Earnings Call Transcript - ST Q2 2025

Operator, Operator

Good afternoon everyone and welcome to the Sensata Technologies Q2 2025 Earnings Call. Please note that today's event is being recorded. I would now like to turn the floor over to Mr. James Entwistle, Senior Director of Investor Relations. Sir, please proceed.

James Entwistle, Senior Director of Investor Relations

Thank you, Jamie, and good afternoon, everyone. I'm James Entwistle, Senior Director of Investor Relations for Sensata and I'd like to welcome you to Sensata's Second Quarter 2025 Earnings Conference Call. Joining me on today's call are Stephan Von Schuckmann, Sensata's Chief Executive Officer; and Andrew Lynch, Sensata's Chief Financial Officer. In addition to the financial results press release we issued earlier today, we will be referencing a slide presentation during today's conference call. The PDF of this presentation can be downloaded from Sensata's Investor Relations website. This conference call is being recorded, and we will post a replay on our Investor Relations website shortly after the conclusion of today's call. As we begin, I'd like to reference Sensata's safe harbor statement on Slide 2. During this conference call, we will make forward-looking statements regarding future events or the financial performance of the company that involve certain risks and uncertainties. The company's actual results may differ materially from the projections described in such statements. Factors that might cause such differences include, but are not limited to, those discussed in our Forms 10-Q and 10-K as well as other filings with the SEC. We encourage you to review our GAAP financial statements in addition to today's presentation. Much of the information that we will discuss during today's call will relate to non-GAAP financial measures. Our GAAP and non-GAAP financials, including reconciliations are included in our earnings release in the appendices of our presentation materials and in our SEC filings. Stephan will begin the call today with comments on the overall business. Andrew will cover our detailed results for the second quarter of 2025 and our financial outlook for the third quarter of 2025. Stephan will then return for closing remarks. We will then take your questions. Now I would like to turn the call over to Sensata's Chief Executive Officer, Stephan Von Schuckmann.

Stephan Von Schuckmann, CEO

Thank you, James, and good afternoon, everyone. Before I begin discussing our results for the second quarter, I'd like to take a moment to congratulate Andrew Lynch, who was named our Chief Financial Officer last week. Andrew has been a valuable partner to me since I joined Sensata, and the Board and I have full confidence in him. Andrew's extensive financial and operational experience at Sensata have prepared him well for this role. I'm excited to have him as a partner on Sensata's transformation journey. Now let's begin on Slide 3. We delivered a strong quarter of 2025 with revenue, adjusted operating income and adjusted earnings per share all exceeding the high end of our guidance for the second consecutive quarter. This is an important proof point for the resilience of our business and our team's determination to execute in the face of challenges, such as volatile end markets, geopolitical uncertainty, and the cybersecurity incident that we disclosed in April. When I first spoke to you in February, I introduced three key pillars, which would serve as my initial focal points for shareholder value creation: improving operational performance, optimizing capital allocation, and returning to growth. At our May call, I provided an update on some of the specific work we are doing on each of these pillars and much of the focus of the update was operational excellence. Today, I'll go a bit deeper on capital allocation and growth drivers. Before we get to capital allocation and growth, I'll share a brief update on operational excellence. We rolled out a number of initiatives over the last six months, and I'm pleased with our recent accomplishments on this journey. Our cash conversion rate in the second quarter was 91%, a significant step up from our first quarter 2025 conversion rate of 74%. This improvement reflects our focus on unlocking cash to execute our capital allocation strategy. With operational excellence initiatives, we are optimizing our working capital and creating margin resilience in our business, enabling us to deliver on our earnings commitments. Now I'd like to go deeper on our next pillar, optimizing our capital allocation. Simply put, we will deploy capital in a manner designed to maximize shareholder returns. In the first quarter, we seized the opportunity to repurchase $100 million of shares. In the second quarter, we repurchased another $20 million of shares and funded our dividend while also accumulating an additional $74 million of incremental cash. In turn, we reduced our net leverage ratio from 3.1x trailing 12-month adjusted EBITDA at the end of the first quarter to 3.0x at the end of the second quarter. This further strengthened our already strong balance sheet. In the past, you've heard me talk a lot about benchmarking as we look to drive operational excellence. We are using external benchmarks for each of our key pillars. As we look at comparable companies across the market, our differentiated margins stand out and our cash conversion is improving. However, our capital structure and net leverage is a bit of an outlier. For the balance of this year and into 2026, you can expect us to continue to prioritize deleveraging. Now I'm excited to share our progress on our growth pillar. Just like capital allocation, growth is enabled by operational excellence. Over my decades of experience in industry, I have learned that the right to win is earned by consistently serving customers on time at the lowest possible cost with high-quality products. Operational initiatives will ensure that we do exactly that. It's equally important that we're disciplined about the new business we pursue. We need to win with the right technologies on the right platforms with the right customers. Over the last several months, I've worked with the Sensata team to study our past business wins a bit deeper and to identify the characteristics of our most successful programs. We're using those learnings to be more selective about how and where we invest and what business opportunities we pursue. For us, it means the following: first, stick to our core product technologies, pressure, temperature, and electrical protection and certain specialty sensing such as force, position, flow, and leak. Next, prioritize platform-driven applications where high switching costs favor incumbency with an emphasis on regulated or mission-critical sockets. And finally, focus on the right end markets with exposure to key secular tailwinds and appropriate diversification. As we apply these criteria, our priorities become clear. In our Sensing Solutions segment, A2L gas leak detection is a recent example of a business opportunity that checked all the boxes for us. We were able to leverage our core sensing capabilities to win the regulated sensor socket by air conditioning system platforms. We established a market leadership position in the U.S., which we are continuing to grow. In 2025, this business is on track to deliver approximately $70 million of revenue, and we continue to increase our market share with a goal of well over $100 million of revenue next year. We look forward to leveraging our incumbency with key OEMs to win globally with similar regulatory requirements on the horizon in both Europe and Asia. In our Performance Sensing segment, we've spoken a lot about the content opportunities on both ICE and EV platforms as well as the rapidly evolving new energy vehicle or NEV market in China. It is clear that we need to win in China to maintain and grow our global market share. The China market is opportunity-rich with a rapid adoption of NEVs and growth of local OEMs. The high-voltage applications on NEVs offer incremental content opportunities for us compared to the traditional ICE business. Our China team is actively driving business development with local OEMs in China to support their growth ambitions, both in China and beyond. We have significantly increased our pace of new business wins in China, primarily on NEVs. Our customers are placing value on our product performance, proven field quality in the local market, cost competitiveness, and well-established production scale. More than 90% of these wins are with top local OEMs and leading NEV players. Due to shorter design cycles in the China market, we expect many of these business wins to materialize into revenue later this year and serve as the foundation for a return to more consistent market outgrowth in 2026. The content wins we are securing include NEV specific electrical protection as well as powertrain agnostic content such as tire pressure monitoring systems or TPMS. One of these recent TPMS wins featured new tire burst detection technology, and we are excited to share that we were the first to bring this technology to market for an active safety application. Tire burst detection enables the vehicle to activate its stability control features at the first sign of a tire rupture event, dramatically improving occupant safety. This is exactly the type of technological differentiation that gives us an edge in the market. Now that we've spoken about our key pillars, I'd like to talk a little bit more about what we are seeing in our end markets today. Let's turn to Slide 4. I will start with tariffs and trade policy. Through a combination of reimbursement agreements with our customers and modifications to our supply chain, we have now successfully mitigated all of our tariff costs in the second quarter compared to approximately 95% when we spoke to you in May. Since our last update, we've also seen a reduction to our exposures in connection with the de-escalation of tariff rates between the United States and China. Additionally, we are pleased to report that we have not seen significant impact from recent tariff escalations on commodities or from export controls on rare earth materials. More broadly, in our end markets, we're seeing a mix of volatility, resilience, and growth. I'll share a few highlights now, and then Andrew will provide more specifics as he walks you through our results and guidance. On the Performance Sensing side, we are pleased with automotive production holding up stronger than initially expected when trade tensions escalated. Global production has grown in the first half as the market in China has been very strong. HVOR markets have been soft, particularly with on-road trucks, and we're starting to see off-road production slowdown as well. As a result, we're managing our costs accordingly. In our Sensing Solutions segment, we're seeing more growth which highlights the advantages of our end market diversification. Our industrials business grew over 9% in the second quarter as markets have stabilized and our new leak detection product is delivering meaningful outgrowth. In aerospace, we saw over 5% revenue growth in the second quarter against the market that grew roughly 3%. Our market outlook for both industrials and aerospace in the second half is largely consistent with what we saw in the second quarter. In summary, I am happy with what we have achieved so far this year, and our Q2 results demonstrate the progress we are making on our transformation plan built upon the three pillars. As we progress through the balance of 2025 and into the new year, we will maintain our focus and rigor on these initiatives to drive shareholder value. With that, I will turn the call over to Andrew to provide greater detail on Q2 financial results and our guidance for the third quarter.

Andrew Charles Lynch, CFO

Thank you, Stephan, and good afternoon, everyone. I want to begin today by extending my gratitude to Stephan and our Board of Directors for placing their confidence in me as Sensata's Chief Financial Officer. I would also like to thank the Sensata team and our finance organization for their support over the last several months. Let me start on Slide 6. We delivered another strong quarter in Q2 with results above our expectations across all of our key metrics. We reported revenue of approximately $943 million for the second quarter of 2025 as compared to revenue of $1.036 billion in the second quarter of 2024. While revenues were lower year-over-year primarily due to the previously discussed divestitures, we saw $32 million of top line growth sequentially from the first quarter of 2025 and exceeded the top end of our guidance range, reflecting our rapid recovery from the cybersecurity incident in April, and general resilience in our end markets. Adjusted operating income was approximately $179 million or a margin of 19.0%, and included approximately $12 million of 0 margin pass-through revenues related to tariff recovery, which were 20 basis points dilutive to our adjusted operating margins. Adjusted operating margins improved 70 basis points sequentially from 18.3% in the first quarter of 2025. Adjusted operating margins were consistent with prior year quarter at 19.0% and increased 20 basis points year-over-year, excluding the dilutive impact of tariff pass-through. Adjusted earnings per share of $0.87 in the second quarter of 2025 represents an increase of $0.09 sequentially from the first quarter of 2025 as we delivered on our margin expansion plans and a decrease of $0.05 as compared to the second quarter of 2024 due to divestitures. We achieved robust free cash flow of $116 million in the second quarter, an increase of 17% year-over-year. This represents a conversion rate of 91% of adjusted net income, an increase of 17 percentage points compared to the first quarter of 2025 and 20 percentage points compared to the second quarter of 2024. As Stephan mentioned, free cash flow is a key focus for us, and our improvements accelerate our ability to execute our capital allocation strategy. Now let's turn to Slide 7, and I will discuss capital deployment. In the second quarter, we executed share repurchases totaling $20 million and returned $18 million to shareholders through our regular quarterly dividend. We reduced our net leverage to 3.0x trailing 12 months adjusted EBITDA compared to 3.1x at the end of March. With our capital allocation strategy, we delivered ROIC of 10.1%, up 30 basis points compared to the second quarter of 2024. Looking ahead, you can expect us to continue to deploy capital in a manner designed to maximize shareholder returns with an emphasis on deleveraging in the near term. Turning to Slide 8. I'll talk through the results for our segments as well as provide more color on what we are seeing in our end markets. Let's start with the segment results. Performance Sensing revenue in the second quarter of 2025 was approximately $652 million, a decrease of approximately 10% year-over-year primarily due to product divestitures and lower on-road truck production in North America and Europe. Performance Sensing adjusted operating income was approximately $147 million or 22.5% of Performance Sensing revenue, representing year-over-year margin expansion of 20 basis points, inclusive of any dilutive impact from tariffs. Sensing Solutions revenue in the second quarter of 2025 was approximately $291 million, an increase of approximately 9% year-over-year. This marks our second straight quarter of year-over-year growth driven by new content in our industrials business and market outgrowth in our aerospace business. Sensing Solutions adjusted operating income was approximately $88 million or 30.2% of Sensing Solutions revenue, representing year-over-year margin expansion of 50 basis points, again inclusive of any dilutive impact from tariffs. As a reminder, corporate and other costs have been recast to exclude certain costs previously referred to as Megatrend spend, which are now presented within the two reporting segments. Corporate and other adjusted operating expenses were up $4 million versus the second quarter of 2024, primarily driven by higher variable compensation due to better underlying performance. Now I'll provide color on what we are seeing in our end markets. In our automotive business, production estimates have been volatile and trade policy has evolved throughout the year. We have seen double-digit market growth in China in the first half, partially offset by market weakness in North America and Europe. Looking ahead to Q3, we see auto production moderating to roughly flat year-over-year and down about 1 million vehicle units sequentially from the second quarter on typical seasonality. In our heavy vehicle and off-road business, we have seen softness throughout the year with on-road truck production down more than 20% in the first half across North America and Europe, and we expect this softness to persist in the second half of the year. Global off-road markets have seen modest growth in the first half, but we are now experiencing a significant slowdown in Q3. In our Sensing Solutions segment, we are seeing market strength. Both industrials and aerospace are seeing low single-digit market growth, and we are seeing high single-digit outgrowth in industrial as our gas leak detection business has ramped nicely. The market outlook I just discussed is reflected in our guidance, which I will take you through in a moment. Looking a bit further ahead to Q4, we are monitoring third-party forecasts and customer demand signals, and we expect more clarity as trade policy develops in the days and weeks ahead. Lastly, before we get to our guidance, I'd like to give just a brief update on the cybersecurity incident that we disclosed in April. In connection with this incident, we experienced an approximately 2-week disruption in our business. Thanks to our team's preparation and resiliency, our business has fully recovered. We are grateful to have this incident behind us without any significant disruption to our customers and without material financial impact. With that, I will now turn the call back to Stephan.

Stephan Von Schuckmann, CEO

Thank you, Andrew. I said this last quarter, but it warrants repeating, there is a significant transformation underway at Sensata. The foundation of this transformation is the key pillars that I've discussed on each of our earnings calls since I joined Sensata at the beginning of the year. I would like to conclude today's remarks by sharing a bit more why these are key to our vision and what you can continue to expect from us. Operational excellence is about stabilizing our core business to serve as an enabler to both our capital allocation and growth pillars. Our capital allocation strategy is to utilize our cash flow improvements to deploy capital in a manner designed to create shareholder value in the short term and long term with an emphasis on deleveraging. And finally, our return to growth will be supported by a focused product strategy and a clear evaluation criteria for growth opportunities. Success on our key pillars will be apparent in phases. Today, consistent execution with adjusted operating margins at or above 19% and free cash flow conversion at or above 80%. The next several quarters, net leverage continues to improve and in the years ahead, a return to more consistent growth. I'm excited about what the future holds, and I look forward to continuing to update you on our progress moving forward. I will now turn the call back to James for Q&A.

James Entwistle, Senior Director of Investor Relations

Thank you, Stephan, and Andrew. We will now move to Q&A. Jamie, please introduce the first question.

Operator, Operator

Our first question today comes from Mark Delaney from Goldman Sachs.

Mark Trevor Delaney, Analyst

Nice to see the free cash flow conversion pick up. And Andrew, congratulations on the expanded role.

Andrew Charles Lynch, CFO

Thank you.

Mark Trevor Delaney, Analyst

I wanted to start with EBIT margins. They expanded 20 basis points year-over-year, excluding tariffs, even as organic revenue was down, I think, about 2%, and you expect sequential margin improvement again in 3Q. Can you go into more detail on what's driving that margin improvement both in 2Q and 3Q? And I guess as you look longer term, do you see a path to 20%-plus EBIT margins?

Stephan Von Schuckmann, CEO

Well look, Mark. Thanks for the question. So first of all, as mentioned in the call, we're undergoing quite a significant transformation at Sensata. And we've designed a number of initiatives that we're focusing on. We didn't start a huge amount of initiatives. It's basically six initiatives that we're focusing on. And just to mention a few, some of these initiatives are focused on pure operational excellence, something I've been speaking about frequently now in the calls in the past. So that's improving plant performance. And what we're doing is we're benchmarking our plants against each other, where we have similar products. For example, in TPMS, and we're trying to improve the plants that are weaker than the best benchmark within Sensata as one example. Another example is we're working on commercial excellence. So we have a much stronger rigor around that. And like I said, there are other examples, so we're working, for example, on improving our procurement and gaining effects from that. And that's basically the effect that you see with other initiatives that you could see the margin improvement. But for more details, let me pass on to Andrew.

Andrew Charles Lynch, CFO

Thanks, Stephan. Mark, I think to summarize, so it's primarily operational productivity that's driving the sequential margin expansion. And we feel pretty good about our margin levels in the 19% range in the near term here. In terms of longer-term margin expansion opportunity, we've not established any targets at this time. We're really focused on short-term and margin resilience. We'll provide more clarity on sort of what the longer-term outlook looks like as we get into sort of the '26 guide period. But for now, we're focused on just margin resilience at the current level and sequential margin expansion quarter-on-quarter.

Mark Trevor Delaney, Analyst

That's helpful. My follow-up is also around EBIT margins and how mix may or may not affect that. You talked about divergent trends you're seeing in some of these end markets, industrial picking up, you said HVOR seeing signs of weakness. And if you see those sorts of divergent trends by end markets, what might that mean, if anything, for EBIT margin? Is that a potential headwind or a tailwind from mix that investors should potentially expect?

Andrew Charles Lynch, CFO

Yes. Good question, Mark. So mix definitely matters in our business. I think as we've highlighted before, our lowest margin business is our automotive business, our highest margin is our aerospace business. HVOR and industrial are kind of in between. As we look at what we're seeing in the current quarter and Q3, we've seen softness in the HVOR business and strength in industrial. And so we've been able to offset any mix headwind from the HVOR softness with the outgrowth that we're driving in industrial. We feel good that the business mix kind of moving forward throughout the balance of the year will support the margin expansion that we've committed to.

Operator, Operator

Our next question comes from Joe Giordano from TD Cowen.

Joseph Craig Giordano, Analyst

Stephan, as you've been reviewing the portfolio for a bit longer, what is your perspective on further product rationalization and SKU reduction? How do you feel about addressing the backlog from previous wins that have been delayed? Where do you think we currently stand on those issues?

Stephan Von Schuckmann, CEO

Sorry. Can you just repeat the question? I didn't get the last part.

Joseph Craig Giordano, Analyst

So I'm just curious on where you stand as you evaluate the portfolio now that you've been here a little while, like how much more SKU reduction is necessary or small divestments and things like scrubbing of the backlog to see how realistic delivery is on things that were won many years ago and when markets were different.

Stephan Von Schuckmann, CEO

Well, look, I think a lot of the SKU reduction or let's call it, portfolio cleansing has been done in the last year. Significant work has been done by the team and around the interim CEO, Martha. And look, it's a continuous process. So I'm looking at all types of SKUs, whether in automotive, HVOR, or industrial. Anything that we don't feel fits our portfolio at this point in time, we will cleanse from our overall SKUs. It's a continuous process. It's not something that is finished after we've gone through all of them; it's something that we follow through month-by-month actually, yes. So nothing significant at this point in time, but something I'll keep a focus on.

Andrew Charles Lynch, CFO

Joe, yes, I think you're probably referring to some of the EV wins and program wins from years back. As the market shifts on that, we work with our customers to make sure that we're securing offsets, whether it's new opportunity to quote on new business, whether it's commercial recovery pricing discussions. We factor all that in as we negotiate with our customers moving forward. But I think the driver there is pretty clear. It's that the time horizon of certain EV programs has moved to the right, and we're just focused on supporting the market as it is today.

Joseph Craig Giordano, Analyst

And then the follow-up, I know it's still early, but just anything incremental, Stephan, you can give us on the China positioning. I know this is a big priority of yours to evolve how Sensata is positioned in China with the local OEMs. So maybe any updates there?

Stephan Von Schuckmann, CEO

Yes. Of course, I can. So look, I think generally, we need to say there's been quite an extreme shift from multinational to local OEMs. We see that the market is roughly at 70% local now. And we see that government incentives benefited 2024, and they continue to drive 2025. On the other hand, it's still encouraging, obviously, to see that multinational OEMs are continuing to make meaningful investments in China. So what does that mean for Sensata? I would say it's a return to outgrowth. So 90% of all the business of the year-to-date new business wins are now with the top five local OEMs and with leading new energy vehicle players. And around that, if I break that down to more product focus, there's a high concentration on high-voltage and powertrain-agnostic content. So we expect modest outgrowth in the back half based on third-party forecasted production mix. We're also pretty confident that it's going to be more consistent outgrowth in the beginning of 2026.

Operator, Operator

Our next question comes from Wamsi Mohan from Bank of America.

Unidentified Analyst, Analyst

This is Ashley on the call for Wamsi. Just one question for me. We were wondering if you saw any pull forward of demand that impacted the Q2 time period, specifically in autos. Just any color you could give us here.

Andrew Charles Lynch, CFO

Sure. Happy to answer that. So the short answer is no. I think a few dynamics at play here. So in the second quarter, the early part of the quarter, the supply chain was coming up the curve on USMCA compliance, particularly in April. What we saw there was the OEMs consuming inventory earlier in the quarter and then replenishing it in the back half of the quarter. But effectively, Q2 was basically normal. And then looking ahead to the third quarter, our order book is pretty solid and filled to where we would expect it to be relative to where we guided the quarter. As we talk to our channel partners on the industrial business and other end markets, we're not seeing any pull ahead in our business. That may be more of a dynamic further down the supply chain, but where we sit, it's pretty much business as usual in terms of order book correlation to production.

Operator, Operator

Our next question comes from Konsta Tasoulis from Wells Fargo.

Konstandinos Evangelos Tasoulis, Analyst

Andrew, congratulations. My first question is for you. You've spent a significant part of your career at Sensata and have likely observed many outdated processes as you've advanced. Now that you're in a key decision-making role, I'm curious about the improvements you're looking to make within Sensata.

Andrew Charles Lynch, CFO

Thanks, Konsta, and thanks for the question. My primary focus here is on enabling the transformation that Stephan has outlined here in his key pillars. I think we've got the right priorities to drive performance. There's a lot of work behind the scenes that goes into enabling these key pillars. As Stephan mentioned, there's a bunch of initiatives that underpin the operational excellence pillar. A lot of that comes down to making sure that we've got the right analytics and the right data to drive the right decision-making. And so that's part of the role of the finance org from a tactical standpoint. And so certainly focused on enabling that. The other piece around capital allocation and growth, ensuring that we're applying the right rigor to our growth investments, and ensuring that we're allocating capital in a way that creates shareholder returns. I think I'd just reiterate the pillars that Stephan has outlined, and I'm fully onboard with enabling those.

Konstandinos Evangelos Tasoulis, Analyst

Great. I'll just dig in on free cash flow a bit. How should we think about cost optimization efforts impacting your inventories? So it sounds like part of the strategy is like standardization, right? So are you bringing in like a single component across your products that reduce cost and variability and therefore, you've got to keep a high stock of that component, and that kind of reduces the working capital tailwind?

Andrew Charles Lynch, CFO

When it comes to inventory, we have two main approaches. First, we need to focus on productivity and reducing unit costs to decrease inventory expenses and ultimately lower product costs, which in turn increases our available working capital. The second aspect is the amount of inventory we maintain. Previously, we’ve mentioned that a possible way to improve this situation is by enhancing our supply chain planning and demand forecasting. It's essential to utilize our systems and the data available in the market to improve our lead times, refine our demand signals, and enhance our production planning. All these efforts can lead to an opportunity for inventory reduction, which I see as an important strategy for improving our free cash flow conversion in the future.

Stephan Von Schuckmann, CEO

If I may add, Andrew, what we do is benchmark our inventory levels from plant to plant. We compare similar plants to identify the best inventory levels and set goals for others. Additionally, we look outside of Sensata to see who is leading in inventory management and measure ourselves against them. This helps us redefine our measures and work towards reducing inventory levels.

Operator, Operator

Our next question comes from Joe Spak from UBS.

Joseph Robert Spak, Analyst

I actually want to pick up on the free cash flow theme and how you're thinking about it for the second half. I think I heard an 80% sort of conversion, I'm not sure if that's a long-term target, midterm target. And then also just on CapEx, and maybe this is obviously part of free cash flow. It looks like you're at 3% of sales in the first half. I think that's below historical, but maybe this is sort of the new normal for Sensata. So maybe just some help there on how you're thinking about that.

Stephan Von Schuckmann, CEO

Thanks for the question. Look, generally, we've set ourselves an ambition to strive for a cash conversion rate at 80% or more.

Andrew Charles Lynch, CFO

Yes. And I would just add to that. A good point on the lower level of CapEx in the second quarter. Some of the dynamic there was candidly just as we were looking at uncertainty in the end markets, and we saw production forecasts dropped dramatically early in Q2 following the trade policy or tariff rate escalations. We throttled back some of our CapEx to respond to potentially lower revenue levels. Obviously, that didn't materialize. We saw that demand get restored. We'd expect an uptick in CapEx in the back half of the year. That said, I expect to be able to maintain pretty high levels of free cash flow conversion going forward, and 80% really is the floor. We have plenty of levers available to us to maintain reasonably solid cash flow conversion here moving forward. Inventory hasn't come down dramatically yet. There's still opportunity there. CapEx, while it may not be as low as it was in the second quarter, we still have the opportunity to underspend or spend at a level consistent with depreciation. I don't see that as a meaningful headwind.

Joseph Robert Spak, Analyst

Okay. So even with depreciation being a good guide, do you think it can be a little bit below the 4% level we have seen in the past going forward?

Andrew Charles Lynch, CFO

I think 4% is probably a good proxy for what sort of normalized run rate CapEx looks like. It can vary in any given quarter. Certainly, we adjust it up or down based on our view on market certainty. The investment opportunities ahead of us, whether those are sort of near-term automation opportunities to drive productivity or longer-term opportunities around growth investment. We try to keep that all in balance.

Joseph Robert Spak, Analyst

Okay. And then just on the deleveraging comment. I guess I want to confirm how you're really thinking about this because you mentioned sort of net leverage going high, which, to me, sort of implies the EBIT that's really coming from higher EBITDA. Or are you also planning to say sort of gross debt down? And are there any sort of leverage targets? Or how should we think about minimum cash just so we understand how investors can think about what's available for dividend, share repurchase or debt repayment.

Andrew Charles Lynch, CFO

Yes. In the short term, we'll look to reduce net leverage by accumulating cash on the balance sheet. That's just a function of where our debt maturities sit and what the current interest rate environment looks like. We don't have any debt maturities until 2029. That doesn't mean that we're going to wait until 2029 to address gross debt. There will be opportunities here in the coming quarters to potentially take some action there. But in the immediate term, our focus is going to be on accumulating cash on the balance sheet. Of course, we still have a share repurchase program. We didn't execute Q2 at the same level we did in Q1, but we'll maintain the flexibility to opportunistically repurchase shares as we see fit and keep that in balance with our net leverage targets. Certainly, we'd like to be below 3x levered in the near term and moving towards 2.5 relatively soon.

Operator, Operator

Our next question comes from Shreyas Patil from Wolfe Research.

Shreyas Patil, Analyst

Maybe just coming back to the China auto piece. Can you just help level set how big this is for you today? And just to clarify, how much of an uplift could we see from the new launches that you mentioned, Stephan, that are starting later this year? And then just to put a finer point on it, how do you see the competitive landscape in China, specifically on the auto business? In the past, the sense was that the mid- to low end of the China market was very difficult to penetrate either given vertical integration or price competition among some of the local suppliers. I'm just curious if that is still how you see it? Or have there been changes in the market.

Stephan Von Schuckmann, CEO

Look, it's pretty much the same. It's obviously a very competitive region, a very competitive country. As you know, there are among OEMs, price wars going on, which obviously trickles down to the Tier 1 level. This leads us to, obviously, being extremely focused on cost. That's something that we have reinitiated. Sensata has a strong history of being very cost focused, and that's something that we've been focusing even more in China. Following through on that in a stringent way to stay competitive within the market. We take our products, go back into the design, and take out as much cost as we can to be competitive. On the other hand, some of the products, as I mentioned in my earnings script early on, come with a certain level of technical differentiation. Take the tire burst systematic, which allows us to enter the market first and gain market share compared to others that do not have these functionalities yet. That's how we tackle competitiveness. It's an important market for us. Some of the Chinese OEMs that are eager for market growth are stepping outside of the country and trying to gain market share in Europe, Southeast Asia, Thailand, Malaysia, and so on. So it’s a dynamic environment, and that makes it interesting for us as a growth opportunity because if we go with the right players like we have. I mentioned that we've won over 90% of our year-to-date new business with the top five local OEMs. So it's really with leading new energy vehicle players. Those are the players that will show growth outside of China, and that gives us another opportunity to benefit from that additional growth in regions like Southeast Asia or in Europe.

Andrew Charles Lynch, CFO

And Shreyas just to give you clarity on the numbers. The China market is about 1/4 of our automotive business, so about 12% or so of overall Sensata's revenue, obviously varying depending on business mix within any given quarter. The growth opportunities that we've highlighted would be sufficient to return us to kind of the low to mid-single digits outgrowth that we've targeted in our auto business. That will give you a little bit of context on the size. We're not talking about specific platforms or programs yet, but that's sort of the magnitude.

Shreyas Patil, Analyst

Okay. Okay. That's helpful. And then maybe pivoting to HVOR you talked about meaningful weakness in the end market there. Curious how you're thinking about outgrowth in that business, both near term and long term. In the past, you've talked about 3 to 6 points of outgrowth as a target for auto. I'm wondering if there's a similar target for HVOR.

Stephan Von Schuckmann, CEO

Well, Shreyas, let me explain it. Let me first start with the end markets, and let me give you our perspective, and then I'll give you an outlook on how business is developing for Sensata. On the end markets for on-road trucks, we see that for the entire year of 2025, production is down. You need to look at that from a regional perspective. In North America, we projected quite a strong downturn of roughly 24% year-over-year for this financial year of '25. In Europe, on-road trucks were soft in the first half, which is roughly 6% down, but projected to be up in the second half of this year. Agriculture and construction are expected to be down in a high single-digit percentage, and then the second half is more positive than the first half. The slowdown drivers for on-road are clear; there's been no buy-ahead on EPA27 in general macro uncertainty, and operators are not renewing their fleets, and that's what we're seeing in our numbers. In Europe, we saw a soft Q2 on macro uncertainty, but we see that Q3 is pretty much normalizing on a year-over-year basis. Now what does that mean for Sensata's business? We undergrew the market in the first half, and the reason for that is as Western production was down, while China production was up. Our content is generally higher on Western OEMs. We expect this to continue in our HVOR segment through the balance of the year given the softness that we've seen in this Western production forecast.

Operator, Operator

Our next question comes from Christopher Glynn from Oppenheimer.

Christopher D. Glynn, Analyst

Just give a little orienting question to start on the guide. Third quarter is down about $30 million sequentially at the midpoint. Is that vast majority impact at Performance Sensing?

Andrew Charles Lynch, CFO

Yes, that's right. We see auto production down about 1 million units sequentially. And then we see some softness in the off-road space accelerating in the third quarter, so all Performance Sensing.

Christopher D. Glynn, Analyst

Okay. Great. And then just a couple content and outgrowth dynamics that might be in play. Curious how you see Europe phasing with some of the relaxation of the mandates for EVs, if that's a CPV mix shift that progresses as well in European auto through the back half of the year? And then you've talked a lot about the gains with local OEMs in China and starting to lap somewhat the share loss from multinationals. Have you indicated a time frame when outgrowth crossover might be expected for China?

Andrew Charles Lynch, CFO

Sure. Let me start with Europe. The relaxation of the mandates may ultimately lead to a slowdown in EV production in Europe. If it does, that would be a content tailwind for us. We haven't seen that yet. We've seen EV production continue to grow in the first half of the year in Europe, but that dynamic played out last year for us. If you see that mix shift again, that would be a potential outgrowth driver. Just a reminder there, we're about half the content per vehicle on an EV in Europe compared to an ICE. As we move to next gens, we get above parity there. But on the current gens, that's where the content mix sits. And then on the China question.

Stephan Von Schuckmann, CEO

Okay. Let me add something about the EV. To add to that, Christopher, on the content side, even if EV growth is not as strong as predicted due to softening regulations. As we know, for example, in Europe, the combustion engine ban might be softened. Then we'd have probably a shift towards hybrids and mainly plug-in hybrids. Sensata has a broad portfolio mix, which we could serve as well as we can also serve the EV market. So it's not a down for us. It's actually beneficial for us.

Andrew Charles Lynch, CFO

And then Chris, I think your question on China is when the win starts to show up in outgrowth? There are really two dynamics here around outgrowth in China. The first is the rapid share shift that we saw last year where multinationals lost share to locals largely played out in the back half of last year. So we'll start to lap those comps into the third quarter, and that outgrowth headwind starts to go away here in the back half of '25. As these new businesses launch, which have design cycles and lead times that are less than a year, they will start to show up in revenue late in '25 and early into '26 and set the foundation for outgrowth in China in 2026.

Operator, Operator

Our next question comes from Samik Chatterjee from JPMorgan.

Samik Chatterjee, Analyst

Andrew, congratulations on your new role. I'd like to revisit the pace of wins in China that you mentioned. I appreciate the insights you've shared so far. Can you expand on your thoughts regarding content per vehicle? As you noted, content per vehicle can sometimes be less than that of Western OEMs. In the recent win activity you're experiencing, what have you discovered about the opportunities related to content per vehicle? Do you envision a roadmap as you continue to achieve these wins? Is there a trend towards narrowing the gap in content between Western OEMs and local Chinese OEMs? I also have a brief follow-up on this.

Stephan Von Schuckmann, CEO

So Andrew, do you want to add to that? As I mentioned in a previous call, we've shifted our focus in China. It's important to us to engage with the leading new energy vehicle producers in China, and that's what we've been working on for the past few months. This focus has allowed us to secure significant new business in the Chinese market. Regarding content in China, it's crucial for us to understand that whether we're talking about electric vehicles or internal combustion engines, or considering local manufacturers versus multinationals, our historical content levels for electric vehicles or local companies were much lower than for multinationals. We're beginning to change that. These new successes will help balance our content levels so that we won't face challenges as local players continue to grow in the market.

Samik Chatterjee, Analyst

Okay. That's helpful. Stephan, I'm interested in your thoughts on where the additional R&D funding will be allocated, especially if we notice a trend in the automotive sector moving towards more hybrids compared to EVs, which would be advantageous for your content. How are you planning to direct the incremental R&D funding regarding your platform strategy?

Stephan Von Schuckmann, CEO

Yes. We are being very selective about our R&D spending. One example addressing your earlier question is our investment in applications for new energy vehicles in China. That is one area of focus. Additionally, we are allocating more R&D funds to the industrial sector. Our gas leak detection products, A2L and A3, are in the process of scaling up, with some still in development. We are also considering follow-up versions to enhance these products. Furthermore, there are significant growth opportunities in aerospace, and we are increasingly dedicating R&D funds to that sector to capitalize on the expected market growth in the future.

Operator, Operator

Our next question comes from William Stein from Truist Securities.

William Stein, Analyst

First, Andrew, congratulations on your promotion. Stephan, I believe analysts and investors have been anticipating a clearer message regarding the long-term growth potential for either free cash flow per share or earnings per share. Just to clarify, are your priorities to maintain the 19% operating margin without a strong emphasis on expanding it, to enhance free cash flow conversion, and to reduce leverage? Is that correct? Additionally, I've heard some analysts mention outgrowth, but those seem to be targets established by previous management. Do you have an outgrowth target or guiding principle for the long term?

Stephan Von Schuckmann, CEO

Thank you for the question. I want to clarify our position. We are undergoing a significant transformation that is proving effective. We have introduced greater focus and rigor within our organization, emphasizing benchmarking, consistency, and standardization. We are committed to improving our operations proactively. Our goal is to enhance free cash flow and prepare for future growth, particularly in the context of our discussions surrounding China. To be specific about our targets, we have set a minimum cash conversion rate of 80% and an operating margin of at least 19%. In the third and fourth quarters of this year, we anticipate increasing margins by 20 basis points. This margin expansion is part of our strategy. Additionally, it's crucial for Sensata to achieve an organic growth rate by securing business in the market, particularly in the automotive sector with key partners, while also making progress in HVOR, industrial, and aerospace sectors. We are targeting an organic growth rate of approximately 2% to 4%, which is the framework we are currently focusing on. We'll see how this evolves.

Operator, Operator

Our next question comes from Robert Jamieson from Vertical Research.

Robert Gregor Jamieson, Analyst

Stephan, I appreciate the color that you've provided over the last few conference calls on your strategic initiatives. But I want to ask about the global sales team. Having spent some time with them, have you seen anything in their process that needed to be changed to enable them to more effectively target the right types of customers in the right regions that you've spoken about? I'm just curious if anything has been implemented there that's driven the year-to-date wins you mentioned in China with the locals and then also in Japan year-to-date.

Stephan Von Schuckmann, CEO

Yes, we have completely changed our focus. The electrification market presents different opportunities based on the region. It's crucial to be very selective about who we choose to partner with for growth. Not everyone is thriving in this market; some may face potential risks, particularly in China, where consolidation is occurring. Our team in China is very focused. We are not pursuing every opportunity but are instead carefully selecting the right customers we believe will be strong future growth leaders in the Chinese market. It’s challenging to identify these customers, but we have developed a good level of insight into this process and remain very selective. In terms of anticipating the consolidation in China, we are also trying to understand which future customers will expand outside of China. Many large customers are entering European markets and seeking growth. For our sales team, it is vital to identify who the winners will be outside of China so we can grow alongside them when we secure business with them. This represents a different focus.

Andrew Charles Lynch, CFO

Just curious if you could elaborate on the total addressable market there, what's that size, and then what's the margin profile versus the legacy industrial sensors business?

Stephan Von Schuckmann, CEO

On the gas leak detection, the overall market size in North America is roughly $150 million. If I just mentioned in the call, we won a significant market share in the market. If you convert that to Europe, we’re now going to attack that market with our so-called A3 product range. The overall European market is a similar size as North America with roughly $150 million in market size. There are emerging markets beyond that. This is interesting; as soon as stronger or tighter regulations come out in South Korea or Japan, we'll be ready with our product. We're busy scaling up A2L, and hopefully, we'll be ready by then with A3. We're selectively tackling those markets, which gives us an additional opportunity to gain market share and gain additional revenues.

Andrew Charles Lynch, CFO

We're coming up the curve on margin, but at the level we’re at today, sort of $70 million or so of annualized revenue, we're at or very close to normalized industrial margins. Scale has certainly helped there, but I think we're over the hump on where we need to be on margin scale. In terms of outgrowth in the third quarter, you're right, the resi dynamic has changed a bit. We're still expecting outgrowth in the third quarter. We were high single digits in Q2, probably low to mid-single digits in the third quarter, and then similar kind of for the balance of the year.

Operator, Operator

And our final question today comes from Luke Junk from Baird.

Luke L. Junk, Analyst

Maybe just one for me, Stephan, and really tapping into what you're just talking about in leak detection, but maybe broadening that out in Sensing Solutions. It seems like tapping into non-auto markets could be a pretty interesting opportunity here. Just hoping to get your sense of urgency, prioritizing that, including the message pretty loud and clear around China on the Performance Sensing side of the portfolio, but how should we think big picture about reinvigorating growth in Sensing Solutions, maybe even beyond the leak detection product and potentially offsetting some of the cyclicality in Performance Sensing.

Andrew Charles Lynch, CFO

Luke, thanks for the question. Yes, certainly, part of our strategy is looking at opportunities to diversify our end market exposure, and we're weighing that in as we evaluate the new business opportunities for investment. Beyond A2L and industrial, we're looking thematically at things like broader demand for electrification and the electrical protection opportunities that come with that. We're looking at grid hardening and grid opportunities and the electrical protection opportunities that come with that. Those are all sort of longer-term secular opportunities. The clear near-term winner is the A2L product and various derivatives of that for other end markets. While we'll continue to look at secular opportunities longer term, the focus in the short term is on taking the business we've already won, expanding margin share, and bringing it to other end markets. Thank you all for joining today's presentation. We look forward to seeing you at various investor events later this quarter. We currently expect to participate in the following events. Evercore ISI Semiconductor, IT Hardware and Networking Conference in Chicago on August 26; Jefferies Industrials Conference in New York on September 3; and Goldman Sachs Technology Investors Conference in San Francisco on September 9. That concludes our second quarter earnings conference call. Operator, you may now end the call.

Operator, Operator

Ladies and gentlemen, we do thank you for joining today's conference call and presentation has now concluded. You may now disconnect your lines.