenses were $54.7 million in the quarter, compared with $55.8 million last year. The decrease was due primarily to personnel-related expenses. Adjusted operating income for the 2016 second quarter increased 14.8%, or $3.9 million, to $30.2 million compared with $26.3 million last year.
The increase in adjusted operating income was primarily due to improved operating performance at Mueller Co. and Anvil of $2.9 million and $1.1 million respectively. Adjusted EBITDA for the 2016 second quarter increased to $43.3 million, compared with $40.7 million last year. For the trailing 12 months, adjusted EBITDA was $189.7 million. Interest expense net for the 2016 second quarter was $5.9 million, slightly down from $6.1 million last year. For the 2016 second quarter, income tax expense of $7.7 million was 32.9% of income before income taxes. We recognized an income tax benefit of $700,000 associated with the adoption of new accounting rules related to income taxes for stock compensation plans. Net income per diluted share and adjusted net income per diluted share both improved to $0.10 for the 2016 second quarter, compared with $0.08 last year.
I also want you to note that adjusted net income for diluted share would have been $0.10, even without the income tax benefit of $700,000 I just mentioned. I'll now move on to segment performance, beginning with Mueller Co. Net sales for the 2016 second quarter of $182.2 million increased to $4.9 million as compared with $177.3 million last year. Mueller Co. sales increased 6.5%, excluding sales of Henry Pratt's water treatment valves, which decreased $4.4 million in the quarter. We experienced strong improvement in adjusted operating income in the 2016 second quarter, largely due to lower raw material costs and improved operational efficiencies. Adjusted operating income improved 9% to $35.3 million as compared with $32.4 million last year. Adjusted operating margin improved 110 basis points to 19.4% as compared with 18.3% last year.
Adjusted EBITDA for the 2016 second quarter increased to $43.9 million compared with $42.1 million last year. Adjusted EBITDA margin increased 40 basis points to 24.1% from 23.7% last year. Continuing with Anvil. Net sales decreased 5.2% to $86.4 million for the 2016 second quarter from $91.1 million last year as an increase in sales of fire protection products and a large engineered pipe support job were more than offset by a 60% decrease in net sales to the oil and gas market. Adjusted operating income for the 2016 second quarter improved 14.9% to $8.5 million as compared with $7.4 million last year. This improvement reflects lower raw material costs and other cost savings, despite lower sales in what have historically been our higher margin products. Now concluding with Mueller Technologies.
Net sales for the 2016 second quarter decreased to $15 million as compared with $21.9 million last year. Despite the overall decline in net sales of our AMI systems increased 26%. Backlog and projects awarded for both AMI and in total were up year-over-year by about 30% at the end of the quarter. Adjusted operating loss for the 2016 second quarter was $4.9 million as compared with $4.6 million last year. Now turning to a discussion of our liquidity. Free cash flow, which is cash flows from operating activities less capital expenditures, was negative $4.6 million for the 2016 second quarter, a $17 million improvement compared with the 2015 second quarter. Free cash flow for the first six months has improved $47.5 million year-over-year.
At March 31st, 2016, total debt was comprised of a $484.8 million senior secured term loan due November 2021, and $2.1 million of other. The term loan accrues interest at a floating rate equal to LIBOR, subject to a floor of 75 basis points plus a margin of 325 basis points. Net debt leverage was 2.1 times at March 31st, 2016, and our excess availability under the ABL agreement was about $180 million. I'll now turn the call back to Greg.
Thanks, Evan. I'll now comment further on our 2016 second quarter results and end markets and provide an overview of our expectations and outlook for the third quarter and full year, beginning with Mueller Company. Second quarter sales growth at Mueller Company was due to demand for our products driven by increased municipal spending and residential construction. We were pleased by the 3.3% increase in domestic net sales of valves, hydrants, and brass products in the quarter. On our last call, we pointed out that we would have tough comparisons given the robust pull forward of orders we saw last year in advance of our price increase on valves and hydrants. We saw a similar pull forward this year, which we believe reinforces our positive outlook for market demand in the second half of the year.
Domestic sales of other water and gas infrastructure products and international sales also increased in the quarter. However, net sales of Henry Pratt's water treatment valves decreased $4.4 million due to the timing of projects. For the quarter, Mueller Company's net sales grew 6.5%, excluding net sales of Henry Pratt's water treatment valves. Mueller Company again delivered impressive operating results. In addition to the 110 basis point adjusted operating margin improvement I mentioned earlier, Mueller Company's adjusted EBITDA margin for the latest 12 months increased 170 basis points to 26.6% from the prior trailing 12 months. Turning to Anvil. Net sales into the oil and gas market declined approximately 60% in the second quarter year-over-year, which was more than we had expected and declined about 25% compared with the first quarter.
As we have said in the past, Anvil sales into this market have generally correlated with the U.S. rig count. Net sales of our fire protection line, primarily from the non-residential construction market, grew nicely in the quarter. We also benefited this quarter from an engineered hangar shipment to a nuclear plant in Taiwan. Anvil's adjusted operating income improved $1.1 million as the impact of lower shipment volume was more than offset by cost reductions and lower raw material costs. In addition, we benefited from higher margins associated with our shipment of hangars to the nuclear power plant project. Mueller Technologies' second quarter net sales declined due to lower AMR meter shipments at Mueller Systems, primarily to one customer. Mueller Systems' sales strategy is transitioning as we are increasing our penetration of the AMI segment of the market and becoming less dependent on one customer.
In fact, AMI shipments grew 26% year-over-year, and AMI orders increased $9 million, or 200% year-over-year. Mueller Systems is beginning to benefit from the recent introduction of new longer-range radio capabilities, which, among other things, lowers the cost of investment for end users. Echologics' quarterly net sales increased more than 40% year-over-year as our fixed leak detection technology continues to gain traction in the market. Additionally, we had a greater number of projects under contract at the end of the quarter compared to the prior year. Turning now to our outlook for the 2016 third quarter, beginning with Mueller Co. Municipal spending and residential construction, our principal end markets, will remain solid, which we expect to drive growth in excess of 10% in domestic shipments of valves, hydrants, and brass products in the third quarter.
We expect Mueller Co.'s overall net sales percentage growth in the third quarter to be in the mid to high single digits year-over-year. We also expect Mueller Co.'s adjusted operating income percentage growth for the third quarter to improve and grow at a greater rate than net sales as Mueller Co. continues to benefit from operating leverage. Turning to Anvil. Net sales for the third quarter are expected to be slightly down year-over-year. As we have mentioned, Anvil's oil and gas business is closely tied to the U.S. rig count, which was down 54% in mid-April year-over-year. Consequently, we expect demand from the oil and gas market to decline. Sales to oil and gas are now less than 8% of Anvil's total net sales, and we expect they will be down about $4 million in the third quarter year-over-year.
Although we expect fire protection net sales to increase in the quarter, we don't believe this will be enough to offset the decline in sales of our oil and gas products. Despite the decline in net sales, we believe that Anvil will generate slightly higher adjusted operating income in the third quarter, driven by ongoing cost savings and lower raw material costs. Mueller Technologies' success in diversifying its customer base and winning AMI projects continues to gain traction, and we believe that in the third quarter, growth in our AMI shipments will more than offset the decline in AMR meter sales to a major customer compared to the third quarter last year. We also expect a meaningful year-over-year improvement in Mueller Technologies' operating performance due to higher shipment volumes of both Mueller Systems and Echologics products and a richer mix with more AMI shipments and cost savings.
With this improvement, we expect Mueller Systems to be profitable in the third quarter. For Mueller Technologies as a whole, we should approach break even or see a slight loss in the third quarter. For the 2016 full year, key variables include corporate expenses, which are expected to be $36 million-$38 million, depreciation on amortization, which is expected to be $54 million-$56 million, and interest expense, which is expected to be $23 million-$25 million. We expect our adjusted effective income tax rate to be 35%-37%, and capital expenditures to be $38 million-$40 million. We expect 2016 free cash flow to be driven by improved operating results and an improvement in working capital. We also expect to make only minimal cash contributions to our pension plans. We expect free cash flow to exceed adjusted net income and to be higher than in 2015.
Domestic sales of Mueller Co.'s valves, hydrants, and brass products grew more than 6% in the first half of 2016, and we remain confident in our full-year expectations that we will continue to see growth and demand from our address municipal and residential construction markets. In addition, we believe domestic sales of Mueller Co.'s valves, hydrants, and brass products will grow in the low double digits in the second half of the year due to growth in that market demand. Additionally, Mueller Co. should have easier comparisons for these products in the second half of the year, in light of the excessive rain certain parts of the country experienced in May and June of 2015, which negatively impacted construction activity in the second half of 2015.
Although we don't expect revenue growth from Anvil in the second half of the year, we should continue to benefit from lower raw material costs and cost savings. Also, as mentioned earlier, the backlogs and projects awarded at Mueller Technologies are up nicely as our mix shifts to our higher-margin AMI products. Most of that backlog remains on schedule to ship in the second half of 2016. For the second half of the year, we expect Mueller Technologies to show year-over-year net sales growth of about 15%-20%. We continue to expect Mueller Technologies adjusted operating results to improve $7 million-$10 million for the full year. Consequently, our outlook for Mueller Water Products for the full year remains unchanged. We continue to feel positive about our outlook, our strengthening financial position, and earnings prospects.
Taking these factors into account, we increased our quarterly dividend to $0.03 per share in March. This increase is part of a disciplined capital allocation strategy that seeks to enhance the value delivered to our stockholders. With that, operator, I'll open up this call for questions.
Thank you. Participants, we will now begin the question and answer session. If you would like to ask a question, please press star and then one. Please unmute your phone and record your name clearly when prompted. Your name is needed to present your question. To cancel your request, that will be star followed by the number 2. One moment, please, for the first question. Our first question comes from the line of Mr. Kevin Meska of BB&T Capital Markets. Sir, your line is now open.
Thanks. Good morning.
Good morning, Kevin.
Greg, can I start on Mueller Tech? Just to make sure I understand what you just said. Originally, we were looking for 10%-15% growth for the full year. We've just had the first half down about 20%, but you think it'll be up 15%-20% in the second half. I know you've been building backlog, and it's up another 30%. The shortfall in the second quarter and the big growth you expect in the second half, was that all timing? Was that a surprise to you? Can you just say a little bit more about what happened there in the second quarter?
Sure, Kevin. I think, in order to answer that question as fully as possible, I think we got to talk about what's happening with us at American Water. We continue to provide AMR radios to American Water. However, in the second quarter, our sales on a year-over-year basis were down about $7 million, and we were not able to offset that decline. I will say that we had about $3 million of AMI shipments that we were expecting to make in late March that went in the early part of April. That was about the $3 million, I think, shortfall from our expectations. In our prepared remarks, when we said that Mueller Systems was transitioning, we were referring to actually becoming less dependent on American Water.
In the third quarter, for example, we expect to make up more than an $8 million decline in net sales to American Water on a year-over-year basis, primarily with AMI shipments. In the second quarter, we were unable to make up that year-over-year decline. In the third quarter, we believe we'll more than offset it because of AMI projects in our backlog. When talking about American Water, I think it's also important to point out that in this quarter, we were awarded a nice AMI contract for one of American Water systems, which we believe is the first in several AMI orders that we will receive from the system. In that sense, I think, Kevin, if I'm addressing your question, we're seeing a transition from American Water being as much as 30% in Mueller Systems sales to it being obviously a much lower percentage.
We think we are now at that point where we are going to be able to more than offset that decline with the AMI businesses in our backlog.
That bar is reset, if you will, on the American Water downdraft. You think that in Q3, total segment revenue will be up and the Mueller System segment will be profitable, but not the entire segment.
We think that we could be approaching breakeven, we think we could also have a slight loss, and more obviously coming out of our Echologics business. Our volume is building nicely at Echologics. We're still in that stage, though, that we need the volume to cover the fixed costs that we've put in the business to support where we think that business can go.
Again, you still expect the $7 million-$10 million smaller loss in the segment this year, even though the loss was actually slightly worse in the first half. A lot of that, if not all of that, goes back to AMI mix?
Yes. It goes back to the amount. It goes back to the volume of AMI we have in the background and the higher margins that we expect to receive in AMI. If you look at our AMI business is margins of about 700 basis points higher than our non-AMI business. It'll be a combination of both the volume that we have, in our backlog to ship, as well as the higher margins.
Okay. Just finally, one last follow-up on that. The backlog up 30%, the orders are similar. What does the pipeline look like? Should we expect more solid trends like that in the second half, or was there kind of some one-time type projects in the first half?
I wouldn't say one-time. We did have, as I said, a very nice order that we got from American Water for an AMI contract. When we look at our pipeline of our quotation activity, we're pretty confident that we're making that transition to greater penetration of the AMI market. There's no question, given the nature of this business, since it's project oriented, we can see some variation from quarter to quarter based on the timing of those shipments. The overall trend on what we're quoting, our success rate, what we have in backlog supports the outlook that we just provided.
Okay, great. Thank you.
Thanks, Kevin.
Thank you. Our next question comes from the line of Mr. Mike Wood of Macquarie Capital. Sir, your line is now open.
Hi, good morning.
Hi, Mike.
Hi. In your prepared remarks, you talked a little bit about the benefits of raw materials. Some steel pricing and other materials have been starting to move back up. Just curious when you would see that, and if you've had any success thus far passing those through with higher prices or what your expectations are to deal with that going forward.
Yeah, Mike. We have benefited when we look at our cost price ratio. You're right. I'd say during the quarter, we've started seeing those inch up a little bit. We still expect to see that as a continued benefit when we look at that cost price mix. Again, the outlook we gave for increased operating income assumes that we will have a positive price cost of raw material mix.
Got it. Great. You mentioned the pre-buy this year, similar to a year ago. What does that do to inventory levels in your view, and where do we stand heading into the rest of the year?
Yeah. Right now, when we look at our Mueller Co. distributors, we believe that inventories are in that $45 to $50 range. Sorry, 45 to 50 days. We think that's about where they target this time of the year, right after the pre-buy, going into construction season. I think that we are optimistic. When we look at our order intake so far in April, and we're just about done with the month, our hydrant and valve orders are up pretty nicely, through the first three and a half weeks. That leads us to believe that our distributors are beginning to turn the inventory that they pulled forward in February. Again, what we're seeing relative to distributor inventory orders in April supports the outlook that we provided this morning.
Great. Finally, I know it's tough to parse out, most of the residential trends have been very positive. A lot of the building product companies have been talking about benefits of weather, though, as well at the start of the year. Curious if you can give any color on what you're seeing on that residential end market.
Yeah, we're seeing very positive growth in the residential market. We're seeing higher growth rates on the residential side than what we are seeing on the municipal side. Again, I think that our expectation is that we will continue to see that nice growth rate through the end of our fiscal year and supports the outlook that we provided. You mentioned weather, and I don't know, in the second quarter, it may be tough for us to say that we saw any unusual benefit. We don't think there were any significant projects that were pulled forward into the quarter. We may have seen some repair work that could've been scheduled on a short notice that utilities may not have been able to do if the weather was not as nice as it was.
Where we did see a benefit was at our cost efficiency at our Chattanooga gate valve plant. Last year, Chattanooga lost two days of production due to weather. We had to work overtime to make up that production. This year, we were able to work all scheduled days and reduce overtime. I think the weather certainly was a plus when we look at residential construction, which I think continues to support our outlook that we will see nice growth from that market segment through our fiscal 2016.
Thank you.
Thank you. Our next question comes from the line of Mr. David Rose of Wedbush Securities. Sir, your line is now open.
Good morning. Thank you for taking my call.
Good morning, David.
Just a couple on the cost savings you highlighted in Anvil and Mueller. Maybe, I guess it was more on Anvil, but if you can articulate what were the particular cost savings that you're expecting. Where are they coming from?
Well, we've continued to take headcount down at Anvil. When you look at Anvil's overall headcount is down about 12% on a year-over-year basis. When you look at those manufacturing operations, where we do manufacture our oil and gas products, the headcount's down 50%-60%. Certainly, we think that with the headcount, I think that we have improved some of our manufacturing efficiencies at our largest Anvil plant in Columbia, Pennsylvania. Relative to our earlier question, we are seeing the benefit of lower raw material costs. At Anvil, we're not having to give up all of those lower raw material costs and lower pricing. We're keeping some of the benefit of lower raw material costs. It's overall efficiencies in our larger plant.
I think a lot of that driven by reduced headcount on a year-over-year basis, I think expected tailwinds from lower raw material costs.
Okay. In terms of cost savings on the Mueller Co. side, should we see anything, any incremental improvements? The operations are pretty leaned out in Mueller Co.
I think, again, we expect to still benefit from lower raw material costs because we're not having to give it all back or give it back with pricing. I think as our capacity utilization increases, we'll get better flow-through rates, just from overhead absorption. I would say that those will be the biggest drivers of cost opportunities at Mueller Co.
Okay. Lastly, if I may, on Mueller Tech. Your guidance is closing the gap for the back half of the year, but is this going to be linear or should we expect continued volatility? You obviously have a good pipeline of projects from which you've articulated. I would assume that profitability continues to improve nicely. Again, is this going to be lumpy?
Well, when we look through the rest of fiscal year 2016, it will be linear, and that's based on our scheduled backlog. We expect the fourth quarter. Well, and it will be lumpy, too. I can use both. We expect a much better fourth quarter than what we expect in the third quarter from Mueller Systems based on the timing of the backlog. I think there'll always be an element of lumpiness because the AMI business really is project oriented. As our backlog continues to increase, we think we'll continue to see year-over-year increases. It just may increase better in one quarter versus another quarter.
I'm sorry. I was really trying to get a little bit more guidance, but not necessarily guidance into 2017. Are your thoughts that in the 2017 that continues to improve nicely? Again, do we take two steps forward and then one step back?
Yeah. I think based on our quotation activity and the pipeline of where we think various contracts stand today, we think we would continue to see the improvement in 2017. Before we can, I think, say that more definitively, we're going to have to get a better idea on how many of these projects we win. When we look at our quotation activity, we think that it bodes well for us to continue to see the improvement, driven by not only increased volume, but by a much richer mix driven by AMI. For me to be more definitive, I think that we'll be able to comment on that probably on the next earnings call.
Okay. That's fair. I'll hop back in the queue. Thank you very much.
Thank you, David.
Thank you. Our next question comes from the line of Mr. Seth Weber of RBC Capital Markets. Sir, your line is now open.
Hi. This is Brendan on for Seth. I just had a quick question around the 7% price increase that you instituted in mid-February, sort of what the response was that, how was that received?
Well, certainly, as we said, that we understand that our competitors also announced a price increase. Our distributors always welcome the price increase. We probably won't get the real handle on it, because we're still, I think, shipping the orders that were pulled forward of the price increase. I would think that we'll know in the next 30 to 45 days, but nothing we see today would lead us to believe it'll be much different than what we have historically seen. As I said in the past, we have the last several quarters and expectations, even though we expect raw material costs to go up slightly in the next quarter or so, they're still well below historical levels. That could put a little more pressure on what we see, what % of the price increase we get to keep.
Right now, we've seen nothing that would say it's different than what we've historically seen.
Okay, thanks. Around the Anvil margin, the improvement there, how much was that due to restructuring versus mix? Is it sort of sustainable at the levels we saw this past quarter?
Evan, I'll let you take that.
I would say when you look at the improvement there, the 14.9% improvement in operating income from the quarter, I think as Greg mentioned before, we did see a nice benefit on the raw material front, specifically around scrap steel. We did see improvement in SG&A of roughly around a million dollars, and that's due to some of the headcount reductions that we've seen, both at the headquarters location, and there's also some cost savings associated with the headcount reductions at the oil and gas facilities and across Anvil as a whole. A good portion being the restructuring, also some support from improved raw material cost.
Okay, thank you. Just one last from me. Any color around Canadian business levels?
Yes. Actually, our Canadian business levels remain pretty solid. We were impacted again by currency, FX. We're still seeing, I'd say, solid business driven by residential construction. Canada is performing perhaps a little better than what we would've expected going into this year.
Okay. Thank you.
Thank you.
Thank you. Our next question comes from the line of Mr. Kevin Bennett of Sterne Agee Capital CRT. Your line's now open.
Thanks. Good morning, everybody.
Good morning, Kevin.
Greg, I wanted to focus on Mueller Co. for a second. I guess you guided the third quarter where your core products are going to be up 10%, but overall segment up a little bit less than that, and was curious if that's the Henry Pratt or if that's exports or any kind of commentary around the various pieces within Mueller Co., both for the third quarter and then I guess for the rest of the year would be helpful.
Yes. The biggest is, when we look at our third quarter on a year-over-year basis, international will be probably the biggest impact offsetting the growth that we expect to see valves and hydrants. Again, that's very lumpy business, project oriented. It's down on a year-over-year basis for us. Our international business will be down about 50%. We still expect to be offset by FX going the other way. When we look at Pratt, it's sort of a mixed bag. We do see some projects shipping in the third quarter, but then that's being offset where we think we will see some softness in other areas. It really is a combination.
The biggest year-over-year impact will be international sales for us, which is down 50%, and then some FX, and also a little bit, I'd say, a much lower growth rate at Pratt than what we expect to see at valves and hydrants.
Got it. Okay. Again, thinking about the core business, I was wondering if you could talk, I guess, within the U.S. about what you're seeing across various geographies, if you're seeing any weakness down in Texas. I know that's a big area that people are focused on.
Yeah. I will say, Kevin, we have not seen a weakness in Texas yet, because I think that probably some of the housing develop projects that were at a stage where they completed those. The other parts of Texas, we haven't seen any negative impact. We wouldn't be surprised if we start seeing perhaps a little bit of slowdown in South Texas, probably more on the residential construction side. I would say that we haven't seen anything that was significant that we could point out at this time.
Got it. Okay. Last question from me, I guess more for Evan, on the capital allocation, I'm wondering if anything's changed. I know you raised your dividend, and you have the buyback authorization out there. Just any updated thoughts around that?
Yeah, certainly, when we think about capital allocation, we have said that taking a look at acquisitions, that's a priority for us, whether it be something around the Mueller Co. segment, really in the water infrastructure side. We did have the two increases in the dividend over the past year, which has also been something. Over time, we've lowered our net debt leverage down from over six to 2.1 times at the end of the quarter. Debt reduction has been a priority. As we look forward, we'll continue to take a look at all avenues there, including the dividend and take a look at acquisitions as we go forward.
Okay. Thank you, guys.
Thank you. Our next question comes from the line of Mr. Walt Liptak of Seaport Global. Sir, your line's now open.
Hi. Thank you. I wanted to just get a couple clarifying questions asked. In the Mueller Technologies business, you talked about a linear progression over the next couple of quarters, but even linear looks like it's a step up from the second to the third in terms of revenue.
Is that how we should be thinking of it, or is it more of a back-end loaded?
No, there'll be a nice step, Walt. When you look at our prepared remarks, we expect to see a nice step in the third quarter. I think the step up, when you look at, as I was discussing a little earlier, in the second quarter we just completed, we were down about $7 million in sales that we had a year ago from American Water that we did not get this year. We didn't make those up. When we look at the second quarter, that was $8 million last year, we expect to more than make that up. Yeah, given the outlook we just provided, we expect our fourth quarter to be better than our third quarter, but we expect to see a nice pickup in this quarter, too.
Okay, great. Switching gears to the Anvil business. You mentioned that you'd be up in operating profit. I wanted to make sure I understood that that's quarter-over-quarter that you're talking about, which wouldn't be much of a stretch. Or I mean year-over-year, or is it quarter-over-quarter?
Yeah, we were talking year-over-year. Yeah. When you look at our second quarter, and moving into the third quarter, we expect to continue to benefit from the cost savings and some of the efficiencies that we've been able to pick up in the Anvil business. We had a nice benefit in the second quarter from the nuclear power plant project to Taiwan, and we don't have a project, especially of those kind of margins, in our third quarter expectations. That's where we would see a sequential drop-off, but we do expect to see a year-over-year improvement.
Okay, got it. All right. Thank you.
Thank you.
Thank you. Our next question comes from the line of Mr. Joe Giordano of Cowen. Sir, you may proceed.
Hey, guys. Most of my question's been answered at this point. I'm just curious if you're hearing any of your municipal customers, do they seem more focused on more substantial improvements to their networks, given some of the high-profile problems we've heard about over the past year? Or is it still just your traditional kind of break and fix?
Joe, I think what we're seeing now is more traditional break and fix. We're hearing more discussion about the recognition it's a bigger issue. It's not so much a discussion at the water systems, the water utilities. I think they've known it all along. I think it's more discussion by the politicians, the city councils that approve, in some cases, have to approve the rate increases. I think they're now talking more about the issue. We don't think it's going to be something that's going to positively drive demand for us in the next couple of quarters. We do think the discussions lend itself to, I think, a pickup in spending as we look out at maybe perhaps over the next 12 or 24 months from now.
Fair point. Yeah, we're hearing that elsewhere as well. Just in terms of Mueller Tech, how big do you think that business has to get on the AMI side to have real scale, where more than just break even, where you're really covering costs? Same with Echologics. Just trying to get a sense of what kind of growth do we need to see to get that to a point where it's material to MWP as a whole?
Yeah. I think that when you look at what we expect to ship the second half of the year in AMI business at Mueller Systems, if we build off that base, we don't need a lot over that base for this to be nicely profitable. We expect this year that we could be shipping three times as much AMI than what we did last year. The profitability that we expect to see at Mueller Systems in the second half of the year, I think that that's a nice base to where if we can continue, I'd say in a 5%, 6%, 7% year-over-year growth rate, that that business becomes nicely, I think, profitable. When I say 5%, 6%, 7%, I'm talking about AMI, because as I mentioned earlier, that's on average about a 700 basis points higher margin product for us.
On Echologics, I think we need probably another $5 million or $6 million to get to that point now where we're covering all of our fixed costs, then we will see a nice margin in contribution to margin, because our gross margins on our projects in that business are around 50%. We think that we're close. We think that if we can continue to build on the base of AMI business, that Mueller Systems will ship the second half of the year, that that puts us into territory where we start seeing nice incremental growth. At Echologics, I think we've always said that we would expect to start seeing that in 2017.
When we look at the acceptance and some of the success we're having with our fixed leak detection, we think that $4 million or $5 million of sales, that puts us at the point where then we would have a nice flow-through. We think we're within 12 months of seeing that.
Great. Just last, is the radio component of the American Water contract, is that still out to bid, or is that secure with you guys?
No, the radio contract is still out to bid. During that period, we continue to provide radios.
Okay, great. Thanks, guys.
Thanks, Joe.
Thank you. Our next question comes from the line of Mr. David Rose of Wedbush Securities. You may proceed.
Thank you. This is really a follow-up call to Joe's question as well as some of the other questions I had earlier. Really, in terms of scale for newer technologies and where you're positioned, maybe, Greg, you can give us some perspective strategically what you need to accomplish to be really relevant in this space. Do you need international distribution? Do you need, as the grid becomes much more focused on the edge, do you need other product additions, whether it be gas or electricity? Maybe you can provide some thoughts secondarily, what that would mean in terms of potential divestitures of existing businesses if you wanted to get bigger, that might be Anvil as an example.
Yeah. Thanks, David. I think that where we are tracking right now with our Mueller Systems business, if we can continue on that trajectory, I point out that we expect that our AMI shipments will be up three times this year where they were in 2015. I don't expect that we're going to increase it three times every year, we do think that we will be able to continue to grow the AMI business, that we think then we become relevant really in that segment. All along, that has been our target segment when five, six years ago, we decided to invest in this business to try to penetrate the water meter market, knowing we were at a competitive disadvantage when we looked at visual read meters and somewhat even on AMR, knowing we thought that the space was open on AMI.
We think the technology, we commented this in our prepared remarks, we think the technology that we introduced 12 months ago, on the LoRa technology that significantly increased the range of our radios, has now made us almost, we say, the system of choice to small to mid-size utilities because the infrastructure requirement is so much less that they're able to build the business case to put in AMI. We expect to continue to penetrate in the AMI market, if we continue to do so as we expect, I think we will be relevant, and we would stay committed to this business. If we find down the road that we're not able to penetrate at the rate that we expect we will, that will bring it into question. I don't think that we really have to expand internationally on the Mueller Systems business.
I think expanding internationally on leak detection, that would be gravy on top of, I think, where we're headed. I think we have made some nice breakthroughs in technology the last 12 months on fixed leak detection. Our vision all along was not to have big field crews in the market doing field surveys and finding leaks. When we have that business, it's profitable. When we don't have that business, we have those crews sitting around as a fixed cost. Our vision all along was to make leak detection 24/7 on a fixed network. That obviously takes a lot of pilots and a lot of work with our end-users. It also takes what we learn from each pilot and make adjustments to the technology.
When we look at some of the success we've had with some of the customers we've had the last six months, customers that have indicated that they are very interested in putting fixed leak detection over a greater portion of their system, that it gives us confidence that I think we're on the right track and we will see meaningful contribution from our leak detection business to our bottom line. As we sit here today, we don't think we have to go out and make a large acquisition to make us relevant, especially in the market segments that we're focused on penetrating. If that opportunity came up, it would be certainly something that we would look at, and I think that's what Evan said when answering the question about our capital allocation, our overall capital allocation strategy.
David, we think we're on a path to be relevant in the market segments that we have focused on penetrating. I think we'll know a whole lot more 12 months from now. Given that what we have in the backlog for AMI that we expect to ship this year, given what we're quoting and what we see our funnel of quotations, that we think we're on the right track. I think it will take, as I said, we'll have a lot better picture 12 months from now, because as I said, we're just 12 months into introducing the LoRa AMI technology, and we started winning the projects. Now we're at the point of starting to ship those.
Thank you. That's a very comprehensive answer. Maybe just briefly, what would it take for you to make a decision to divest yourself of Anvil?
We always analyze our portfolio of businesses. A divestiture of Anvil, as we've talked about, we think our real growth opportunity is on the water side. I don't know if I can say there's any one thing that would be the catalyst or the trigger for us to divest Anvil, but I would say that it is something that we're giving a lot of attention to.
Thank you.
Thank you.
Thank you. At this time, there are no further questions. Speakers, you may proceed.
Well, again, thank you very much for your interest. Look forward to seeing some of you over the quarter and in our time on our next quarter's conference call. Thanks very much.
Thank you. That concludes today's conference. Thank you for participating. You may now disconnect.