ADTRAN (ADTN) Q4 2018 Earnings Conference Call Transcript

ADTRAN (ADTN)
Q4 2018 Earnings Conference Call
Jan. 24, 2019 10:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

See all our earnings call transcripts.

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and thank you for standing by, and welcome to ADTRAN's fourth-quarter 2018 earnings release conference call. [Operator instructions] During the course of the conference call, ADTRAN representatives expect to make forward-looking statements which reflect management's best judgment based on factors currently known. However, these statements involve risks and uncertainties, including the successful development and market acceptance of core products, the degree of competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies and other risks detailed in our annual report on Form 10-K for the year ended December 31, 2017. These risks and uncertainties could cause actual results to differ materially from those in the forward-looking statements which may be made during the call.

It is now my pleasure to turn the call over to Tom Stanton, chief executive officer of ADTRAN. Sir, you may begin.

Tom Stanton -- Chief Executive Officer

Thank you, Aaron. Good morning, everyone. We appreciate you joining us for our fourth-quarter 2018 conference call. I am joined by ADTRAN's CFO, Roger Shannon.

Following my remarks on the quarter and what we expect to see going forward, Roger will review the quarterly financial performance in greater detail and then we will take your questions. Overall, the 2018 fiscal year was difficult on several fronts as we worked to broaden our customer base and mitigate the impact of a direction change from one of our largest customers. However, we continued to make progress in terms of customer engagement, product development, and expansion of our market opportunity, both domestically and around the world. From a top-line perspective, we had a solid fourth quarter with revenues of $140.1 million, aligning with our expectations.

Q4 revenues were up 10% over the same period last year and flat compared to Q3 as an increase in our domestic tier one revenues and strong international sales negated typical seasonal declines. Network solutions accounted for the majority of our $116.9 million, while global services and support contributed $23.2 million or 17% of total revenues for the quarter and a 20% increase over the prior quarter. Revenues for domestic markets came in at $74.8 million or 53.4% of the total, while international revenues were $65.3 million or 46.6% of the total. International revenue was up 15% over the previous quarter and up 101% on a year-over-year basis.

Strong growth in our international business was driven by material contributions in new orders from tier one operators in our EMEA, pacific rim and LAT AM regions. Breaking revenue is down a little further. Our access and aggregation business came in at $100.5 million, up 9% from the previous quarter and up 27% on a year-over-year basis. The build-out of broadband access infrastructure outside the U.S.

led this growth were -- with our international access and aggregation revenues up 17% versus last quarter and up 115% over the same period last year. We saw material increases in LAT AM and Asia Pacific tier one carriers, while business with our European tier one carrier remained strong. Along with our previously mentioned domestic tier one strength within the U.S, our connect America fund business grew 24% over the previous period, and we remain focused on growing our broadband access penetration in adjacent markets, with 44% year-over-year revenue growth from our cable MSO service provider customers. Across our other revenue category, subscriber solutions and experience revenue, which was formerly known as customer devices, was $31.2 million.

With the addition of SmartRG during the fourth quarter, which I will discuss further, and our increasing focus on enhancing the customer experience for both our business and consumer broadband customers, subscriber solutions and experience more accurately represents this revenue category with our vision going forward. Traditional and other products came in at $8.3 million. Overall, our customer engagement across the domestic, EMEA, Pacific Rim and LAT AM regions continued to be extremely strong as communities across these geographic seek gigabit services and operators look to leverage our software-defined access solutions and integration services to transform their networks. We expect this momentum to continue into 2019 as we work to further strengthen our customer, geographic and product diversity, led by growing interest and market traction in our 10-gig XGS-PON solutions, SD access solutions, Mosaic software applications and integration services, our 10-gig EPON portfolio for cable and MSO operators and our recently acquired open-source connected home platforms in cloud services.

A growing number of service providers are looking to ADTRAN as the leader in software-defined access as they believe this technology will underpin the next phase of our network evolution and service velocity. As many of you know, the drive to 10-gig has been a priority for ADTRAN and the market in general. Our leadership in this emerging market has recently recognized by leading industry analyst firm, Broadband Trends, who named ADTRAN as the top 10-gig provider across all categories measured for delivering the next-generation technology, products, services and solutions needed to help network operators build their best 10-gig fiber access networks. This level of industry support and validation should serve us well moving forward as 79% of the carrier-surveyed plan to deploy 10-gig PON by 2020 according to that same report.

At Broadband World Forum in Berlin, ADTRAN announced that U.K.-based Community Fiber was leveraging our market-leading 10-gig solutions to build a 10-gig regional full fiber-to-the-home network. ADTRAN's scalable, flexible 10G solutions and the breadth of our access technology, including XGS-PON and NG-PON2 make it the ideal partner for carrier such as Community Fiber that are looking to maximize revenue and service growth potential within residential and commercial markets. By deploying ADTRAN's XGS-PON solutions via ADTRAN's fiber broadband platform, Community Fiber plans to scale services to over one million customers over the next few years. Community Fiber joins a growing list of ADTRAN customers that are leveraging 10G services to gain a significant competitive advantage in the broadband market.

The interest in our 10-gig solutions is extremely high at 65% of North American RFP responses during the quarter and all of our international RFP responses during the period addressed 10-gig PON as a main requirement for key and future business requirements. We believe that our customers agree that once this level of bandwidth is readily available for both residential and business services, the conversation will change from a focus on capacity to one centered on the subscriber experience. This is an area of development where ADTRAN's software focus over the past decade shines. With markets as diverse and distributed as ADTRAN's having a broad base of technology options, platforms and services has proven to be a key differentiator for us.

These products are unified through our commitment to open standards and our operable systems and the ability to help customers build their best networks to meet their specific needs, demographics, infrastructure and customer mix. To that end, ADTRAN has announced commercial availability of the world's first second-generation G.fast products. And interest in G.fast is largely driven by network operators leveraging this technology within their fiber to the distribution point and fiber to the basement deployment footprints. ADTRAN is the first broadband access supplier to deliver G.fast solutions that conform with Amendment 3 of the ITU G.fast standard, which doubles the usable spectrum from 106 megahertz to 212 megahertz.

With Amendment 3, G.fast is now capable of providing an aggregated bandwidth of two gigabits per second, delivering fiber-like speeds for multi-dwelling units and other applications which require leveraging the existing phone or cable television wiring infrastructure. Deployment of ADTRAN's G.fast solutions are already under way in tier one networks in North America, Europe, Australia and the Middle East as network operators look to complement fiber-to-the-home deployments to deliver gigabit services network wide. We were pleased to announce during the quarter that ADTRAN's market-leading G.fast solutions are one of the key enablers to NBN's nationwide rollout of its fiber to the curb network. We have successfully helped NBN define, design and build this next-generation fiber network, and we are pleased to have been able to contribute in such a meaningful way.

ADTRAN to date has shipped hundreds of thousands of gigabit-capable G.fast ports to our customers, and this technology addresses a wide range of applications to advance gigabit services delivery around the globe. During the final quarter of 2018, we entered the connected home market through our acquisition of SmartRG, a leading global provider of connected home solutions. We are excited about this opportunity as it enables our customers to fully leverage their multibillion dollar investments in their access networks and optimize how services are delivered and consumed in a rapidly growing connected home market. This will also expand these operators' ability to address the need to small and medium businesses as well.

SmartRG software platform approaches delivering both hardware-based and virtualized solutions, will enable us to extend the value of our open programmable and web-scalable Mosaic platform. We continue to take a long view of the strategic opportunities ahead of us to disrupt, leverage and transform the market. ADTRAN is well-positioned to capitalize on the market shifts ahead in both our core Broadband access business and the new opportunities within the emerging connected home. All work with all types of operators from traditional tier one providers to rural broadband service providers, cable operators and municipalities and utilities that are now entering the broadband market, create multiple engines for growth for ADTRAN.

With that, I will turn the call over to Roger to provide some more details on the financials and following his comments, I'll be happy to answer any questions you may have. Go ahead, Roger.

Roger Shannon -- Chief Financial Officer

Thank you, Tom, and good morning. I'll speak about our fourth-quarter results and discuss what we see for the next quarter. During my report, I'll be referencing both GAAP and non-GAAP results. The differences between reported GAAP and non-GAAP includes stock-based compensation, acquisition-related expenses and amortizations, restructuring expenses and tax reform expenses.

As Tom stated, ADTRAN's fourth-quarter revenues came in at $140.1 million compared to $140.3 million last quarter and $126.8 million for quarter four of last year. Our Q4 '18 results include approximately $3 million in revenues resulting from our November 30 acquisition of SmartRG, which Tom discussed in his comments. Our network solutions revenues for the fourth quarter were $116.9 million versus $121 million reported for Q3 of 2018 and $95.8 million in Q4 of last year. Our global services and support revenues in Q4 of this year were $23.2 million compared to $19.3 million reported for the third quarter and $31 million in the fourth quarter of last year.

Across our revenue categories, access and aggregation revenues for quarter four of 2018 were $100.5 million compared to $91.9 million last quarter and $79.2 million in quarter four 2017. Revenues for our subscriber solutions and experience category, formerly customer devices, were $31.2 million for the quarter versus $38.6 million for quarter three of 2018 and $32.8 million for quarter four of last year. Traditional and other products revenues for the quarter were $8.3 million compared to $9.9 million for quarter three of 2018 and $14.9 million for quarter four of 2017. Looking at our revenues geographically, domestic revenues for Q4 of 2018 were $74.8 million versus $83.7 million reported in quarter three of 2018 and $94.3 million in quarter four of last year.

Our international revenues for quarter four 2018 were $65.3 million compared to $56.6 million for quarter three and $32.5 million in quarter four 2017. We've published a reporting of each of these categories on our investor relations webpage at adtran.com. For the quarter, we had 3 10% of revenue customers. Our GAAP gross margins for the fourth quarter of this year were 39.5% compared to 41.6% last quarter and 46.4% reported in the fourth quarter of 2017.

Non-GAAP gross margins for quarter four were 40% versus 42% in the prior quarter and 46.4% in quarter four of last year. The quarter-over-quarter and year-over-year decreases in our gross margins was primarily driven by mix and decreased volumes in our domestic products portfolio and an increased weighting of our international business. Total operating expenses on a GAAP basis were $59.2 million for quarter four of 2018, $1.5 million lower than the $60.6 million reported last quarter and a decrease of $3.8 million compared to $63 million for quarter four of last year.On a non-GAAP basis, our quarter four operating expenses were $56.5 million compared to $58.3 million last quarter and $60.7 million in quarter four of 2017. The quarter-over-quarter decrease in operating expenses was primarily the result of larger-than-typical decreases in compensation and labor expenses, partially offset by increased project-specific R and D spending and one month of operating expenses from the acquisition of SmartRG.

The year-over-year decrease is primarily attributable to larger-than-typical decreases in compensation and labor expenses, partially offset by the addition of operating expenses from SmartRG. Operating income on a GAAP basis for the quarter just ended was a loss of $3.8 million compared to an operating loss of $2.2 million in the prior quarter and a loss of $4.2 million reported in Q4 of last year. Non-GAAP operating income for quarter four of 2018 was a loss of $413,000 compared to operating income of $647,000 reported in Q3 of 2018 and a loss of $1.8 million for quarter four of last year.The quarter-over-quarter decrease in GAAP and non-GAAP operating income is primarily the result of lower gross margins driven by our higher international sales volumes and domestic product mix, partially offset by reduced operating expenses. The decrease in our Q4 GAAP and non-GAAP operating losses as compared to Q4 of 2017 is attributable to lower operating expenses, partially offset by lower gross margins resulting from the previously mentioned higher international sales volumes and domestic product mix.

As described in the supplemental information provided in our operating results disclosure, stock-based compensation expense, net of tax was $1.5 million for the current quarter compared to $1.3 million last quarter and $1.4 million reported in quarter four of last year. Acquisition-related expenses, amortizations and adjustments for the quarter were $1.1 million net of tax compared to $681,000 last quarter and $297,000 in quarter four of last year, with the increase driven by the previously mentioned SmartRG acquisition. Restructuring net of tax was $19,000 for the quarter just ended compared to $193,000 last quarter and $36,000 reported in quarter four of last year. In Q4 of last year, we reported an $11.9 million expense related to the Tax Cuts and Jobs Act as compared to 0 this quarter.

All other income and expenses for quarter four of 2018 was a loss of $6.8 million compared to income of $5.4 million last quarter and income of $3.4 million for quarter four of 2017. The other income loss in the quarter was driven by unrealized losses in our equity investment portfolios resulting from the significant equity market decline during the quarter. The company's GAAP tax provision for quarter four of 2018 was a tax benefit of $2.1 million as compared to a $4.4 million tax benefit in the third quarter and a tax expense of $10.4 million in quarter four of 2017. The shift from a tax expense in Q4 of last year to a tax benefit this year was primarily driven by a completed analysis of the impact of the Tax Cut and Jobs Act, completion of other tax projects and current year net losses in our domestic business.

As a reminder, our GAAP tax expense in Q4 of last year reflected a onetime writedown of the deferred tax assets resulting from the implementation of the Tax Cut and Jobs Act. GAAP net income for quarter four of this year was a loss of $8.4 million compared to income of $7.6 million last quarter and a loss of $11.1 million for the fourth quarter of last year. Non-GAAP net income for the fourth quarter of 2018 was a loss of $5.9 million compared to income of $9.8 million last quarter and income of $2.5 million in quarter four 2017. As mentioned above, the GAAP and non-GAAP losses for Q4 of this year were driven by unrealized mark-to-market losses in our equity investment portfolio.

Our Q3 GAAP net income reflected a benefit of $5.4 million in other income from equity gains and a tax benefit of $4.4 million. Earnings per share on a GAAP basis were a loss of $0.18 compared to income of $0.16 per share for last quarter and a loss of $0.23 per share in fourth quarter of 2017. Non-GAAP earnings per share for the fourth quarter of this year were a loss of $0.12 compared to earnings of $0.21 per share last quarter and earnings of $0.05 per share for quarter four of last year. We've provided a reconciliation between diluted GAAP earnings per share and diluted non-GAAP earnings per share in our operating results disclosure.

Now turning to the balance sheet. Unrestricted cash and marketable securities, net of debt totaled $173.1 million at quarter-end after paying $4.3 million in dividends and repurchasing 100,000 shares of common stock for $1.3 million during the quarter. For the quarter, we generated $7.9 million of cash from operations. Net trade accounts receivable were $99.4 million at quarter-end, resulting in a DSO of 65 days compared to 67 days last quarter and 105 days at the end of the fourth quarter of 2017.

The decrease in DSO versus the same period last year and last quarter is mainly attributable to customer mix and the timing of shipments within the quarter. Last year's DSO was also higher, driven by customer-specific payment terms that are no longer in effect. Inventories were $99.8 million at the end of the fourth quarter compared to $106.1 million last quarter and $122.5 million at the end of quarter four of 2017. We have completed a preliminary purchase accounting related to the SmartRG transaction.

Management is currently in the process of finalizing the assessment of the fair value of the assets acquired as part of the SmartRG transaction. The results reflect that primary assessment. We expect to finalize our purchase accounting entries by the time we file our 10-K. Looking ahead to the next quarter.

The book-and-ship nature of our business, the timing of revenues associated with large projects, the variability of order patterns in the customer base into which we sell and the fluctuation in currency exchange rates in our international markets we sell into may cause material differences between our expectations and actual results. However, our current expectations are that our first-quarter 2019 revenues will be in the range of $100 million to $142 million. After taking into account the potential impact of currency exchange rates and anticipated mix, we expect that our first-quarter gross margins on a non-GAAP basis will be around 40% due to a continued higher mix of international business. We expect that non-GAAP operating expenses for quarter one of 2019 will be in the range of $59 million to $60 million for organic ADTRAN and in the range of $2 million to $3 million incremental million for SmartRG.

Finally, we anticipate the consolidated tax rate for the first quarter of 2019 on a non-GAAP basis will be a benefit of approximately 15%. We believe the significant factors impacting revenue and earnings realized in 2019 will be the following: Macro spending environment for the carriers and enterprises; currency exchange rate movements; the variability of mix and revenue associated with project rollouts; the proportion of international revenues relative to total revenues; professional services activity levels, both domestic and international; the timing of revenue related to the connect America fund projects; the adoption rate of our broadband access platforms; and inventory fluctuations in our distribution channels. Additional financial information is available at ADTRAN's Investor Relations website by going to www.adtran.com and following the investor relations link. With that, I'll now turn the call back over to Tom.

Tom Stanton -- Chief Executive Officer

Thanks, Roger. I think it was unclear. The revenue guidance was $140 million to $142 million. OK.

With that, Aaron, we're ready to open it up for call -- for any questions.

Operator

[Operator instructions] And we can take our first question from Rod Hall with Goldman Sachs. Your line is open.

Ashwin Kesireddy -- Goldman Sachs -- Analyst

Yes, hi. Thank you for taking my question. This is Ashwin on behalf of Rod. Tom, I wanted to ask about the situation and the impact from government shutdown and how are you thinking about that in the guidance.

And I have a follow-up.

Tom Stanton -- Chief Executive Officer

Well, yes. I mean, the government shutdown is something that I think, to the extent that it goes on, will have ramifications that are ultimately going to be end-user driven if we don't start doing something, but having said that, we're -- in relation to CAF, the portion of -- the largest portion that we're connected with is actually not under the shutdown piece. So the payment schedules and things associated with the work that's being done right now is not materially affected by the shutdown. For some of the newer dollars, like some of the Tier three stuff that is relatively new, where they're putting in architecture plans and future designs, so let's say, for a year out, I think that work has been affected.

But for the work that we're expecting this year, we don't see any big impact.

Ashwin Kesireddy -- Goldman Sachs -- Analyst

Thank you. And regarding your comments about the U.S. Tier one sales increase in Q4, is it the same carrier that caused the weakness in rest of 2018? Did you see some spending come back there? Or are you talking about...

Tom Stanton -- Chief Executive Officer

Yes. We did see a pickup there.

Ashwin Kesireddy -- Goldman Sachs -- Analyst

OK. Finally, on the international business. Looks like for full-year 2018, international was about 45%, 46% of total revenue. Just curious how you are thinking about that going forward? And is there a level at which it could settle as percentage of your overall revenue?

Tom Stanton -- Chief Executive Officer

I don't envision it settling. I mean, I think it's always going to be dependent upon which projects are going on in the U.S. versus outside of the U.S. We have pretty good project flow right now outside of U.S.

We have -- I mentioned one of the carriers in Europe, we've actually picked up several carriers over the second half of last year. Most of those are tier two carriers. But there are -- well, obviously, I may have mentioned this on the last call, quite a few RFPs that are out right now with tier one carriers, all looking for 10-gig services. And that's actually -- I mentioned some activity here in the U.S.

I would tell you the carriers in Europe are typically larger carriers. They're tier one carriers that are looking what they're going to -- how they're going to deploy 10-gig. So I can't -- that's just going to be dependent on a year-by-year and in some instances, quarter-by-quarter basis on how the revenue flows and the projects come in.

Operator

And we will take our next question from Paul Silverstein with Cowen and Company. Your line is now open.

Paul Silverstein -- Cowen and Company -- Analyst

Yes, I have four questions but [Inaudible]. First off, Roger, can you just repeat what the SmartRG contribution was?

Roger Shannon -- Chief Financial Officer

For the one month that we had of consolidated in Q4 is approximately $3 million revenue.

Paul Silverstein -- Cowen and Company -- Analyst

Thank you. With respect to gross margin, any change in pricing is the -- somewhat soft, the softness is that just reflective of the geographic mix? And what are your expectations to go throughout the year?

Tom Stanton -- Chief Executive Officer

If you look at U.S. gross margins versus international gross margins, there's really no material change there. So some of that is going to be mix driven. We do, this year, expect geography outside of the U.S.

to shift a little bit. So I think we're going to see a little more strength out of Latin America than what we have seen over the last couple of years. As you know, they'd been through kind of a regulatory hold, which seems to have unlocked. So I think you'll see some shift there.

Those gross margins are being negotiated as we speak. So right now I would just say it's going to follow the trend. We would expect the U.S. to pick up some as it typically does seasonally through the year and then international, there's just a lot of activity.

Our thought of the trends of being in the kind of low to mid-40s, which is kind of where we've been, this really hasn't materially changed in our projections for the year.

Paul Silverstein -- Cowen and Company -- Analyst

Got it. And Tom, just to be clear, you're not -- you haven't seen a change in pricing versus historical change?

Tom Stanton -- Chief Executive Officer

No, I have not.

Paul Silverstein -- Cowen and Company -- Analyst

All right. The Latin America strength you saw, was that your historical customer in Mexico that waxes and wanes over the past many years? Or is there some new business you picked up?

Tom Stanton -- Chief Executive Officer

The material piece for this year will probably be that same customer.

Paul Silverstein -- Cowen and Company -- Analyst

All right. If I may, one last question. In terms of those big projects, Tom, the incremental above and beyond the NBN, AT&T, et cetera, can you give a little bit more insight, how many large tier one RFPs are out there right now? Are these a function of last 90 days or have they been out there for the past six to twelve months? How does it compare to six to twelve months ago? And do you have any sense for the timing of the awards, putting aside whether or not you win?

Tom Stanton -- Chief Executive Officer

Yes. I mean, let me answer this in a way that doesn't -- that's clear. The -- so as far as they're in the last 90 days, not all of them are in. All of them are expected, let's say, within the next 90 days.

So if you look at that 6-month window, that's the right way to look at them. Some of them are -- they many times tell you what date the RFPs are going to come out. It's somewhere between -- let me think, somewhere between five and ten.

Paul Silverstein -- Cowen and Company -- Analyst

Given that they're tier ones, are these typically $100 million-plus type opportunities?

Tom Stanton -- Chief Executive Officer

Not necessarily in one year, but in aggregate, for a particular carrier, yes.

Paul Silverstein -- Cowen and Company -- Analyst

All right. I appreciate it. I'll pass it along.

Tom Stanton -- Chief Executive Officer

And Paul, let me just tell you, we haven't necessarily won those yet. So just -- and I know you mentioned that. But I'm not at all saying that we're going to win every one of them.

Paul Silverstein -- Cowen and Company -- Analyst

Understood. Good luck.

Operator

And we will take our next question from Rich Valera with Needham and Company. Your line is now open.

Rich Valera -- Needham & Company -- Analyst

Thank you. Just a follow-up on the SmartRG. I understand, you got $3 million for the month you had it in the fourth quarter. Do we just sort of linearize that for the first quarter? Or you want to give us some more specific contribution you're expecting for SmartRG in the first quarter?

Tom Stanton -- Chief Executive Officer

I don't think you'll see it linear in the first quarter. I think we still were -- we're trying to understand their seasonal pattern. So it would be -- if you just linearize it, that'd be 9. We don't expect nine out of it and we've given it a fairly broad window.

But on a going-forward basis, let's say, and I'm just going to pick a quarter of saying, second quarter, if we expect the run rate to be -- that shouldn't be an atypical run rate. So if you think about something less than nine Q1 and then it ramping to a nine-ish number, I think, that's the way we think about it.

Rich Valera -- Needham & Company -- Analyst

Got it. That -- that's helpful. And can you just say what their historical gross margins have been?

Tom Stanton -- Chief Executive Officer

We really -- I don't think we've really dissected that enough because I know you're going to take that as the number going forward. We also do think that there's some improvement in adding our supply chain to it. So we're not really at a point yet to be kind of speaking about that yet.

Rich Valera -- Needham & Company -- Analyst

Fair enough. So the Latin American development sounds pretty significant. If I recall, it's been about two years, I believe, since you had any revenue since that big tier one down there. What are your thoughts on the potential for that this year? Is this something where you think they're kind of ramped back up and this can be a significant contributor for the balance of this year and beyond? How can we think about them relative to their historical run rates?

Tom Stanton -- Chief Executive Officer

So they typically -- you've followed us for a while, they typically bind in chunks that are fairly large and they deliver over a period of time. And then there's typically work on the services side associated with that. And I'd say the pattern seems similar to that, yet we would expect them to be material this year at this point in time. That is not the easiest customer to forecast and they're very demanding on when they do actually decide if they want to do something, so it typically accelerates supply chains and things.

But the direct answer to your question is, we expect them to be a meaningful contributor this year.

Rich Valera -- Needham & Company -- Analyst

Got it. That's helpful. And then you provided some growth statistics from your MSO customers. Pretty impressive year-over-year growth for the MSO group in 4Q.

And it sounds like you have some pretty good momentum into '19 with that group, with your -- I guess, presumably, but mostly with the EPON products. Anything you can say about the expectations for that business in '19 relative to '18?

Tom Stanton -- Chief Executive Officer

We expect it to grow. I don't think we're going to see the same growth rate. Some of that was acquired businesses when we acquired -- when we initially acquired the CommScope piece and then we acquired the Sumitomo piece. And there's just -- it happens to coincide with the growth in what their EPON business, it happens because we expected it to coincide with growth in their EPON business.

We have projects with the two major MSOs here in the U.S, where we are in the lab getting some new products approved that we think will meaningfully open up the EPON business. Those are coming and will get through the pipeline this year. In the meantime, and the largest one of those were the sole source supplier, which is a good place to be as they continue to try to enhance their EPON deployments. So we would expect that business to grow this year.

Rich Valera -- Needham & Company -- Analyst

Got it. And one final one for me. Can you give us an update on the Verizon PON opportunity? I think last time we talked, you were fairly optimistic that you would get qualified for at least one of their use cases, I believe, the low-cost Internet within perhaps early this year. Anything you can provide us by way of update on that opportunity?

Tom Stanton -- Chief Executive Officer

We are still in the lab and still working with them. We -- that's probably all I want to say, right? They are -- we have target on a specific use case as the first piece to get out of the lab and we're still working through that. So really no change there.

Operator

And we will take our next question from George Notter with Jefferies. Your line is now open.

George Notter -- Jefferies & Company -- Analyst

Hi, guys. Thanks very much. I guess, I wanted to go back to the SmartRG acquisition. So I guess, mostly, it looks like it would be annualizing at $35 million in top line.

I think you paid from the cash flow around $15 million in change for that. I guess I'm wondering if that business is profitable? Is it accretive? Can you talk about the profitability or lack of profitability that would come with SmartRG? Just what does that look like? And then also I wanted to ask [Inaudible] -- go ahead, sorry.

Tom Stanton -- Chief Executive Officer

Just to answer that question, we expect it to be profitable this year, yes. And it was profitable when we bought it.

George Notter -- Jefferies & Company -- Analyst

OK, great. And then I'm just curious about the use case on SmartRG. I mean, I heard what you said in terms of trying to create new service offerings in homes. Can you just talk about specific examples of what you might offer to broadband users in that case? And how you'd sell it in conjunction with the existing portfolio? Thanks.

Tom Stanton -- Chief Executive Officer

So it's actually a good fit with our existing portfolio. And it -- for probably the piece that we're the most excited about is the potential for virtualization of the software itself, which we've been working on here. They're a big add to that. So first of all, they have a whole suite of residential require services, including land management, kind of, land and WAN management with inside the home, customer portal access, additional service capability being on it as an application widget.

So they have a lot of these things that are already in the cloud and they had been in the midst of converting their customer base toward those. They have Tier one customers not just here in the U.S. But around the world, actually including some of our customers. So this energy on the CPE side of that.

And the virtualization side is probably the biggest thing. It's a nice -- it's a suite of services that we have been working on to add into our Mosaic cloud for some time. This not only accelerates that, but in areas where somebody does not want to buy Mosaic cloud, allows us to have a stand-alone virtualized cloud-based offering that we just don't have today. And the demand, as you know probably as much as anybody, George, is there, not just in the tier ones, but in the tier threes as well, where they're looking to, kind of, compete on a service-level basis with the larger carriers.

And it materially helps on their maintenance and troubleshooting and everything else when somebody says their Wi-Fi doesn't work.

George Notter -- Jefferies & Company -- Analyst

Great. Thank you very much.

Operator

And we will take our next question from Michael Genovese with MKM Partners. Your line is now open.

Michael Genovese -- MKM Partners -- Analyst

Yes, thanks very much. First of all, I think the guide for the quarter seems much more narrow and much more specific than what you guys have given in the past. So is this just sort of a change in the way you plan to give guidance? Or is the visibility somehow actually different this quarter?

Tom Stanton -- Chief Executive Officer

Yes. We -- our guide tends to really -- like it was fairly wide last quarter and that is literally visibility. So if we feel that the number has a wide range to it, then we tend to give ourselves latitude to that. And when we don't, we don't.

So that's almost directly dependent upon the visibility you have within a quarter.

Michael Genovese -- MKM Partners -- Analyst

OK. Great. And then -- so from the GM guidance from the commentary, I mean, as I think about the move from 4Q to 1Q and major regions and major customers, can you just sort of highlight for me any big changes that you're expecting because it sounds like it's fairly consistent. I'm not really seeing big regional or customer changes in your outlook.

And so am I missing anything there?

Tom Stanton -- Chief Executive Officer

I haven't exactly put it in my head to what are you thinking about. So it's a very logical question. Let me just give you regions. We'd expect LAT AM to be pretty strong.

We'd expect Europe to be moderately strong, they tend to grow from Q1 to Q2. U.S. typically starts out a little slow because there are budgets that have to get approved. And those budgets, for instance, last year, was a very slow budget cycle.

So we'd expect the U.S. to be a little bit slower coming out. So if anything, you may expect a little bit more shift toward Europe -- and I mean not Europe, excuse me, international, although NBN had a pretty strong Q4. So I think the way you're thinking, which is not big shifts, although there are customers' shifts, but on a regional basis, not material shifts.

That's probably not a bad way to think about it.

Michael Genovese -- MKM Partners -- Analyst

Great. Very, very helpful. And a couple of more here. Just in terms -- can you give us a -- let me back up here -- gross margins, when we are going to have a better, sort of, U.S.

mix? Would you expect that in 2Q and 3Q of this year? Is it too early to tell? And how many points of gross margin -- I know you're not giving 2Q, 3Q guidance yet, but how should we think about the gross margin for the next two quarters after this one?

Tom Stanton -- Chief Executive Officer

It's a -- I can give you trends and trends are exactly right. Q2, Q3 are up from a mix perspective in the U.S., depending on what happens in Europe. Sometimes, Europe overcomes that. In the case today, we would expect 2Q and Q3 U.S.

revenue to be up, but we have also now a Latin America component that may -- that we'll figure in. And as you know, we're -- I just mentioned, we're kind of working through those numbers with that customer as we speak. So I -- it's -- I -- you know the mix that we're dealing with, so it really depends on how that comes out. To the extent that international is a higher component in Q2 and Q3, then typically you would expect it actually to follow a revenue trend that would be positive.

Michael Genovese -- MKM Partners -- Analyst

OK, great. And then one final one for me and then I'll pass it on. Just in terms that -- can you give us an update on the NG-PON2 and 5G? Could that be revenues in 2019? Or is that going to be more of a 2020? How does that look?

Tom Stanton -- Chief Executive Officer

I don't know about 5G specifically. That one's -- that one puts a little question mark, but as far as NG-PON2 revenue in this year, the answer to that is yes.

Michael Genovese -- MKM Partners -- Analyst

OK. Thanks so much, Tom. Appreciate all the questions.

Tom Stanton -- Chief Executive Officer

OK.

Operator

And we will take our next question from Bill Dezellem with Tieton Capital. Your line is now open.

Bill Dezellem -- Tieton Capital Management -- Analyst

Thank you. I'd actually like to follow-up on the SmartRG question. I mean, essentially, you're saying that one plus one is greater than two. And the question I have is, what's the timing before that becomes apparent to those of us on the outside?

Tom Stanton -- Chief Executive Officer

Well, I just -- we just talked about a target number for revenue, which was kind of this $9 million. I think there are things that we add to. So I mentioned a little bit about the portfolio and [Inaudible] capability. Of course, the thing that we add to this acquisition for scale and manufacturing and probably more importantly, scaling customer basin and access to customers.

So we know that we are actively involved in deals today that the stand-alone company would not have been involved in a material number of deals actually, but the company alone would not have been able to come in to. So to the extent we able -- were able to increase that $9 million run rate to something materially above $9 million, I would say, that's where you'll see it. And I'm just -- I'm not at this point, I know you're wanting to hear, but at this point, I'd like to be a little conservative on how we actually do this until we have -- it's a very new acquisition, right? It was 1.5 month ago. We're just now getting into customer discussions of meaningful depth on the technology side to make sure that there aren't any gaps.

So that's a little early. We're pretty confident with the $9 million run rate number, but it's a little early to talk about upside on that number.

Bill Dezellem -- Tieton Capital Management -- Analyst

Great. Thank you. And then let me switch, if I may, to Latin America. It has been some time since that region has had the strength that you're experiencing this quarter.

What has driven that shift? What's your sense there?

Tom Stanton -- Chief Executive Officer

I think it is -- it has been on regulatory freeze for over two years now. And I think it's just a matter of that being over with and a strong desire to increase the broadband access capabilities within that country, which is not a bad thing.

Bill Dezellem -- Tieton Capital Management -- Analyst

Got it. And then lastly, there's been lots of conversations since your last conference call about Huawei. Talk to us, if you would, please, but the implications of this additional commentary and if you're seeing any benefit. And if so, what part of the globe is it -- is that benefit appearing to be most prominent or the greatest potential?

Tom Stanton -- Chief Executive Officer

So Europe and the Americas. More specifically, North America. And yes, it has been beneficial. I mentioned that there were a string of RFPs that have been coming out.

It is a -- from a requirement for new technology in the network, timing wise and the visibility that is being shed on what has been happening in the market, I think the timing is perfect. And probably -- and we are absolutely seeing a change in mindset because of that. So I think it's a positive thing for us.

Bill Dezellem -- Tieton Capital Management -- Analyst

Great. Thank you. And we'll look forward to you winning that two or...

Tom Stanton -- Chief Executive Officer

And with that...

Bill Dezellem -- Tieton Capital Management -- Analyst

Go ahead.

Tom Stanton -- Chief Executive Officer

I was about to put an end to it. But go ahead, please.

Bill Dezellem -- Tieton Capital Management -- Analyst

I was just going to say we look forward to you winning two or three additional deals that they would have otherwise won.

Tom Stanton -- Chief Executive Officer

Go ahead. Hello?

Operator

And pardon the interruption.

Tom Stanton -- Chief Executive Officer

Go ahead. I think we have another caller.

Operator

Certainly. We will take our next question from Fahad Najam with Cowen. Your line is open.

Fahad Najam -- Cowen and Company -- Analyst

Thank you for squeezing me in. I wanted to ask you a big picture question. Well at the start of the year, what are you most excited about for '19? And what are you most concerned about? What are the things that are in your outlook for '19?

Tom Stanton -- Chief Executive Officer

Honestly, what I'm excited about, so what I'm excited about is the -- and the problem is it doesn't necessarily effect '19, it's a longer-term outlook. What I'm the most excited about is the number of customers that are actively pursuing, upgrading their network. It has never been bigger than what we have seen. Now it is, there are some in the U.S.

and some of those carriers, they're working out their capital budgets and their capital constraints and it's kind of less deterministic as to when those things will actually break free. But in Europe, there -- it's just -- it's a very strong level of engagement. And if I think about what that means for our longer-term future and us being able to kind of break out of a customer base that is small enough to where it leads to material volatility from time to time, I get very excited about that. So I like that.

I like where we are in the MSO space a lot. And this all has to do, again, with customer diversifications and we have never had material revenues coming out of the MSO space in over the last year and a half, although it's been clouded by the big downturn we had of our customer in the U.S. We have done a fantastic job of aggregating technologies and building relationships within the MSO space. And that is going to pay for meaningful returns over the years in the future.

So that's really the thing I'm the most excited about. If you look at it from just a 2019-specific thing, then it is -- it's the fact that we have lended some customers in Europe that will materially bring us -- in aggregate, materially bring us revenue in 2019, as well as the fact that the Latin American market has been frozen for some period of time. And it seems to be in a quick defrost. So those are things that kind of effect this year more than other things.

But my, the thing that I'm most excited about is really the longer-term prospects. What I worry about, is what I always worry about, which is we still have a very -- a relatively definitive set of customers that can materially move the needle. And that leads to pain and it's very hard to forecast when that happens. So that's the thing that keeps me up.

And we try to -- when we fall into a hole like that, we do the best we can. On picking ourselves up and making sure that we're ready to continue on and continue to execute our plan, but that is a diversion when that happens. It's more than a diversion. And it's very difficult for our shareholders as well.

So we're doing what we can do. But that takes time as far as diversification. Right, with that that concludes our call. I appreciate everybody for joining us today.

And we look forward to talking to you next quarter.

Operator

[Operator signoff]

Duration: 52 minutes

Call Participants:

Tom Stanton -- Chief Executive Officer

Roger Shannon -- Chief Financial Officer

Ashwin Kesireddy -- Goldman Sachs -- Analyst

Paul Silverstein -- Cowen and Company -- Analyst

Rich Valera -- Needham & Company -- Analyst

George Notter -- Jefferies & Company -- Analyst

Michael Genovese -- MKM Partners -- Analyst

Bill Dezellem -- Tieton Capital Management -- Analyst

Fahad Najam -- Cowen and Company -- Analyst

More ADTN analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.