Apr 27, 2016
Executives
Martie Zakas - SVP, Strategy, Corporate Development & Communications Greg Hyland - Chairman, President & CEO Evan Hart - CFO
Analysts
Kevin Maczka - BB&T Capital Markets Mike Wood - Macquarie Capital David Rose - Wedbush Securities Kevin Bennett - Sterne Agee Capital CRT Walter Liptak - Seaport Global
Operator
Welcome and thank you all for standing by. [Operator Instructions].
Now I will turn the meeting over to your host, Mrs. Martie Zakas.
Ma'am, you may now begin.
Martie Zakas
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 31, 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 3 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 2 and 3 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. In addition, 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 now turn the call over to Greg.
Greg Hyland
Thanks, Martie. 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 Company's end markets remain solid as demand for Mueller Company's core products continue to grow in the second quarter.
Increased shipment volumes coupled with better operating efficiencies and lower cost led to a 9% increase in Mueller Company's adjusted operating income and a 110 basis points improvement in adjusted operating margin. Mueller Company's adjusted EBITDA margin in the second quarter was 24.1% and on a trailing 12 months basis it was 26.6%.
And our second quarter net sales excluding sales to the oil and gas market increased 3.3% year-over-year. Additionally, Anvil adjusted operating income increased 14.9% despite overall net sales declining $4.7 million to $86.4 million.
Mueller Technology remained focused on growing sales of it's higher margin, AMI and lead detection technologies and on improving operating performance over the course of the year. Backlog and projects awarded at both Mueller Systems and Echologics continued to be up substantially on a year-over-year basis at the end of the quarter.
Mueller Technologies from this transition, the 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 and we believe we are on track to meet our expectations for the full year.
With that, I'll turn the call over to Evan.
Evan Hart
Thanks, Greg, and good morning, everyone. I'll first review our second quarter consolidated financial results and then discuss segment performance.
2016 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 Company 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 as compared with $26.3 million last year.
The increase in adjusted operating income was primarily due to improved operating performance at Mueller Company 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 know that adjusted income per 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 Company. Net sales for the 2016 second quarter of $182.2 million increased $4.9 million as compared with $177.3 million last year.
Mueller Company's 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 cost 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 and 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 cost and other cost savings despite lower sales in what has historically been our higher margin products.
And 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 as 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 31, 2016 total debt was comprised of 484.8 million being a secured term loan through November 2021 and $2.1 million of other. The term loan accrues interest at a floating rate equal to LIBOR subject to a floor [ph] 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.
Greg Hyland
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 odds we saw last year in advance of our price increase on valves and hydrants but 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 points 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 nonresidential 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 volumes 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 for 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 investments for end users. Echologics quarterly net sales increased more than 40% year-over-year as our fixed lead 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 Company.
Municipal spending and residential construction, our principle end markets 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 Company'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 Company's adjusted operating income percentage growth for the third quarter to improve and grow at a greater rate in net sales as Mueller Company's 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 Echologic 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 breakeven 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 to $38 million, depreciation and amortization which is expected to be $54 million to $56 million, and interest expense which is expected to be $23 million to $25 million. We expect our adjusted effective income tax rate to be 35% to 37% and capital expenditures to be $38 million to $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 Company's valve, 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 as we address our municipal and residential construction markets.
In addition, we believe domestic sales of Mueller Company's valves, hydrants and brass products will grow in the low double digits in the second half of the year due to growth in their market demand. Additionally, Mueller Company's should have easier comparisons for these products in the second half of the year in light of the excessive rain in 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 in 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% to 20%.
We continue to expect Mueller technologies' adjusted operating results to improve $7 million to $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.
Operator
Our first question comes from the line of Mr. Kevin Maczka of BB&T Capital Markets.
Sir, your line is now open.
Kevin Maczka
Greg, can I start on Mueller Tech? So just to make sure I understand what you just said.
So originally we were looking for 10% to 15% growth for the full year. We've just had the first half down about 20 but you think it will be up 15% to 20% in the second half.
Is this -- I know you've been building backlog and it's up another 30%. Was this a 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?
Greg Hyland
Sure, Kevin. And, you know, I think in order to answer that question as fully as possible, I think we've got to look a bit -- 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. So that was about -- that was about $3 million, I think, shortfall from our expectations.
But in our prepared remarks, when we said that Mueller Systems was transition we were referring to actually becoming less dependent on American Water. In the third quarter for example we expect to make up more than a $8 million decline in net sales to American Water on a year-over-year basis.
Primarily with AMI shipments, so in the second quarter we were unable to make up that year-over-year decline. In the third quarter we believe we will more than offset it because of AMI projects in our backlog but 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 waters, AMI orders that we will receive from this system.
So in essence, 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, and we think we are now at that point where we are going to be able to more than offset that decline with the AMI business that's in our backlog.
Kevin Maczka
Okay. So that bar is reset, if you will, on the American Water downdraft and you think that in Q3, total segment revenue will be up and the Mueller Systems segment will be profitable but not the entire segment.
Greg Hyland
We think that we could be approaching break-even but we think we could also have a slight loss, and we're 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 more volume to cover the fixed cost we've put in the business to support where we think that business can go.
Kevin Maczka
And again, you still expect the $7 million to $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?
Greg Hyland
Yes, it goes back to the amount, it is 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, talking about margins of about 700 basis points higher than our non-AMI business, so it will be a combination of both the volume that we have in our backlog to ship, as well as the higher margins.
Kevin Maczka
Okay. And then just finally, one last follow-up on that, so 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?
Greg Hyland
You know, I wouldn't say one-time. We did have, as I said, the very nice order that we got from American Water for an AMI contract, but 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 its project oriented, we can see some variation from quarter to quarter based on the timing of those shipments, but the overall trend on what we're quoting, our success rate, what we have in backlog supports the outlook that we just provided.
Operator
And our next question comes from the line of Mr. Mike Wood of Macquarie Capital.
Sir, your line is now open.
Mike Wood
In your prepared marks you talked a little bit about the benefits of raw materials, you know, 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?
Greg Hyland
Yes Mike, we have benefited, when we look at our cost price ratio, you're right, during the quarter we've started seeing those inch up a little bit, but we still expect to see that as a continued benefit when we look at that cost/price mix. So, you know, again, the outlook we gave for increased operating income assumes that we will have a positive price/cost of raw material mix.
Mike Wood
And 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?
Greg Hyland
Right now when we look at our Mueller Company distributors, we believe that inventories are in that 45 to 50 days, and 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 3.5 weeks, so that leaves us to believe that our distributors are beginning to turn the inventory that they pulled forward in February.
So, again what we're seeing relative to distributor inventory orders in April supports the outlook that we provided this morning.
Mike Wood
And finally, I know it's tough to parse out, but you know, most of the residential trends have been very positive. A lot of the building product companies have been talking about benefits in weather, though as well at the start of the year.
Curious if you have any color on what you're seeing on that residential end market?
Greg Hyland
We’ve seen very positive growth in the residential market, we’re seeing higher growth rates on the residential side than what we’re seeing on municipal side and again I think that our expectations 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 maybe tough for us to say that we saw any unusual benefit.
We don’t think there were any significant projects that were pull forward in the quarter. We may have seen some repair work that could have scheduled on a short notice that utilities may not have been able to do if the weather was not as nice as it was, but we did see a -- where we did see a benefit was at our cost efficiencies at our Chattanooga gate valve plant.
Last year Chattanooga lost two days of production due to weather. We had a workover time to make up that production.
This year we were able to work all scheduled days and reduce overtime. But 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 2015.
Operator
And our next question comes from the line of Mr. David Rose of Wedbush Securities.
Sir, your line is open.
David Rose
Just a couple on, you know, 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?
Greg Hyland
Yes, well, we've continued to take headcount down at Anvil. When you look at our Anvil's overall headcount, it's 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 headcount is down 50% to 60%. So 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, and you know relative to our earlier question we are seeing the benefit of lower raw material costs and at Anvil, we're not having to give up all of those lower material costs and lower pricing and so we’re keeping some of the benefit of lower raw material costs.
So its overall efficiencies in our larger plant, I think a lot of that driven by reduced headcount on a year-over-year basis and I think expected tail winds from lower raw material costs.
David Rose
Okay. And in terms of, you know, cost savings in the Mueller Co side, should we say anything, any incremental improvements from -- I mean, operations are pretty liened out in Mueller Co.
Greg Hyland
You know, 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 and I think as our capacity utilization increases, we'll get better flow-through rates just from overhead absorption. But, I would say that those would be the biggest drivers of cost opportunities at Mueller Co.
David Rose
And then lastly if I may, on Mueller Tech, your guidance is closing the GAAP 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 if you’ve articulated so I would assume that profitability continues to improve nicely or again is this going to be lumpy?
Greg Hyland
Well when we look for the rest of fiscal year 2016 it will be linear and that’s based on our scheduled backlog. So we expect the fourth quarter -- well it will be lumpy too, so I can use both because we expect a much better fourth quarter than what we expect in the third quarter from Mueller System based on the timing of the backlog.
So I think there will always be an element of lumpiness because the AMI business really is project oriented but as our backlog continues to increase we think we will continue to see year-over-year increase. It just may increase better in one quarter versus another quarter.
David Rose
And I'm sorry, I was really trying to get a little bit more guidance without necessarily guidance in the '17. Is it your thoughts that in the '17, that continues to improve nicely or again do we take two steps forward and then one step back?
Greg Hyland
Yes, I think based on our quotation [ph] activity and the pipeline of where we think various contracts stand today, we think we would continue to see the improvement in 2017, but 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 but 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 a much richer mix driven by AMI, but for me to be more definitive, I think that we'll be able to comment on that in the next -- probably on the next earnings call.
Operator
And our next question comes from the line of Mr. Seth Weber of RBC Capital Markets.
Sir, your line is now open.
Unidentified Analyst
This is Brendon [ph] 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 to that and how was that received?
Greg Hyland
Yes. Well, certainly, as we said, 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.
So 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 will be much different than what we have historically seen.
You know, if 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, how much -- what percent of the price increase we get to keep, but right now we've seen nothing that would say it's different than what we've historically seen.
Unidentified Analyst
And then around the Anvil margin, how much would you say that the improvement there -- how much was that due to restructuring versus mix, and then is it sort of sustainable at the levels we saw this past quarter?
Evan Hart
I would say when you look at the improvement there, the 14.9% improvement in operating income for the quarter, I think as Greg mentioned before, we did see a nice benefit on the raw material front, specifically around scrap steel, but we did see improvement in SG&A of roughly around $1 million and that's due to some of the headcount reductions that we've seen, both at the headquarters location and then there's also some cost savings associated with the headcount reductions at the oil and gas facilities and across Anvil as a whole. So a good portion being the restructuring, but then also some support from the improved raw material cost.
Unidentified Analyst
And then just one last for me, any color around Canadian business levels?
Greg Hyland
Yes, actually, our Canadian business levels remain pretty solid. We were impacted again by currency, FX, but we're still seeing, I'd say solid business driven by residential construction.
So Canada is performing perhaps a little better than what we would have expected going into this year.
Operator
And our next question comes from the line of Mr. Kevin Bennett of Sterne Agee Capital CRT.
Your line is now open.
Kevin Bennett
Greg, I wanted to focus on Mueller Co for a second and 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 you know the various pieces within Mueller Co both for the third quarter and then I guess for the rest of the year would be helpful.
Greg Hyland
Yes. The biggest is, when we look at our third quarter on a year-over-year basis, we do -- international will be probably the biggest impact, offsetting the growth that we expect to see in valves and hydrants.
And again, that's a very lumpy business, project oriented but it's down on a year-over-year basis for us. Our international business will be down about 50%.
When we look at -- you know, we still expect to be offset by FX going the other way and 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.
So it really is a combination of -- 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.
Kevin Bennett
Okay. And then 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.
Greg Hyland
Yes, I will say, Kevin, we have not seen weakness in Texas yet because I think that probably some of the projects that we're -- developing projects, you know, the housing development projects that we’re at a stage where they completed those. And the other parts of Texas, we haven't seen any negative impact.
But 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. But I would say that we haven't seen anything that was significant that we could point out at this time.
Kevin Bennett
Okay. And then the last question for me, I guess, more for Evan.
On the capital allocation, I'm wondering if anything's changed or if we're -- I know you raised your dividend and you have the buyback authorization out there, just, you know, any updated thoughts around that?
Greg Hyland
You know, certainly, yes, when we think about capital allocation, you know, we have said that taking a look at acquisitions that’s a priority for us, whether it would be something around the Mueller Company segment in the water infrastructure side, and we did have the two increases in the dividend over the past year which is also you know been something we've, over time we’ve lowered our net debt leverage down from over 6 to 2.1 times at the end of the quarter, so debt reduction has been our priority, but 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.
Operator
And our next question comes from the line of Mr. Walter Liptak of Seaport Global.
Sir, your line is now open.
Walter Liptak
I wanted to just get a couple clarifying questions asked. In the technologies business, you talked about a linear progression over the next couple of quarters but, you know, even linear looks like it's a step up in 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 guidance?
Greg Hyland
No, there'll be a nice step -- if you look at our prepared remarks, we expect to see a real nice step in the third quarter. And I think that it's a step up.
When you look at, as I was describing, you know, 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, we think -- that was $8 million last year. We more than make that -- we expect to more than make that up.
So, yes it will be -- if we expect our -- given our outlook -- 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.
Walter Liptak
And switching gears to the Anvil business, you mentioned that, you know, 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 that year-over-year or is it quarter over quarter?
Greg Hyland
Yes, we were talking year-over-year. 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, but we had a nice benefit in the second quarter from the nuclear power plant project to Taiwan and we don't have a project in the -- especially of those kind of margins in our third quarter expectations.
So that's where we would see a quarter -- I mean a sequential drop-off, but we do expect to see a year-over-year improvement.
Operator
And our next question comes from the line of [indiscernible]. Sir, you may proceed.
Unidentified Analyst
Most of my questions have been answered at this point but 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 problems -- the high profile problems we've heard about over the last over the past year or is it still just your traditional kind of break and fix?
Greg Hyland
You know what we're seeing now is more traditional break and fix, but we're hearing more discussion, and more discussion about the recognition it's a bigger issue and 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 that the -- you know, the City Councils that approve, and in some cases have to approve the rate increases, I think they're now talking more about the issue. So, we don't think it's going to be something that's going to be positively drive demand for us in the next couple quarters but we do think that discussions will lend itself to I think a pickup in spending as we look out maybe perhaps over the next, you know, 12 or 24 months from now.
Unidentified Analyst
And, yes 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 kind of sense of how -- what kind of growth do we need to see to get that to a point where it's material to MWA [ph] as a whole?
Greg Hyland
Yes. I think that when you look at what we expect to ship the second half of the year in AMI business at Mueller Systems, and if we build off that base, we don't need a lot over that base to you know, for this to be nicely profitable and, you know we expect this year that we could be shipping three times as much AMI than what we did last year.
And so the profitability that we expect to see at Mueller Systems in the second half of the year, you know, 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, but that business becomes nicely profitable. And 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 and then we will see a nice margin in contribution to margin because our gross margins on our projects in that business are around 50%, so it really is -- so we think that we're close. We think that if we can continue to build on the base of AMI business that Mueller System's will ship the second half of the year, 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 a sale 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.
Unidentified Analyst
And just last, is the radio component of the American Water contract, is that still out to bid or is that secure with you guys?
Greg Hyland
No, the radio contract is still out to bid and during that period, we continue to provide radios.
Operator
Thank you. And our next question comes from the line of Mr.
David Rose of Wedbush Securities. You may proceed.
David Rose
This is really a follow-up call to Joe's question as well as some of the other questions I had earlier but 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 -- you know, 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 if that might be Anvil as an example.
Greg Hyland
I think that where we are tracking right now with our Mueller Systems business, if we can continue on that trajectory, and 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, but I mean 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. And 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 in a competitive disadvantage when we looked at visual read meters, and it's somewhat even on AMR.
But knowing we thought that the space was open on AMI. We think the technology and we commented this in our prepared remarks, we think the technology that we introduced 12 months ago on the lower technology that significantly increased the range of our radios, has now made us almost I would say the system of choice too 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 could penetration in the AMI market, and 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, then that will bring it into question.
Relative to -- and so 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, of where we're headed.
Again, 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 had that business, it's profitable but 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 us -- you know, take what we learn from each pilot and make adjustments to the technology, but 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. So 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 want to -- 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. So, David, I think that 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. But given 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, but 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 lower [ph] AMI technology, and we started winning the projects, now we're at the point of starting to ship those.
David Rose
And that's a comprehensive answer. And maybe just briefly, what would it take for you to make a decision to divest yourself of Anvil?
Greg Hyland
We always analyze our portfolio of businesses. It would be a divesture of Anvil as we have talked about, we think our real growth opportunity is on the water side and I don’t know if I can say there is anyone thing that would be the catalyst or a trigger for us to divest Anvil but I would say that is something that we’re giving a lot of attention to.
Operator
Thank you. And at this time there are no further questions.
Speakers, you may proceed.
Greg Hyland
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.
Operator
Thank you. And that concludes today's conference.
Thank you for participating. You may now disconnect.