Earnings Call Transcript - ST Q4 2025

Operator, Operator

Good day, and welcome to Sensata's Fourth Quarter and Full Year 2025 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to James Entwistle, Senior Director of Investor Relations. Please go ahead.

James Entwistle, Senior Director of Investor Relations

Thank you, operator, and good afternoon, everyone. I'm James Entwistle, Senior Director of Investor Relations for Sensata, and I would like to welcome you to Sensata's Fourth Quarter and Full Year 2025 Financial Results 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. As we begin, I would 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 financial measures, 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 business. Andrew will cover our results for the fourth quarter and full year of 2025 as well as our financial outlook for the first quarter of 2026. 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. Let's begin on Slide 3. As I typically do at the start of our earnings calls, I would like to begin today with an update on Sensata's transformation journey. Throughout the year, I've spoken about our transformation through a framework of three key pillars: operational excellence, capital allocation, and growth, along with the various initiatives which underpin them. These key pillars for value creation are fundamental to everything we do. Initiatives that we discussed this year are simply building blocks, laying a foundation on which we build our future. As we enter 2026, I'm proud of the work we did to put those building blocks firmly in place, and I'm excited to share more about the next phase of our transformation. Before we get to the next phase of our transformation, I would like to take a moment to acknowledge the magnitude of what we accomplished this year and to thank the Sensata team for their tremendous work. Our team demonstrated resilience and determination to perform, continuously overcoming the many challenges that came our way and always delivering on our commitments. I'll share more proof points in a moment, but at a high level, as we reflect on the year, the outcome of our three-pillar approach is compelling. With our focus on operational excellence, we reported results at or above the midpoint of our guidance ranges every quarter this year. With our focus on capital allocation, we created urgency to improve cash generation, reducing both gross and net leverage and returning capital to shareholders. And with our focus on returning to growth, we overcame structural challenges in our business and end market mix, ultimately returning to outgrowth in the second half of 2025 and returning to revenue growth in the fourth quarter. We have a structured way of working, starting with a measure-based approach to prioritize hitting our targets. To compound value over time, we continuously raise the bar, setting new targets incrementally higher than the previous ones. This way of working is now ingrained in our organization and is embedded in everything that we do. Maintaining this rigor requires determined, resilient leadership. Let's turn to Slide 4, as I would like to highlight the industry-leading executive team we have assembled over the past year. Our leadership team is a balanced mix of new talent with best-in-class industry experience and proven Sensata performance. The team has demonstrated that they will rise to meet the challenge of the moment, and I'm confident that we have the right team in place to lead us through the next phase of our transformation journey. With that, let's turn to Slide 5, and I'll share a bit more about this past year's transformation. This year's performance demonstrates not only the progress we made, it also sets a benchmark for the organization we expect to be. We finished 2025 with a strong fourth quarter, capping off a year in which we met or exceeded our expectations across each of our key metrics for four consecutive quarters. The results are proof points for the progress we made across each of our key pillars. Let's start with operational excellence. We exited the year with Q4 adjusted operating margin of 19.6%, representing 30 basis points of year-over-year margin expansion despite headwinds from tariffs. With that strong finish in 2025, we delivered on our commitment of 19% adjusted operating margin for the year. This was a major inflection point for us, and it was the first year since 2021 without year-over-year margin contraction. This is a testament to the resilience we have installed in this business and the seriousness with which we take our commitment to our margin floor of 19%. Free cash flow has been an area of significant focus, and we believe our progress is a leading indicator of the impact to come from the operational improvements we are making. We made significant strides in improving free cash flow this year, generating a record $490 million at a 97% conversion rate. This conversion rate was an improvement of 21 percentage points from the prior year and is significantly higher than any year in our history aside from the abnormal 2020 pandemic year. With our strong free cash flow, we accelerated value creation through our capital allocation pillar, returning $191 million to shareholders through buybacks and dividends while also retiring $354 million of long-term debt in the fourth quarter. Our net leverage now stands at 2.7x trailing 12 months adjusted EBITDA and with $573 million of cash on hand as of December 31, we have ample liquidity. Our third key pillar is growth. In our long-cycle business, the initiatives we took this year to drive growth will show up in the quarters and years ahead, and we're already seeing compelling signs of progress. We delivered on our commitment to return to outgrowth in the second half of 2025, outgrowing production in Q3 and delivering 4% organic growth in Q4. With this progress, we are doubling down on our growth mandate moving forward. I'm tremendously pleased with the transformation that we've executed this year and the value we created in our first year on this journey. I also want to be clear that we are not done. What we have accomplished sets the foundation for an even brighter future. I'm excited to share more about the next phase of our transformation. Turn to Slide 6, and I will start by more clearly defining Sensata. Sensata is a uniquely diversified business. We install sensing and electrical protection products into multiple end markets, with automotive being our largest market. This at times creates confusion. Some see Sensata as an automotive business with exposure to other end markets. Others see Sensata as a diversified Industrial business with outsized automotive exposure. Neither view is entirely accurate. As we look towards the next phase of our transformation, we reconsidered how we are organized. We looked at factors such as business cycles, market cycles, customer mix, and go-to-market strategy. After careful evaluation, we reorganized Sensata into three operating segments, each with a distinct mandate for value creation and growth. These three segments are Automotive, which was approximately 57% of 2025 revenue; Industrials, which was approximately 21% of 2025 revenue; and Aerospace, Defense and Commercial Equipment, which was approximately 22% of 2025 revenue. Each operating segment is aligned to market verticals that are clearly delineated by customers, sales channels, growth drivers, and business cycles. Automotive is a relatively mature end market with limited underlying production growth, making this a market outgrowth-driven segment. We enjoy high volumes and revenue certainty tied to underlying vehicle production because our products are designed in on long-lived vehicle platforms. We outgrow production by increasing our content on vehicle platforms and by positioning the business to succeed on all propulsion technologies. Our ability to grow regardless of propulsion type is an enviable position in the automotive market compared to many of our peers and competitors who are leveraged primarily to either ICE or EV. This also positions us to grow in all geographies despite differing powertrain trends. Industrials is a highly diversified and primarily short-cycle business with a mix of direct to OEM distribution channel and project-based sales. Our Industrial segment includes derivatives of sensor products from our other end markets as well as products developed specifically for Industrial applications such as gas leak detection and certain electrical protection devices. Because the Industrial segment is so diversified, it offers the most growth opportunity in terms of new applications or markets for our products. This includes several areas with secular growth such as thermal management, grid hardening, and data centers. Aerospace, Defense, and Commercial Equipment is also highly diversified but is more long cycle and platform-driven. The end markets we serve include commercial aviation, defense, commercial trucking, construction equipment, and agricultural equipment. The platform lives in these markets are significantly longer than in automotive, often spanning multiple decades. The applications for our products cyclically support long service lives often in harsh environments, leading to much higher specifications and at premium price point for higher durability. Each of the markets we serve in this segment experienced cyclical growth. The cyclicality is influenced by macroeconomic factors as well as by government policies such as defense spending, environmental standards, tax incentives, and farm subsidies. As a result, we see a confluence of different cycles, often affording us the flexibility to manage the segment by balancing contracyclicality. Historically, the market thought of Sensata as having high automotive concentration and therefore being a market outgrowth business in a low-growth market. Sensata's growth history has, to a certain extent, reinforced that view. As we think about value creation moving forward, we see a much wider field of opportunity, which is best summarized in our three-part growth framework. Let's turn to Slide 7. First, we design, produce, and sell sensing and electrical protection products in multiple end markets, each with the different growth dynamics I just described. Second, we leverage our automotive scale and pedigree to our advantage. The high volumes and production certainty afford us the flexibility to manage through market volatility in our other end markets while underwriting growth investment. The high quality and delivery standards in automotive enable us to win in other markets. Third, we use the common characteristics of our most successful programs to set clear guardrails for new business opportunities. That means we stick to our core products and technologies while focusing on high-volume platform-driven business opportunities, serving mission-critical or regulated applications. As we develop growth strategies for each of our segments, we have been disciplined about filtering the market for growth opportunities that fit this framework, and we're excited about the opportunities we see. With that, I would now like to offer a glimpse into the next phase of our transformation, accelerating value creation by delivering growth in each of our segments. Let's turn to Slide 8, and I will discuss our Automotive segment, where our mandate is to foster our core business while delivering growth across all propulsion types. Recently, we have seen content accretive business opportunities on plug-in hybrid vehicles or PHEVs, and extended range electric vehicles or EREFs. This vehicle type is particularly attractive for Sensata. Allow me to illustrate as we turn to Slide 9. Approximately half of the dollar value of content that we have on a traditional ICE vehicle is outside of the powertrain and thus is still relevant on an EV. This includes sensor sockets in the air conditioning and brake systems as well as tire pressure sensors. On a typical EV, we see these same sensor sockets as well as additional content opportunity from electrical protection sockets in the electric powertrain and charging architecture. In aggregate, our content per vehicle opportunity on an EV is approximately double that of an ICE. In between ICE and EV are various hybrid platforms. A mild hybrid will look more like an ICE vehicle, while a plug-in hybrid or range extender will be more like an electric vehicle. Let's turn to Slide 10 to unpack this further. In 2026, in an automotive market that is expected to be approximately flat, PHEV and EREV production is expected to grow 17%. Over the balance of the decade, we expect a 12% CAGR for these vehicle types. The content potential on a plug-in hybrid or range extender is attractive due to the availability of all three socket categories: ICE powertrain, high-voltage electrical protection, and sensor content outside of the powertrain. As these vehicles win in the market, we expect they will emerge as a meaningful outgrowth driver for us and yet another proof point for our competitive advantage in not being indexed to any single propulsion technology. Now let's turn to Slide 11 and take a look at Industrials. Our Industrial segment has a strategic mandate to deliver growth across three key technology areas: power and peak management, thermal management, and electrical protection. We see demand over these products in multiple areas, including HVAC, appliances, buildings, and microgrid. One of the most compelling growth vectors is data centers, and I'd like to briefly click down to share more about where we see opportunity. Let's turn to Slide 12. In the past, we have shared that we have some content in data centers today, but that we are underpenetrated in this market. These opportunities span our key Industrial product areas. As you can see illustrated on this page, the content opportunity inside the data center is significant. Turning to Slide 13. There are meaningful opportunities outside the data center as well. One of our growth initiatives in 2026 is to expand our share in data centers. What I can share today is that in the fourth quarter of 2025, we stood up an initiative to deliver growth in data centers. We allocated some of our top performers to this critical growth initiative. And as we demonstrated in 2025, we take execution of our initiatives seriously. I look forward to sharing a positive update here as the year progresses. Lastly, I will discuss our Aerospace, Defense, and Commercial Equipment segment, starting on Slide 14. We serve multiple market verticals in this segment, which can be grouped as aviation, ground transportation, and off-highway equipment. We have a dual mandate for this segment to position the business to weather market cycles and to grow our aerospace and defense business into a more meaningful part of the portfolio. We see ample opportunities for revenue growth in the super cycle that is developing across both commercial aviation and defense. With that, again, I will briefly click down to share a bit more about where we play and where we see opportunity. Let's turn to Slide 15. Aerospace is one of our smaller and often overlooked market verticals today, yet it is one of the darlings of our portfolio with high margins and outstanding growth potential. Earlier, I talked about our automotive pedigree. In aerospace, pedigree matters too, being in flight on commercial airliners is the gold standard, and we're in flight today, both with position sensors and aircraft circuit breakers. Given the backlog for commercial aircraft, we expect meaningful growth from this part of our portfolio. With increased defense spending as a clear secular trend, let's turn to Slide 16 and take a look at that sector. UAVs offer high-volume platform-driven opportunities for both sensing and electrical protection products, perfectly aligned to the growth framework I described. We look forward on future calls to sharing more about our progress on accelerating growth in this key end market. With that, I will now turn the call over to Andrew to offer more insights into Q4 and full-year results as well as to share our outlook for 2026 and guidance for the first quarter.

Andrew Lynch, CFO

Thank you, Stephan, and good afternoon, everyone. Let's begin on Slide 18. As Stephan mentioned earlier, 2025 was a transformative year for us as we rolled out new initiatives framed around three key pillars. Our Q4 and full-year results are proof points for the progress we made. We reported revenue of $918 million for the fourth quarter of 2025, which exceeded the midpoint of our guidance range by $13 million. Fourth-quarter revenue represented an increase of $10 million or approximately 1% compared to $908 million in the fourth quarter of 2024. This was the first year-over-year quarterly revenue increase since the first quarter of 2024. On an organic basis, revenue increased approximately 4% year-over-year in the fourth quarter. We delivered adjusted operating income of $180 million and adjusted operating margin of 19.6% in the fourth quarter of 2025, an increase of 30 basis points, both sequentially and year-over-year. Adjusted operating margin was diluted by approximately 30 basis points due to approximately $15 million of 0-margin pass-through revenues related to tariff recovery. Excluding the dilutive impact of tariff pass-through, fourth-quarter adjusted operating margin increased by 60 basis points year-over-year and 40 basis points sequentially. Tariff pass-through revenues did not meaningfully impact sequential performance as we recorded similar levels of tariff cost and pass-through revenues in both the third and fourth quarter of 2025. Adjusted earnings per share of $0.88 in the fourth quarter of 2025 increased by $0.14 year-over-year as we delivered on our margin expansion plans. Adjusted net income was $130 million in the fourth quarter of 2025, an increase of approximately 16% year-over-year. We recorded approximately $50 million of restructuring-related and other charges in the fourth quarter. While these charges primarily related to our ongoing transformation efforts, they also included approximately $16 million of primarily non-cash charges related to an electric vehicle program cancellation by an OEM customer. These costs were excluded from our non-GAAP financial metrics. Now let's turn to Slide 19 to review our financial performance for the full year 2025. 2025 revenue was $3.70 billion compared to $3.93 billion in 2024, a decrease of 6%, primarily due to our previously disclosed divestitures and product life cycle management actions. On an organic basis, revenues were approximately flat year-over-year against a challenging market backdrop. We delivered $705 million of adjusted operating income in 2025, which was a decrease of 6% from $749 million in 2024, primarily due to lower revenue. Adjusted operating margin was 19.0%, flat to 2024 despite the 6% lower revenue as our productivity gains offset any deleveraging impacts. 2025 adjusted operating margin was diluted by approximately 20 basis points due to approximately $40 million of 0-margin pass-through revenues related to tariff recovery. Excluding the dilutive impact from tariff recovery, 2025 adjusted operating margin increased by 20 basis points year-over-year. 2025 adjusted earnings per share of $3.42 decreased by $0.02 year-over-year, and 2025 adjusted net income of $503 million decreased by approximately $16 million year-over-year. The primary driver of these decreases was lower net revenue due to product divestitures. Adjusted net income as a percentage of net revenue increased by 40 basis points year-over-year from 13.2% in 2024 to 13.6% in 2025. Now let's turn to Slide 20 to discuss our free cash flow performance. We delivered record free cash flow of $490 million in 2025, an increase of 25% compared to 2024 free cash flow of $393 million. Free cash flow conversion was 97% of adjusted net income, an increase of 21 percentage points year-over-year. In 2025, we reduced net leverage from 3.0x trailing 12-months adjusted EBITDA as of December 31, 2024, to 2.7x as of December 31, 2025. In the fourth quarter, we took advantage of favorable bond market conditions to retire $354 million of our long-term debt. In connection with this transaction, we recorded a net gain of approximately $3 million, which we excluded from our adjusted operating results. Turning to Slide 21. We returned $191 million to shareholders in 2025, which consisted of $121 million in share buybacks and $70 million in dividend payments. Last month, we announced our first-quarter 2026 dividend of $0.12 per share payable on February 25 to shareholders of record as of February 11. Our capital allocation strategy continues to prioritize deleveraging as a means to compound value for our shareholders. ROIC in the fourth quarter increased to 10.6%, which is an improvement of 40 basis points year-over-year compared to the fourth quarter of 2024. Now let's turn to Slide 22, and I will walk through the results for our segments for the fourth quarter of 2025. In connection with the reorganization that Stephan described, our reporting segments are now Automotive, Industrials, and Aerospace, Defense, and Commercial Equipment. This new segmentation reflects a reorganization of our business and leadership to align with our strategic imperatives and to most effectively execute our strategy. With this new reporting structure, we look forward to giving investors enhanced visibility into our business results and the ongoing progress of our transformation journey. Growth is an increasingly important metric for us as we move to this next phase of our transformation journey. We were pleased that each of our segments delivered year-over-year organic revenue growth in the fourth quarter. Automotive segment net revenue was $527 million in the fourth quarter of 2025, a decrease of approximately 1% year-over-year on a reported basis, primarily due to product divestitures. Organically, revenue increased approximately 1% year-over-year, which was approximately in line with the market. Segment adjusted operating income was approximately $129 million in the fourth quarter of 2025 or 24.4% of segment revenue, representing year-over-year margin expansion of 100 basis points. Industrial segment net revenue was $191 million in the fourth quarter of 2025, an increase of 6% year-over-year on a reported basis and 8% organically. This strong year-over-year growth was driven by continued growth in our gas leak detection business. Segment adjusted operating income was $59 million in the fourth quarter of 2025 or 30.9% of segment revenue, representing year-over-year margin expansion of 620 basis points. Finally, Aerospace, Defense, and Commercial Equipment segment net revenue in the fourth quarter of 2025 was $199 million, which grew approximately 4% year-over-year on a reported basis and 7% organically. Segment adjusted operating income was approximately $56 million in the fourth quarter of 2025 or 28.1% of segment revenue, representing year-over-year margin expansion of 310 basis points. Adjusted corporate and other costs include higher variable compensation costs associated with the improved segment performance. Before we get to our guidance for the first quarter of 2026 and outlook for the year, I will share what we are seeing in our end markets. Let's turn to Slide 23. In automotive, we saw Q4 light vehicle production growth of a modest 2%. For the year, we saw light vehicle production growth of nearly 4%, with the market in China growing 10%, while production in the West, where we have higher content per vehicle, decreased by 1%. Looking ahead to 2026, we expect global light vehicle production to be flat to down 1% with similar trends across each region. In Q1, we expect global light vehicle production to decrease by 3% to 4%, and then we expect modest year-on-year production growth each quarter thereafter. In our Industrial segment, 2025 GDP growth was just under 2% in the West and just over 4% in Asia. We expect similar regional growth differences in 2026, including in the first quarter. Our Industrial business is primarily indexed to housing, construction, and HVAC, and we continue to see soft end market demand and limited year-on-year market growth as the market works through the drawdown of inventory that was built up in response to tariffs and regulatory changes. We expect this drawdown to continue through the first half of 2026, and we are optimistic that market expectations for lower interest rates set up a second-half recovery. In our Aerospace, Defense, and Commercial Equipment segment, North America On-Road truck production decreased 26% year-over-year in 2025 and decreased 22% in the fourth quarter. We are expecting similar decreases through the first half of 2026, followed by modest recovery in the second half with an overall production decrease in the mid-single digits for the year. However, as this end market recovers in the second half of 2026 and ramps sequentially from the first half, it will be margin accretive for us. In Aerospace and Defense, we saw low single-digit blended growth for both Q4 and full-year 2025, and we are expecting similar growth throughout 2026. With that, let's turn to Slide 24, and I will walk through our expectations for the first quarter of 2026. We expect first quarter revenue of $917 million to $937 million, adjusted operating income of $168 million to $175 million, and adjusted operating margins of 18.4% to 18.6%. Adjusted net income of $118 million to $125 million and adjusted earnings per share of $0.81 to $0.85. At the midpoint of our guidance range, we expect year-over-year revenue growth of approximately 2%, year-over-year adjusted operating income growth of approximately 3%, year-over-year adjusted operating margin expansion of 20 basis points and year-over-year EPS growth of $0.05 per share. At the midpoint of our guidance range, we have assumed approximately $12 million of tariff costs and pass-through revenues. As noted in our press release and earnings materials, our guidance and tariff assumptions are based on trade policies and tariff rates in effect as of February 18, 2026, and do not incorporate any impacts from potential changes to trade policies. As we discussed last quarter, our Q1 guidance range reflects Q4 to Q1 margin seasonality related to the timing of customer pricing, supply chain productivity, and inventory turns. We have taken measures to improve this dynamic, which is reflected in the 110 basis point step down at the midpoint of our guide compared to the approximately 200 basis points experienced during the reference period of 2015 to 2019. Similar to 2025, we expect margins to normalize to 19% or better in the second quarter and then expand each quarter thereafter. While we are not providing full-year guidance, I would like to share some early thoughts on our outlook for 2026. We currently expect low single digits year-over-year revenue growth. We expect to participate in market growth in both our Industrials and Aerospace, Defense, and Commercial Equipment segments, and we expect to deliver market outgrowth in our Automotive segment. Precious metals pricing has emerged as a headwind for us to mitigate in 2026. Our most significant exposures are silver, gold, and platinum, all of which we hedge, affording us time to work through pricing with our customers. With the work we did to mitigate tariffs last year, we developed a toolkit of measures which we are now deploying to manage precious metal inflation. We do not see risk to our Q1 guide associated with metals. On a full-year basis, we expect to offset any precious metals headwinds through a combination of supply chain optimization, product redesign, and pass-through of these costs to our customers. Our cost recovery muscle is well developed, and we take margin resilience seriously. We reiterate our annual margin floor of 19%. However, we are targeting margin expansion of at least 20 basis points on a full-year basis. Finally, with respect to free cash flow, we were thrilled with our 2025 free cash flow performance, converting at 97% of adjusted net income, which allowed us to accelerate the execution of our deleveraging plans. As we look ahead to 2026, we may see slightly lower free cash flow conversion than what we delivered in 2025, particularly in the first half of the year. First quarter seasonality is impacted by variable compensation payments related to prior year performance, which in 2026 are approximately $20 million higher than they were in 2025 due to the stronger underlying performance. We have additional seasonality related to interest payments, which are largest in the first and third quarter. Consequently, we expect Q1 free cash flow conversion to be our seasonally lowest quarter and likely below our 2025 result, primarily due to the higher variable compensation payments. On a full-year basis, we are targeting performance in the high 80s, well above the 80% floor that we established last year. With that, I will now turn the call back to Stephan.

Stephan Von Schuckmann, CEO

Thank you, Andrew. Let's turn to Slide 25, and I'll make a few closing remarks. I'm tremendously pleased with the 2025 results that Andrew just shared. We are in the early stages of what we expect will be a multiyear transformation journey. However, these results are evidence of just how significantly our business has changed for the better in such a short period of time. As we look ahead to 2026, we are in a fundamentally different place than we were a year ago. We have built an organization that is intently focused on execution, and we have adopted a highly structured way of working. We start with KPIs that are designed to create value. We underpin those KPIs with targets that are benchmark-driven, always against best-in-class performance. For each target, we define metrics against which we regularly evaluate progress. And behind those metrics are a pipeline of measures, each with accountable owners. The structured style of working is deeply ingrained in our organization. While 2025 was indeed a compelling proof point that our approach is working, maximizing value creation must always be our goal. Unlocking value means continuously raising the bar. As we turn the corner into 2026, we must build upon the foundation we laid in 2025. We have taken bold steps to do exactly that. We have reorganized our business into three distinct operating segments, each with unique growth and end market characteristics and specific growth mandates. We developed a clear framework through which to pursue growth, and we installed the right leadership team, including new segment leaders to execute the next phase of our transformation journey. As with everything we do, the goal of this transformation is value creation, and that is how we will measure our success. I could not be more excited for what is ahead. The future is bright, and I look forward to updating you on our progress along the way. I'll 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. In order to ensure adequate time for all participants to ask a question, we will limit each participant to one question. Should you wish to ask a follow-up question, please reenter the queue. Operator, please introduce the first question.

Operator, Operator

The first question today comes from Wamsi Mohan with Bank of America.

Wamsi Mohan, Analyst

Stephan, given the transformation underway where you've made a lot of progress here, can you just talk about how you see the longer-term revenue potential of the portfolio? I appreciate your 2026 guidance that you have given. But how should investors think about the ultimate revenue growth potential here over a longer period of time, especially since you emphasized how key it is to your strategy?

Stephan Von Schuckmann, CEO

Wamsi, thanks for the question. So I think it's very important to mention that the overall growth opportunity that we've shown you on the slides today and especially in the call and in the different segments, that is real. So it's definitely real growth. We have different products, different solutions for each segment. So we feel that's real, and that's definitely also the next building block of value creation. Secondly, we have a very clear growth mandate per segment. And also equally important to mention, we have the right team in place to execute this growth. So we've had our proof points, as we've mentioned in the call, and Sensata has returned back to growth in the second half of 2025. And additionally to that, we have a broad opportunity for growth across all products and all segments. So if you ask me, I feel really good about the growth opportunities that we have in 2026, and I feel equally optimistic around the growth opportunities that we've shown in each and every segment in 2027 and onwards. Yes, there's still a lot of work to do. And we still need to penetrate some of these markets and some we're in, like I've mentioned. But I feel very confident that we're on a good track, and I feel very confident about growth going forward in 2027 and onwards.

Operator, Operator

The next question comes from Joe Giordano with TD Cowen.

Joseph Giordano, Analyst

I think you all explained the segmentation well, particularly the reasoning behind it. My first impression was that two of these segments are relatively small, and this is a company focused on efficiency. So, Stephan, can you discuss how you balance having three reporting structures and three presidents? It seems to introduce more fixed structure. How do you weigh that against the benefits of separating it this way?

Stephan Von Schuckmann, CEO

Let me let Andrew start on the fixed cost structure part on the overhead, and then I'll jump in. Thanks, Joe.

Andrew Lynch, CFO

Yes. So Joe, I mean, just from a cost perspective, you're right. We've added a little bit of cost to the overhead structure here in our corporate costs, and we expect that to be sort of the normalized run rate moving forward, taking variable compensation costs out. That was a little higher in Q4. But in general, we expect the second-half run rate to sort of be our normalized run rate moving forward. We expect that to pay for itself. I mean the expectation is that, that's an investment. And with that investment, we will drive growth and margin expansion in each of our segments that more than offset that incremental cost. And I'll let Stephan talk to the thinking around strategy here.

Stephan Von Schuckmann, CEO

Exactly. So Joe, I see it as this, the re-segmentation, and we mentioned it in the script, is all about value creation. And we've been executing, which is the first building block around value creation. But if you look at the second building block, which is everything around growth, we felt that this segmentation gives us this level of opportunity. And allow me to order that a bit strategically. So the re-segmentation is anchored in our end markets. And I think that's very important around value creation. It also reflects how we structurally manage and operate the business at Sensata despite now having three instead of two segments. What it also does, it strengthens alignment with our strategic pillars. So driving focused growth and again, operational excellence, which was a focus in 2025, and does this by recognizing the distinct characteristics and value drivers of each segment. That alone is, for me, value creating. And additionally to that, each segment now operates with a clear growth mandate and defined accountability, supported by designated leadership which is responsible for executing these very segment-specific strategies. So that's our path to value creation by splitting up into three segments coming from two in the past.

Operator, Operator

The next question comes from Mark Delaney with Goldman Sachs.

Unknown Analyst, Analyst

You mentioned targeting low single-digit growth in the Auto segment for 2026. You also discussed focusing on bookings with domestic OEMs in Asia and China. Could you elaborate on how those bookings with domestic companies are performing and how they, along with other factors, influence the low single-digit growth expectation for 2026?

Andrew Lynch, CFO

Yes. Absolutely. Thanks for the question. Do you want to start?

Stephan Von Schuckmann, CEO

To address the topic of securing more business in Asia, I'll clarify in this manner. Since our last call, we've made significant strides in business development over the past few months. We’ve enhanced our Asia team, particularly by appointing a President for China, Jackie, who has been notably successful in acquiring new business within the region. Since our previous discussion, Jackie has secured additional contracts, especially with Chinese OEMs. This achievement positions us positively, and I'm optimistic about our progress. We have also gained business with contractors and expanded our offerings in sensing technologies, leveraging our facilities for broader business successes. Looking at the region from a wider perspective, we have also established solid business relationships in Japan. For instance, we have doubled our revenue with a prominent Japanese OEM and have recently captured more business in Japan. My recent visit to Japan highlighted the impressive achievements of our team there. Moreover, while visiting, I went to South Korea to connect with our local team, where we've also secured significant contracts with customers. Notably, the content per vehicle from the business we've acquired in South Korea has surpassed that of North American OEMs, which is traditionally our highest content per vehicle market. This indicates considerable progress on our part. While there remains much work to be done, we have ambitious goals for 2026, but I am very pleased with the advancements we've made in China, Japan, South Korea, and throughout Southeast Asia.

Andrew Lynch, CFO

Yes. I'll just add on the content per vehicle dynamic. As you noted, we had a challenge earlier in the year with our mix and our exposure to local OEMs. The enabler for us returning to outgrowth in Q3 was effectively that we've overcome that headwind. We won enough business with local OEMs in China that if you take the top 10 to 20 OEMs in that market and compare them to the multinationals where we've historically had really strong content, we're effectively at parity. And so we've overcome that mix headwind in China, which has enabled us to outgrow that market in the back half. And then more broadly, the automotive market as a whole, we saw production start to normalize in the sense that China was not outgrowing the broader market by such a rate that it made it impossible to outgrow the market. And we expect similar in '26. We expect market growth across regions to be more or less similar. And so our content difference in China will be less relevant because of the similar market growth in each region.

Operator, Operator

The next question comes from Robert Jamieson with Vertical Research.

Robert Jamieson, Analyst

I want to return to the new segment structure. The separation clearly makes sense, and as Joe mentioned, there are some costs associated with it. However, as we look ahead, could this allow you to be more agile in your organic reinvestments across different segments, especially since you have dedicated leadership? This could enhance your ability to seize opportunities more quickly and drive growth throughout the cycle, particularly with your focus on succeeding with the right products and customers in your portfolio. Is this the correct way to view this change?

Stephan Von Schuckmann, CEO

To keep it short, that's exactly the right way to see it, yes. That's exactly the thinking behind it. Each segment that we've defined is unique for itself and has ample opportunity for growth. With a strong and partially new leadership team in place, we feel confident that we can generate value by doing that. I think you summarized it very well.

Operator, Operator

The next question comes from Joseph Spak with UBS.

Joseph Spak, Analyst

I wanted to discuss some of the opportunities you mentioned in the data center, and I know you have some content both in and out, as highlighted in the slides. Some of that appears to be new for '26. My question is, as you form this team to focus more on the opportunity, is this expected to mainly produce organic results? If so, will that involve leveraging existing technology and discovering new applications, or does it indicate new R&D? Are there any potential inorganic opportunities that might arise? Additionally, I know you've taken nearly $400 million in write-downs on Dynapower, but did any of those involve asset write-downs? If you start utilizing that technology for these opportunities, could the margin improvement be significant?

Stephan Von Schuckmann, CEO

Thank you for your question. I’d like to explain our perspective on data centers and the organic growth opportunities available. First, it's important to note that our products are already present in operational data centers. This includes products used both inside and outside of data centers. Inside, we focus on electrical protection like circuit protection, circuit breakers, and fuses. We also have sensing products, such as pressure and temperature sensors, and refrigerant leak detectors, which are actively utilized in current data centers. These products are integrated into the designs of hyperscalers that use Sensata’s technology. Similarly, for products outside of data centers, we have solutions for power management and electrical protection, including converters and motor protection devices. All of these are existing products that contribute to organic growth as data centers expand in line with our designs. Furthermore, we are also involved in designing products for future data center concepts specified by hyperscalers. Once our products are approved, they are integrated into new projects. We aim to have our designs included in the majority of future hyperscaler concepts, with ambitions for 2026 targeting companies like Google, Amazon, and Meta. Additionally, we plan to leverage our sensing capabilities to develop unique products, which will enhance our current portfolio through our own R&D. For instance, we're working on a specific flow sensor tailored for data centers, which will meet the demands of upcoming projects we are currently discussing. In terms of focus areas, we are particularly concentrating on liquid cooling solutions for data center racks, where we believe we hold a competitive edge. Overall, we have a robust position with our existing products, a wealth of ideas for new products in development, and significant opportunities for growth in the data center market.

Andrew Lynch, CFO

And on the Dynapower question, just to add some clarity there. So the charge that we took was a goodwill impairment charge. And so we won't see any margin lift associated with lower amortization or depreciation for that example. But I think it does raise an important point, which is how we think about margin expansion and productivity. And we're focused on real margin expansion. And so when we say we're looking to expand margin at least 20 basis points next year, we're focused on doing that through a combination of improved volume and volume leverage and productivity. One of the things that will help margins over time is the fact that we've gotten more disciplined about our capital expenditures and deploying flexible line concepts to keep CapEx lean, and we expect that will show up in lower depreciation expenses over time. But our focus is on real margin expansion and not write-offs.

Operator, Operator

The next question comes from Luke Junk with Baird.

Luke Junk, Analyst

Just curious about a couple of the newer areas that you unearthed tonight, specifically data center and defense. Just wondering if you'd be able to speak to materiality for both of those in terms of percentage of sales today. And then just as we're trying to think about the growth profile potential, I don't know if you could speak to any historical growth in terms of recent growth trends or maybe put a finer point on some of the opportunity from here?

Andrew Lynch, CFO

Sure, Luke. I'll take the first part of that question on the size of the segment. So Aerospace, Defense, and Commercial Equipment segment in total is about $800 million of revenue on an annualized basis. If you break that down, there's obviously multiple market verticals that we serve within that segment. I'll give you sort of a high-level breakdown. About 40% of that is on-road truck across the three key regions that we serve there. Another roughly 25% tied to the construction end market. Another roughly 10% tied to the agricultural market. The balance of that segment would be in other off-road vehicles as well as commercial aviation, defense, aftermarket, distribution. Those all break down pretty equally in sort of the 7% to 10% size range each. So pretty diversified. And within those, we see the highest growth opportunity from end markets in commercial aviation and defense given the higher level of spend. And then on top of the end market growth opportunity, there's obviously opportunity around new content that we called out. And I'll turn it over to Stephan to talk a little bit more about the growth that we see.

Stephan Von Schuckmann, CEO

Exactly. So let me explain the growth opportunity around defense in a bit more detail. So here, I think it's important to mention, we also said it in the script, we're obviously in a period of a supercycle growth of EU and U.S. Defense spending. And Sensata has a fantastic opportunity to participate in this growth. And today, there are multiple defense applications being served with our products across fighter jets, helicopters, ground transportation vehicles. These are obviously all strongly growing applications. And then we have the emerging UAV, or unmanned aerial vehicle market, where we really see significant growth opportunities. And you also saw in the slide that within those UAVs, we really have existing business with all different types of products in powertrain systems, precision sensing and feedback, flight control and actuation systems, and mission systems and targeting, where we have a broad range of products within the actual drones or UAVs today. And because this market where we expect a double-digit percent CAGR is growing significantly, we feel we're going to participate with our products in that growth.

Luke Junk, Analyst

Andrew, would it be possible just to break down the Industrials segment as well, similar from an end market standpoint, quick?

Andrew Lynch, CFO

Sure thing. Industrials, as you know, we've historically talked about that in terms of commercial versus residential. And I think that split still largely applies. We're focused on those verticals rather than applications, like we've previously disclosed. So I'll just give you the breakdown here. So that resi and commercial sort of combined would be about 80% of the segment and then the remaining 20% would be the clean energy opportunities that we see around, for example, Dynapower microgrid applications outside of the data center as well as electrical protection components that we sell into grid hardening applications.

Operator, Operator

The next question comes from Samik Chatterjee with JPMorgan.

Manmohanpreet Singh, Analyst

This is M.P. speaking on behalf of Samik Chatterjee. I wanted to ask how much of the industrial growth during the full year was associated with A2L gas leak detection sensors, and how did the rest of the industrial business perform throughout the year? Additionally, regarding the flow sensor you plan to launch in 2026, will it provide a similar contribution as the A2L this year?

Andrew Lynch, CFO

Yes, I'll address the first part of the question regarding size. We launched A2L last year, and in 2024, we generated approximately $10 million to $15 million in revenue, primarily in the fourth quarter. This is expected to increase significantly to around $70 million in 2025. Therefore, you can consider the year-on-year growth to be in the range of $50 million to $60 million. We anticipate it will stabilize at over $100 million in annualized run rate business as we continue to secure additional wins and as the market develops.

Stephan Von Schuckmann, CEO

Let me add that we've had a successful year in 2025, winning two significant new businesses with long-term agreements with A2L. This is a considerable achievement for us. The team has excelled in filling our order books, and we hold a substantial market share in North America. What's interesting about this business, as we discussed during our trip to Japan and Korea, is that depending on regulations, we also see great opportunities there. The market size in North America is approximately $150 million, and we see a similar market potential in Southeast Asia, particularly in Japan and South Korea. This represents a strong opportunity for us. Additionally, we are working on a business of similar size with A3. We anticipate significant growth in 2025 and expect continued growth into 2026 and beyond, especially if we gain traction in South Korea and Japan, which will also be beneficial for us.

Operator, Operator

The next question comes from Konsta Tasoulis with Wells Fargo.

Konstandinos Tasoulis, Analyst

How long have you been working on the data center opportunity, and where do you see the greatest value-add potential? Which area do you believe is more differentiated: electrical protection or sensors? Additionally, do you think this could lead to another significant revenue opportunity, similar to A2L and the leak detectors, in the next year or two?

Stephan Von Schuckmann, CEO

We have been focusing on this for a significant amount of time, especially in 2025 where we've ramped up our efforts. The scope is quite broad; it's not limited to just one category of products like electrical protection sensors. When we discuss designing for future data center concepts, we're not just concentrating on a specific product range. We're exploring all the opportunities we've mentioned, both within and outside of data centers. Please allow us some time as this is still in development, and we will provide more detailed updates in future quarterly calls. We see a lot of potential here and are confident that this could become a major growth driver for our segment and for Sensata.

Operator, Operator

The next question comes from Steven Fox with Fox Advisors.

Steven Fox, Analyst

I was just curious if you could provide any more color around the segment margins from the aspects of where do you see the most opportunity for margin expansion and maybe where the incremental margins may differ?

Andrew Lynch, CFO

We are focused on expanding our operating margins across all segments over time. Growth will play a significant role in this margin expansion, and we anticipate higher growth opportunities in the Industrials and Aerospace, Defense, and Commercial Equipment sectors due to the stronger market growth we expect in those areas. In Automotive, we aim to outpace the market by a few percentage points, targeting a variable contribution margin in the 20% to 30% range, depending on the product mix and region. The outlook for Industrials and Aerospace is similar, but with higher growth rates.

Stephan Von Schuckmann, CEO

When it gets to strengthening our margins, we don't differentiate between segments. So when we speak about improving productivity or plant performance irrespective of the individual segment, we do that across all segments. When we speak about reducing product costs, we tackle all our products in every single segment. We don't only focus on specific products per segment. So it's an exercise that we've been pushing very hard in 2025 overall businesses that we have with Sensata, and we're going to do exactly the same, if not even harder in 2026 going forward. So it's not a specific segment-related exercise. This is a very, very broad initiative to push on margin improvement.

Operator, Operator

The next question comes from Shreyas Patil with Wolfe Research.

Shreyas Patil, Analyst

Looking at Q4, you noted that the organic growth in the auto sector was 1%, while industry production increased by 2%. It seems you lagged behind the market by about 1 point. You mentioned low single-digit outgrowth expectations for '26. Can you provide some insight into the factors driving outgrowth this year? Additionally, are there opportunities to add content in areas beyond the powertrain, such as domain consolidation or autonomy?

Andrew Lynch, CFO

Yes, sure. I'll take the first part of that question. So a little bit of this is a function of using whole numbers here on the percent. But yes, you're right, the Auto production rounds to 2% and our revenue rounded to 1%. Biggest reason for that is, again, regional mix. So if you unpack the growth rates in Auto production in the fourth quarter, China grew about 4% year-over-year in Q4. The North America and Europe both decreased by about 0.5%. Korea, where we mentioned we now have even higher content per vehicle, dropped by about 6% year-on-year in the fourth quarter. And so while there was average market growth of close to 2%, the market mix of where that growth occurred was not in our favor from a content per vehicle perspective. Looking ahead to 2026, as we look at third-party production forecasts as well as what we're hearing from our customers and seeing in our order book, we're seeing relatively similar growth rates in every region. And so we don't expect this regional mix dynamic to be meaningful in 2026. And that's important because as the regional mix and growth rates normalize, our underlying content growth will be the true driver of our market outgrowth.

Stephan Von Schuckmann, CEO

Let me add to that. You asked about growth opportunities, so I want to start broadly. Sensata is in a very advantageous position because we can grow in any region and with any type of application, whether it's an internal combustion engine, hybrid, or electric vehicle. This means we can adapt to the pace of electrification, whether it speeds up or slows down. For example, with the strong push for electrification in China, we have significantly increased our content in internal combustion engines. Winning business in that market will support our growth. Additionally, we see potential for growth in the plug-in hybrid and electric vehicle market, which is growing at a rate of 12% annually. If we secure business with plug-in hybrids or extended-range electric vehicles, we will grow in line with where they are sold the most. This presents another opportunity for Sensata to increase our content and drive growth.

Operator, Operator

The next question comes from Joe Giordano with TD Cowen.

Joseph Giordano, Analyst

I appreciate the follow-up here. One thing I just wanted to like a more existential question, I guess. But Sensata in the past got itself into trouble by chasing the shiny thing, right, and then ending up with a bunch of businesses that were subscale. So as you talk about small businesses today into attractive markets like data center and grid hardening and all these things, I think we all appreciate why Sensata would want to chase that. But how do you make a decision and be confident that these are businesses that we should win, that we can participate in profitably and then we can ultimately have scale and kind of prevent the same issues that we all kind of saw years ago?

Stephan Von Schuckmann, CEO

In this case, it's important to note that many of these products are already part of Sensata's current offerings. They fall within our existing product range, which may include the automotive sector and other areas of our business. This means we're not developing entirely new products; rather, we're making slight adaptations to existing ones. We maintain high standards and quality, allowing us to apply our automotive products to other applications, such as data centers. Thus, I believe the associated risk is manageable. Furthermore, if you consider our growth strategy, we aim to maximize value from our core products, which is achievable because we’re utilizing our established product portfolio. We also intend to leverage our scale and expertise. Many of these products are already manufactured at a high scale with existing production lines and equipment, which means no new assets or plant structures are needed. We take advantage of our competitive global footprint to produce our products, adjusting them for a new market segment. Additionally, we have established stringent standards for this new business area. It's essential that it be a high-volume, platform-driven operation that is mission-critical and regulated. These criteria are significant to us, and the applications must also be complex. We have set high standards for ourselves before entering these markets or expanding into new segments to effectively manage risks.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to James Entwistle for any closing remarks.

James Entwistle, Senior Director of Investor Relations

Thanks, everyone, for joining today's presentation. This concludes our fourth quarter and full year 2025 earnings conference call. Operator, you may now end the call.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.