Avnet - Q4 2019

Transcript

Operator (participant)

I would now like to turn the floor over to Joseph, Investor Relations at Avnet.

Joe Burke (Head of Investor Relations)

Thank you, operator. Earlier this afternoon, Avnet released financial fourth quarter of 2019. The release is available on the Investor Relations section of the company's website. A copy of the slide presentation that will accompany today's remarks via the link in the earnings release, as well as on the IR section of Avnet's website. All information contained in the news release and on this conference call contains forward-looking statements that involve risks and assumptions that are difficult to predict. Such are not the guarantee of performance, and the company's actual results could differ materially from those statements. Several factors that could cause or contribute to such differences are described in detail in Forms 10-Q and 10-K, and subsequent filings with the SEC.

These forward only as of the date of this presentation and the obligation to publicly update any forward-looking statement or supply new information regarding this after the date of this presentation. Today's call will be led by Bill Amelio, Chief Executive Officer, and Tom Liguori, Avnet's Chief Financial Officer. Also, Phil Gallagher, Electronic Components, joins us to do Q&A session. With that, let me turn the call over to Bill Amelio. Bill?

Bill Amelio (CEO)

Thanks, everyone, for joining us for our fourth quarter and fiscal year 2019 earnings call. At our fiscal fourth quarter, we delivered sales of $4.7 billion. This was a midpoint we provided to investors in April. We closed our sales growth at 3%, despite the deceleration we saw in the second half of our fiscal 2019. Since April, companies across the industry have seen signs of slowing due to macroeconomic headwinds and tariffs. Avnet was no exception. We remain agile as market, and we acted quickly to accelerate cost reduction programs that were already part of our long-term plan. By taking these swift actions, we met our commitment to keep SG&A expenses on a down. Year-over-year, spending was down meaningfully, and we remain spending and our investment priority.

Pricing and margin pressures certainly were greater than anticipated due to multiple factors. These include the shortening of lead time and reduced average selling prices, or ASP. This occurred at Farnell, which happens when supply rebounds and demand moves back to broadline distributors. Pricing pressures felt broadly across the catalog space in a down market. Based on our supplier and our outside analyst checks, Farnell's decline was equal to market. Assuming working conditions improve, we see a clear path to achieving Farnell's 15% operating margin. Now I'll talk about... Let me first finish reviewing some of the key metrics. Avnet's adjusted operating income fiscal quarter was 3.3%. This is down from 3.6% a year ago, to 0.8% in the March 2019 quarter.

A quarter of strong, positive cash flow from operations at $335 million, and this was on the heels of paying cash flow of $269 million we recorded in the March quarter. Overall, our performance, regardless of market fluctuations, our ecosystem strategy and the plan we presented at 2018 Investor Day, remains the right course for the company. We are building on our core expertise, component distribution, supply chain and logistics, plus expanded the new market opportunity for solutions where the higher margins reside. This plan will enable us to return value to our shareholders and capitalize on several important trends, AI, artificial intelligence, and 5G. Now I'll provide updates on our core elements of our strategy. They encompass amplifying our distribution business, scaling higher margins, extending digital capabilities, leveraging our ecosystem for growth, and driving continuous improvement.

Let me start with the results of our Electronic Components business. For the fourth quarter, our Electronic Components sales of $4.3 billion. What's notable here is that this business unit held fairly steady at 3.3%, despite a 7.1% sales decline from a year ago. Over the course of this past year, the Avnet Integrated business, which is reflected in the Electronic Components, improved its mix of customers. We expect that when Avnet Integrated completes the transformation activity, margin gains as well. As you may know, their primary focus forward solutions, displays, and data center solutions. When we look at their pipeline, the margins are higher than in our Electronic Components business. It's this progress that will build up 2020 and beyond. Now let me break down our fourth quarter for Electronic Components.

The Americas continue to gain momentum as a bright spot for the quarter. The Americas electronics sales sequentially. Year-over-year, they achieve growth and demand creation, design win dollars. They also continue to gain market share. The quarter significant increase in Americas Net Promoter Score, clearly indicating customer satisfaction remains on the rise. Conditions. The Americas exited Q4 with a book-to-bill. Turning to EMEA. Europe, in particular, saw market factors take their toll. They have book-to-bill. It remains below parity. For the year, EMEA IP&E segment saw faster growth and finished ahead of target. We believe IP&E remains an underpenetrated, high-margin opportunity, at even a more accelerated pace than last year. Recognizing that ASP pricing pressure. This past quarter, our EMEA team strong growth for our suppliers in Q4 and received more than 20 awards as a result.

In Asia, originally, but down from a year ago. The inventory correction that started in Asia and worked its way across other geographies. Book-to-bill in the region ended the quarter below parity, was hard hit by market decline. In addition, demand shifted from the high service catalog business as their inventory stabilized. Fourth quarter sales in Farnell were $343.5, up 0.5% sequentially, and down 12% from a year ago. Discussions with outside analysts and our suppliers. Revenue and pricing pressure was felt broadly across the catalog space. Pricing pressure correlated into lower margins. Farnell saw a decline in certain products in IP&E, especially passives. We expect the pricing pressure to persist through the end into 2020. Farnell sales benefited from the launch of new Raspberry Pi 4 Model B computer. This is the Raspberry Pi model ever made.

Farnell continues to be the largest licensed distributor of Raspberry Pi. Our exclusive customization agreement allows us to develop the Avnet Smart IoT Gateway. Interest in this secure industry, and it has applications in vehicle monitoring, building automation, predictive maintenance, and smart factory. Successful launch reinforces Farnell's position as the market leader in Raspberry Pi. It's a testament to the strong Farnell and the Raspberry Pi Foundation. Farnell added 159,000 SKUs to its website, while also adding three new suppliers. E-commerce global order penetration also rose for the eleventh consecutive month. E-commerce represents 70% of all Farnell orders. Our new warehouse in Leeds is expected to come online. This will enable us to reduce costs, dramatically increase our SKU count, and improve service. Turns around, we will be able to capture market share, due in part to the increase in SKU count.

Our optimization programs will deliver margin improvement. We're really pleased with the opportunity Farnell has created for us in the catalog space, and we believe Farnell is well-positioned to grow. Next, I'll take a few minutes to cover our digital transformation. Deploying our digital capabilities this year was critical to driving growth and, of course, efficiency. For example, we released 53 robotic process automation projects in IT. We're now in the process of launching our artificial intelligence pricing tool, Vendavo, with Salesforce in the Americas and in Asia Pacific. Europe will come online later this summer. At the same time, Marketo, our marketing automation tool, has thousands of leads and millions of dollars in revenue, and it's still in its early stages.

Combining these 360-degree view of our customers worldwide and have led us to 20,000 leads being shared in our electronic components business in the fourth quarter alone. We also continue to get better demand creation category versus the fulfillment category of Avnet. Now, let's turn to how we are leveraging our ecosystem that stands up both existing and new types of customers. As the larger technology trends around data-driven economy takes, is well positioned to add value as an end-to-end solutions provider. In IoT, we help customers unite the device, gateway, network, cloud, analytics, and insights in a seamless way. This is great to help customers achieve their business objectives and create -- opportunities are expanding within our existing customer base, too, as we focus on the connected.

Here, we're helping customers add new connected technologies to their existing equipment in such industrial and manufacturing settings. We closed the year with approximately $70 million of sales in IoT. This includes end-to-end solutions that encompass device, software, security, and cloud applications. It does not include device or component sales. Our three-year IoT reached $630 million. In a market with a TAM that exceeds $150 billion today and it is growing, this demonstrates the scale of this high-margin business. Our strategic partnership with Microsoft is an important strategy. It continues to deliver customer opportunities. We're seeing strong pickup since we started thousands of seed units of our Azure Sphere. Azure Sphere Kit support rapid prototyping of highly secured end-to-end IoT And finally, I'll provide an update on our continuous drive to operational excellence.

We're continuing to mine the data we now are able to collect, given our increased level of transparency and insight. This improves our visibility and lays the foundation for driving excellence across Avnet operations. Avnet's performance by vertical for the fourth fiscal quarter, we opportunities in retail, healthcare, specifically in medical devices. Signals continue to be positive for defense. Industrial and automotive are among the verticals that were hardest market slowdown began, and we first saw this in Asia. These verticals were further impacted, seen more recently in Europe. As for how macroeconomics will play out, as I indicated, we believe this through the end of calendar year 2019 and potentially into 2020.

Some of the key indicators gauge whether the market has turned the corner include: inventory gets worked through the channel, any pickup in demand in Europe and in China, and momentum industrial vertical. Regardless of what the market does, we're focused on the areas that are within our control. We made plans to put in place and navigate through the challenges ahead of us, and we'll continue to be agile on the front that arrive. There is significant opportunity ahead for Avnet, and we are committed to our long-term strength, a great customer experience, improved execution, and growing growth targets. This includes our long-term target to achieve 4.5%-5% operating income. With that, I'll let Tom give you more details on the financial benefits of the actions that we're taking and how we have put in place pay off significantly when the market.

Tom Liguori (CFO)

Thank you, Bill, and good afternoon, everyone. This quarter, we effectively managed those variables well by responding to shifting market dynamics with well-executed strategies and continued. We were disciplined in our efforts to control costs and improve cash flow, while product and customer demand impacted by external factors. Let me take you through our key metrics for the quarter on slide 4 and discuss in more detail how our fourth quarter operating more affected and the actions we took to mitigate those impacts. We delivered revenue $ billion, in line with our guidance. This was down 7.5% from a year ago, and % from the prior quarter. Gross margin declined 30 basis points year-over-year to 12%, predominantly due to lower sales and margins in Farnell. We continued our focus on managing with SG&A expenses, declining to $40.6 million.

Our tax rate improved to 18.9% in the quarter to 20.5%. We continue to opportunistically repurchase shares at attractive valuations. End of fiscal year nineteen, with diluted shares of 160 million, down from 118 million a year ago. Adjusted earnings per share totaled $0.95, a decline year-over-year, reflecting the items just discussed. Turning to business performance, starting with Farnell. Revenues in year-over-year to $343.5 million. With inventory and lead time stable for past, the market demand shifted from catalog distributors, including Farnell, back to high-volume distributors. So price erosion during the quarter as well. Farnell operating income decreased 12.4%, predominantly due to the decline in passives. Q4 Farnell operating margins were 9.7%. More on Farnell later in this discussion.

Electronic components results were fairly solid in a slowing demand environment. Revenues at $4.3 billion and operating margins came in at 3.3%. Year on electronic components, revenues were down 7%, and the 3.3% were within 20 basis points of the prior year. While we see revenue year, stable gross margins, coupled with lower SG&A costs and an improved, helped stabilize operating margins close to prior year. Sales for Avnet by region were as follows: Asia, which first saw the macro order, show signs of stabilizing, as revenues were up sequentially by 7% to $1 billion, but still 8.5% lower than the. EMEA revenues of $1.6 billion, was down sequentially 5.9% expected in our guidance, and 7.9% lower than a year ago.

Americas, $1.27 billion, was down 2.4% sequentially and 5.4%, so the Americas EC business managed to expand operating margins with an increasing growth and good leveraging of expenses compared to the prior year. We ended the quarter with a book-to-bill of 0.92. By region, with above parity at 1.01, EMEA was 0.82, and Asia finished at 0.2. Turning to the balance sheet and cash flow statement on slide 16, [cash flow from] operations in the quarter was $335 million, bringing our total for the last six months million. We returned $138 million in Q4, comprised of $117 million in buyback and $21 million in- We recorded a goodwill impairment totaling $137 million.

This was related to Avnet's operating group and was driven by the economic environment and outlook. The impairment is related to acquisitions prior to 2013. During Q4, we reduced revolving debt by $354 million and ended the quarter with a net debt and a net debt leverage ratio of 4. Our solid capital structure positions us well to continue our capital allocation of buyback, dividends, M&A, and other strategic investments. Let's discuss our management focus for the coming months in light of the macro slowdown. First, Farnell. Well, in the near term, we are seeing market pressures and anticipate operating margins below 10%. 10% operating margins is achievable. On the cost side, our teams are integrating Farnell, as well as transitioning to lower cost geographies, with a roadmap to achieve an additional plus of annual savings.

This quarter, Farnell is moving approximately 100 roles to our service operations, as well as streamlining headcount. Our new distribution center is scheduled to ramp operations this fiscal year 2020. This will enable us to continue expanding the number of SKUs offered by close to 20 million per year. The capital investment for the distribution center. We anticipate another investment in Farnell over the next 18-24 months for SKU expansion. This 159,000 SKUs Bill mentioned being added in Q4. For comparison, we added $60 million of inventory in Farnell, which has been included in our financial. While these cost efforts are underway, it's important to know that we are continuing our investments in pricing and quoting tools, targeted marketing spend, plus improvements. To fully achieve the 15% operating margin target, we want and pricing across the catalog industry to stabilize.

For the broader Avnet, we remain focused on three key aspects of our financial strategy: optimizing costs, generating cash flow for buyback, and minimizing taxes. Team, you can see our progress to our three-year goals. Optimizing costs has been a key part of our three grow operating margins in EPS. Times our OpEx roadmap for savings of $245 million. We've made good progress. Year 2019, we reduced our operating expenses by $117 million compared to fiscal year 2018. It's important to know these are net bottom line, taking into account the additional expenses for investments we made in engineering, design tools, IoT staffing, SaaS-based pricing and CRM tools, and more. Managing costs is that we are disciplined in reducing OpEx. We reinvest part of the savings back into the company for growth.... and we assure a portion of the savings structure.

Our Q4 operating expenses of $460 million represent an annual run rate $8 billion, which is favorable to our three-year target. Due to the macro slowdown, we are pulling forward $50 million of cost reduction actions in the $245 million plan. We anticipate these will be implemented in Q1, within Q2 and Q3. Next, cash flows. We reduced working capital $100 million in the last six months and generated over $600 million of cash flow, or with opportunistic buybacks. As a reduced share count is now 106 million shares, a 10% year-over-year reduction, at below 100 million shares in the coming quarters. Taxes, our fiscal year 2018 was 23%, and at Investor Day, we explained our goal to reduce our 20% over three years by this operation.

We ended this fiscal year at 20.5%, well on our way. While we anticipate some level of fluctuating tax rate, we remain confident in being able to achieve a tax rate in the high teens. Turning to Q1 fiscal year 2020, on slide 9, our guidance reflects the fourth quarter of expected continued headwinds. Compared with our last quarter was later in the quarter. Our conservative approach to macroeconomic factors continues in the range of $4.4 billion, and adjusted EPS in the range of $0.60-$0.70. While we see all geographies, our guidance today reflects a sequential decline in Americas and EMEA, just stable, and continued revenue in our Asia businesses. In summary, we continue to manage the factors that are within our control: working capital, cash flow, and buyback.

We believe the actions we are taking will make us financially stronger when the demand environment improves. With that, let's open the operator.

Operator (participant)

Thank you. Ladies and gentlemen, we will question and answer session. If you please press star one on your telephone keypad. A confirmation tone will indicate that your line. You may press star two if you would like to remove your question from the participant using speaker equipment. It may be necessary before pressing the star key. One moment while we pull for questions. Please limit yourself question and one follow-up. Thank you. Our first question comes from Param Singh with Bank of America. Your question?

Param Singh (Associate Research Analyst)

Hi, thank you for taking my question. Just wanted to first dive into your guidance and how you, you know, your EPS guidance, in particular, why that is, you know, flat on a sequentially flat revenue guide, you would probably have to see a significant marketing margin and possibly even Premier. Maybe you could help me bridge the gap up.

Bill Amelio (CEO)

Sure, Param, I'll take it first. So what we saw in the back half of the quarter was a falloff in the kind of lead times are coming in, and then there's a migration, as I pointed out in my remarks, from base back to the broad line guide, which affects our margin because the mix then changes between Farnell and the core. Our core held with respect to margin. So in the next quarter guidance, what you'll see is a full quarter of Farnell that we saw at the end of this quarter, and that explains the majority of why the guide's down the way it is. Tom?

Tom Liguori (CFO)

I must say hi, Param. You know, demand softened throughout the quarter and pricing softened throughout, pricing it was, you know, somewhat across, notably in passives. So what you're seeing from Q4 to Q1 is, fact of what we saw.

Param Singh (Associate Research Analyst)

So, I'm sorry, before my follow-up, just to assume that EM margin marginally year over year, that would imply a significant falloff in Premier Farnell margins, probably even lower to when, unless my math is off. And then I also wanted to have a follow-up after that.

Tom Liguori (CFO)

Yes. So Farnell figure in the 7%-10% range, so still high them, but most likely down sequentially from our-

Bill Amelio (CEO)

And most importantly, you know, we see this as a temporary thing. As the market rebounds again, we're positioned well to be able to play heavily in the upside. And we also did channel checks with what's happening with our... This is not a phenomena that's Farnell only. This is our catalog space. Each of the catalog players also significantly declined quarter-over-quarter, the particular slowdown that we're seeing. And as the market rebounds back, which is looking like something towards the end of the year, we'll see this respond well, and as you know, we're putting in our new warehouse, and we will have SKUs. I mentioned us bringing on board a lot, but we plan to bring on even more by the end of the year. It's just in time for when the market rebounds.

Param Singh (Associate Research Analyst)

But, I mean, you know, you had previously alluded to getting towards a 4% margin by the end of the year, so 4, 4.5, 5. Do you think that 4% margin even exiting fiscal 2020 as well? What would be the moving pieces to get those back? You know, what would be the core improvement, particularly the EMEA volume, Premier? Maybe you could help me bridge if that's possible.

Tom Liguori (CFO)

So Param, this is all about, you know, the work we're doing today as the demand picks up. And, you know, that's why the focus on OpEx, working capital, cash. You know, I don't want to put out a time frame because, you know, markets destabilize and pick up to where they were to hit the 4%. But when we, as far as what are we executing to our plan, you know, really what we're missing is the mix because of a lot of this downturn. The good news is, you know, when you do your models, take our, what we're talking about, and I think you'll-

You'll see where we, where we plan to land.

Param Singh (Associate Research Analyst)

Yep. Yeah, absolutely. Thank you so much.

Tom Liguori (CFO)

Thanks.

Operator (participant)

Thank you. Shawn Harrison with Longbow Research, please state your question.

Shawn Harrison (Vice President, and Senior Research Analyst)

Good evening, everybody. I wanted to, not surprisingly, follow up on for now. The margin target, is that required to get back to a similar scenario that was out there in fiscal 2018? Because, you know, pricing and lead times lag very often in semis and passives, and so wondering what type of environment you really need to see a 15% operating margin.

Bill Amelio (CEO)

So if you recall last earnings call, investment plan that we have within Farnell, we still are over the 15%. I think in the near term, it will be back to 12-13 first and then more like 3%-15%. But what we're investing in is more SKUs. That was one of the areas that, if you looked at our other competitors, was because we didn't have the same SKU coverage that they did. So that's going to be fixed as we also invested in some improvements in pricing, our web speed, our infrastructure, which was one of the things that we pointed to when we acquired the company, that we had to start changing, were relatively old.

Finally, we have done a solid piece of work on marketing, so pay per click and how we do SEO more, more efficiently, enabling us to be able to get more traffic on the site, more conversion at higher margin.

Shawn Harrison (Vice President, and Senior Research Analyst)

Okay, and then you pulled forward $50 million of savings. Tom, if you could talk about just what were the savings realized year, and are you or what is the total that you're forecasting for this fiscal year?

Tom Liguori (CFO)

We're still 45 plan in the 50s, part of that 245. You know, we're planning, we should be in the high $100 million by the end of the, by the end of this site to $210 million of the $245 million. We have a number of projects to pull in the $245 million. Help everybody with the model. You know, expect that this quarter flat, slightly up perhaps. You'll see the $50 million reduction in the, and all of it, you know, being in our financials by the March quarter.

Shawn Harrison (Vice President, and Senior Research Analyst)

Should you receive this past fiscal year in savings? Sorry.

Tom Liguori (CFO)

We were down 107 in investment.

Shawn Harrison (Vice President, and Senior Research Analyst)

Okay, thank you.

Operator (participant)

Our next question comes from with Raymond James. Please state your question.

Adam Tindle (Equity Research Analyst)

This is on for Adam. Thanks for taking my question. So I think you mentioned on the call, you expect some of these pricing pressures to under 2019 and into 2020. So should we think about similar levels of negative operating leverage during these accelerated offsets, where negative leverage should begin to be more muted?

Tom Liguori (CFO)

The $50 million of cost reduction will, you know, definitely, you know, improve our OpEx going forward.

Adam Tindle (Equity Research Analyst)

Okay, fair enough. And then, from-

Tom Liguori (CFO)

Does that answer your question, Adam? Did that answer? If not, I'll try to help you.

Adam Tindle (Equity Research Analyst)

Uh, no.

Tom Liguori (CFO)

Adam.

Adam Tindle (Equity Research Analyst)

Over to cash flow, which has actually been fairly several quarters. I know you have generally thought about cash flow as converting greater than 75% of net income, and we should continue to see on a forward basis. And as we think 20, what are the puts and takes to cash flow that you are thinking about?

Tom Liguori (CFO)

Yeah, I, you know, I think the more of what we're doing, you know, we've explained before, our buybacks are based on a pricing, lower the share price, the more we buy back, the higher the share price, the less we buy back. So it'll fluctuate every quarter. You know, we still have, you know, plenty of opportunity for the working capital reduction. We'll contribute to the cash flows going forward on top of our operating income, net income.

Adam Tindle (Equity Research Analyst)

Okay, thanks for taking the questions.

Tom Liguori (CFO)

Thanks, Adam.

Operator (participant)

Our next question comes from Matt Sheerin with Stifel. Please state your question.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Yes, thank you. Just following up on the margins and how they may play out over the next few quarters. It looks like sort of backing the gross margin number. It looks like it's going to be 12s or lower. So it sounds like it's, you know, the ASP and pricing is clearly affecting, you know, both. But I guess the question is, as you look forward for the next, you know, couple quarters, particularly, given that December quarter, at least in your higher margin regions, why should we not expect margin, gross margin, at least for the next few quarters?

Tom Liguori (CFO)

Well, your assumption. You know, I think we were trying to say, Matt, that we expect the softness to continue at least through December. You know, it's hard to predict when it will recover. You know, the gross margin percentage will most likely our current quarter due to pricing. You know, again, so therefore, you know, put into place our metrics that will... And land is in a good place again, but clearly, our margins will be at a, this or lower level for the next quarter.

Bill Amelio (CEO)

Exactly the reason, Matt, that we pulled in some of the OpEx to look for opportunities to do even more.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. And then, I mean, just on that and the OpEx roll through, FY 2020, on an absolute dollar basis, do you expect OpEx or SG&A to be down, like in the $50 million-$80 million range?

Tom Liguori (CFO)

Yes.

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay. And just lastly, your commentary about the more stable demand in Asia, that sounds encouraging, but you're also guiding, I think, kind of stable in Asia, and it's typically up sequentially. So you're tail end of a inventory correction, and would you expect the December quarter to be up this point?

Bill Amelio (CEO)

... Let me let Phil take that one.

Phil Gallagher (President, Electronic Components)

How you doing?

Bill Amelio (CEO)

Hey, Phil.

Phil Gallagher (President, Electronic Components)

Yeah, from as far as Asia goes, we see it. They're not stabilized. There's still so many there. Seasonally, we're actually up in Asia, okay, a bit this quarter, which is tough to call December quarter yet, but we're pretty optimistic about it, again, stabilizing December quarter, which is really tough to call with everything going on. But just talking to our team there the other day, the lower number, okay, you know what we did there in December, and you know what we did down substantially, but doesn't appear to be continuing to fall. And I think it's to Bill stabilized there as well, including Japan, by the way, we're back to one to one, but-

Matthew Sheerin (Managing Director and Senior Equity Research Analyst)

Okay, that's helpful. Thanks a lot.

Operator (participant)

Thank you. Our next question comes from Tim Yang with Citi. Please state your question.

Tim Yang (Analyst)

Hi, thanks for taking. It seems like you are one-to-two quarters component vendors in terms of seeing the end demand weakness. So my question is, based on your end demand recovers maybe next year, would you still be a lagging indicator compared to the vendors? And if so, are you using any tools to monitor our visibility into end demand? And then I have a follow-up.

Bill Amelio (CEO)

Yeah, let me talk about the visibility and demand. One of the things that's great about having a, a catalog, so a lot of data that we can look at, and whether it's actual lead times versus stated lead times, margin, ASP decline, name it, we have a lot of indicators that we're looking at. We're hopeful we'll, we'll be able to sort this out and be able to give us better headstart, starts to turn back around again. And we don't think there's going to be much of a lag between us and our supply base again. And I think the real jump ball is what's happening with the China tariffs and, and Brexit. Those two are things on the entire market, and hopefully we'll get some certainty.

Tim Yang (Analyst)

Got it. Thanks. That's very helpful. You mentioned softness for this. Can you talk about other segments, communication, as some of your component vendors actually mentioned the demand softness in that space as well? Thanks.

Bill Amelio (CEO)

Our exposure to communications is a lot less, and I will give you another vertical that's still doing well. Mil-Aero is still healthy and continuing to be robust. Pressure in the industrial and automotive, as you pointed out, but hopefully, as things turn back around, we'll see more robust growth there. The IoT is a, is a real bright spot for us. We've seen the pipeline increase dramatically there. Our three-year pipeline, we expect that that'll, half of that'll convert over the next, three to five years. So the encouraging signs for our solutions piece of our business with higher margin opportunity for us, that's more like a 15% operating income business.

Phil Gallagher (President, Electronic Components)

Yeah, but defense, Tim or However, clearly a strength for us, a strength in the market, which is great. And then tying to Bill's last comment and with IoT and some of the new solutions, we're also seeing quite a opportunity in medical, too. So medicals is one that, particularly when it comes to IoT, definitely seeing some nice opportunity emerging in that space.

Tim Yang (Analyst)

Got it. Thank you so much.

Operator (participant)

Thank you. And once again, just to cue for a question, press star one on your telephone keypad, that's the star key, followed by the one key on the keypad. Our next question comes from William Stein with SunTrust Robinson Humphrey.

Joe Burke (Head of Investor Relations)

Hey, guys, this is Joe Burke dialing in for William Stein. You've done a good job of explaining, like, what's going on at Farnell. I'm just in the process of doing your channel checks with the catalog guys. If you've heard any reason why customers, the broad, more broad-based players?

Bill Amelio (CEO)

Yeah, yeah, sure. This is a common phenomenon described in earlier calls. But when lead times are extended, what happens is our suppliers will ship more of the allocated supply into the catalog guys because it's a higher margin opportunity for them, and of course, our catalog guys. And you saw most put all of the catalog companies together, you see that outgrew the broad line at the same time. The lead times start to collapse, what happens is supply becomes more available and then becomes the broad line guys, and customers will naturally shift costs them more to something that cost them less. And that's the phenomenon that you're seeing.

Joe Burke (Head of Investor Relations)

Got it. I guess that's what Sean was getting in. That's, that's helpful for me. That's all I have. Thanks, guys.

Operator (participant)

Thank you. There are no further questions. I would now like to turn the call back over to Bill for remarks.

Bill Amelio (CEO)

Well, in summary, I'd like to make the point that those areas of the business where we can make an impact, regardless of the macroeconomic situation. We're first to execution of the strategies that we put in place. We add significant value to all of our stakeholders, including our investors. Looking forward to you and our progress in the coming weeks and months ahead, and I want everyone to have a great day. Thank you.

Operator (participant)

Conference, all parties may disconnect. Have a great day.