Earnings Call Transcript - ST Q1 2026

Operator, Operator

Good afternoon, everyone, and welcome to the Sensata Technologies Q1 2026 Earnings Call. The operator provided instructions for participating in the question-and-answer session. Please also note, today's event is being recorded. I would now like to turn the conference call over to Mr. 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'd like to welcome you to Sensata's First Quarter 2026 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. A 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 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 earnings 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 then cover our detailed results for the first quarter of 2026 and our financial outlook for the second quarter of 2026. Stephan will then return for closing remarks. After that, we will take your questions. Now I would like to turn the call over to Sensata's Chief Executive Officer, Stephan Von Schuckmann.

Stephan Von Schuckmann, Chief Executive Officer

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'd like to begin today with an update on Sensata's transformation journey. When we talk about transformation at Sensata, what we mean is that we have embarked on a journey to unlock untapped potential across our organization. We are encouraged that the market has taken notice of the progress we're making. However, what I find even more exciting is the vast opportunity ahead of us. Tapping into that opportunity means maximizing value for our shareholders, sustainably over the short and long term. We'd like to think of this as a pursuit of excellence over multiple phases, and that we are still early in this journey. The initial phase, which we completed last year, was to define what 'exit' looks like and systematically build it into the foundation of our business. Our next phase is one of acceleration, expanding on the foundation by delivering incrementally better performance and increasing focus on strategic initiatives in pursuit of our aspiration to be best-in-class. And finally, transformation maturity means achieving and sustaining best-in-class performance and market leadership. Last year, as we embarked on the first phase of our journey, we defined what 'exit' looks like for us. And we deployed a key pillars framework designed to maximize value creation. As we built up a system around those pillars, we focused on consistency of execution, sequentially improving each quarter and creating value for our shareholders. When updated during February on our year-end call, I shared that this framework is now foundational to everything that we do and is deeply ingrained in our business. As we advance to the next phase of our journey, our priorities framework is, first, to retain the consistency of execution and margin resilience that we installed in the business over the past year. Second, to continuously compound value by delivering year-over-year growth and margin expansion, not only in aggregate but now also at the segment level. And third, to fulfill our growth mandate by delivering on our near-term growth targets while also, importantly, priming our future growth engine as we work on the strategic growth initiatives we laid out for each of our segments. In this phase of our transformation, these priorities are all equally important. Balancing strategy, growth and executing effectively is the standard to which we hold ourselves. Just as we did last year, each quarter, we will update you with proof points of our progress. Before we get to the first quarter proof points, allow me to set the stage on where we have made progress these last few months. Our new leadership team is gaining meaningful momentum in their respective areas. Nicolas and our operations team are making progress on inventory reduction and supplier payment terms optimization, which is evident in our first quarter cash conversion. Similarly, with improved focus on factory performance, productivity is accelerating, which is demonstrated in our first quarter margin expansion. Marcus, Elis and Brian have hit the ground running in their respective roles, and I will share more color on this as I provide segment updates in just a few moments. Before we get to the segments, let's turn to Slide 4, and I will briefly cover our strong first quarter results, which clearly demonstrate the continued and consistent progress that we are making. We delivered revenue and adjusted operating income at the high end of our guidance range, and we exceeded our expectations on adjusted EPS and free cash flow. Free cash flow of $105 million was again a bright spot and this represented 83% conversion, outpacing the first quarter of 2025, which is particularly noteworthy as 2025 was a record year for Sensata. With our improved free cash flow, we progressed further on our deleveraging journey. The results of the quarter are indicative of the progress we are making on our transformation journey and demonstrate that our strategy is creating value for shareholders. This is evident in the quarterly results, but also in the sustained improvement in return on invested capital, which has continuously increased and now stands at 10.8%. Last year, I spoke a lot about margin resilience, which requires operating our business with an inherent understanding that headwinds will arise. To prepare for this, we continuously make structural improvements, which increase our underlying earnings power. Margin resilience not only positions us to manage through headwinds, it also ensures we maximize the benefit from tailwinds. Our Q1 results are an example of margin resilience in action. Despite multiple headwinds, including precious metal inflation of over 100%, our first quarter adjusted operating margins improved by 30 basis points year-over-year to 18.6%. This stands in sharp contrast to the first quarter of 2025 when our results decreased 40 basis points from the prior year. While I'm pleased with our consolidated results for the first quarter, I'm even more excited by the performance we are seeing in our segments with our reorganized business. Growth in our clear strategic focus and our Q1 results are indicative of the progress that we are making as we delivered organic growth in each of our segments. Let's turn to Slide 5, and I will take you through a few highlights for each of our segments. In our Automotive business, we again delivered market outgrowth, demonstrating our ability to grow regardless of powertrain mix. As you may recall, we returned to market outgrowth in the back half of 2025 after several challenging quarters. Our growth accelerated to 4% in the first quarter as we are gaining traction on multiple fronts. For example, in Europe, we are outgrowing production as our content per EV continues to improve. In the U.S., we're outgrowing production as our portfolio benefits from the resurgence of truck and SUV production. We're also securing future growth stacking electrification wins with innovative new products, such as our high-efficiency contactor, or HEC, and our Folta contactor, where we have secured meaningful new business wins in both Europe and the U.S. For example, in Europe, we secured a design win on an EV platform at a large German automotive OEM leveraging our HEC to enable switching between 400- and 800-volt charging architectures. In China, our local contactor volume continues to ramp as we expand our business with key local OEMs, and we are now gaining traction with battery and battery systems manufacturers. Japan and Korea continue to be growth accelerators for us as we enjoy our highest content per vehicle in Korea, and we continue to grow our market share with leading OEMs in Japan. We're also seeing green shoots of our next wave of growth in automotive with our performance in India. We are significantly outgrowing production in this fast-growing market, and our revenue with a key OEM more than doubled year-over-year. Andrew will cover our detailed Q2 guidance and the full year outlook in his remarks. But as I speak about automotive, I want to take the opportunity to assure you that while we are thrilled with our first quarter results and excited about our second quarter outlook, we are also clearly aware of some of the end market demand risks that are posed by geopolitical events and the effect on oil prices. In the spirit of margin resilience, we have developed plans for a number of scenarios and we are prepared to act swiftly to preserve our margins in the event that automotive end markets deteriorate. Our Aerospace, Defense and Commercial Equipment segment was a star performer in the quarter with double-digit organic growth. Our truck production remains soft, particularly in North America, but we're seeing increased demand for build slots in the back half of the year. Given the longer lead times for these vehicles, we're now entering a replenishment cycle. We also observed an increase in demand from our diesel engine and power generation customers as they are benefiting from the demand for generator sets tied to data center construction. Aerospace and defense continues to experience steady mid-single-digit growth driven by both strong commercial backlog and increased military spending. In addition to ramping up to supply the market-driven growth, we are focused on securing our share of well-timed near-term content growth opportunities in defense applications. We recently secured a circuit breaker win from a German manufacturer of armored ground transport vehicles for a defense application in Europe, and we have similar opportunities in Europe in our pipeline. We're also closely monitoring recently publicized developments around the U.S. government asking traditional automotive OEMs to support defense production. It's still too early to quantify any impact, but we will update you should opportunities materialize. Our industrials business continues to experience end market softness, particularly in HVAC, where unit shipments in the North America market decreased in the first quarter. Nonetheless, we delivered modest organic growth primarily through share gain. We booked two additional HL leak detection wins in the first quarter, further expanding our market leadership position as this product line continues to be a growth accelerator in North America. We remain focused on expanding this product offering into Europe and Asia. In the near term, European heat pump demand has returned to growth, supported by elevated fossil fuel prices alongside policy incentives, energy security concerns and improving cost economics. We expect this combination to be a positive demand driver for us over time. Let's turn to Slide 6. I'd like to elaborate on the data center opportunities in our industrial business. We have increased conviction around our right to win in data centers, building on our existing data center business. I'd like to provide more color on the opportunity and general time frame for growth acceleration. Inside the data center, electrical protection, sockets and power distribution units and sensing in power distribution units create demand for our products. Outside the data center, there are meaningful opportunities for our Dynapower product in uninterrupted power supply, or UPS, systems and HVAC demand grows with recurring needs for each data center. We are incumbent in data centers today with both low-voltage AC electrical protection as well as with sensing and HVAC applications. With this incumbency, we are already benefiting from secular growth. As we look at the technological road map for data centers, we see a major inflection point in the data center ecosystem. The opportunity for Sensata is significant and our right to win is compelling. This inflection point is driven by the rapid evolution of GPU platforms and the associated changes in power and thermal management requirements. Allow me to elaborate. Today, most deployed data centers rely on low-voltage AC electrical architectures where air cooling meets current thermal requirements. Industry road maps from leading GPU manufacturers point towards higher-voltage DC power systems, including 800-volt DC, which drive substantially higher rack densities and accelerate the need for liquid cooling solutions. These transitions increase demand for high-voltage contactors and for pressure, temperature and flow sensors. These application areas are closely in line with our portfolio where our performance, reliability and application expertise support a strong competitive position. In parallel with our EPC and distribution partnerships, we're engaging earlier in the design cycle with hyperscalers and ODMs to support upfront specifications. This approach strengthens downstream pull-through by enabling EPCs' internal partners to deliver against predefined customer requirements. Since our last update, the strategy has resulted in our products being specified by two hyperscalers and our new flow sensor product has advanced from development to customer validation. From a timing perspective, industry road maps indicate that adoption of liquid cooling is expected to accelerate beginning around mid-2027, particularly in high-density AI and high-performance computing deployments. At system scale, leading GPU and infrastructure suppliers anticipate a subsequent shift towards higher-voltage power architectures. While the revenue opportunity is medium term, the time to get specified in is not, and that's exactly where our focus is. This is, as well, a call to our automotive legacy. In parallel, our Dynapower business is actively bidding on several large programs with an extensive opportunity pipeline for UPS projects. The highlights I just shared are just a peek into the growth engine that we are priming at Sensata. I have even more conviction in our growth prospects than I did just a quarter ago. With our new segmentation, Marcus, Elis and Brian each have clear growth mandates for their respective businesses. They, along with their strong teams, are bringing the end market focus that is required to deliver on a growth mandate. With that, I would like to extend my gratitude to teams for their collective commitment to our transformation and consistency of execution. Now let me turn the call over to Andrew to provide greater detail on the first quarter and our thoughts around the second quarter and full year.

Andrew Lynch, Chief Financial Officer

Thank you, Stephan. Let's turn to Slide 8. For clarity, unless otherwise specified, amounts are referenced in millions of U.S. dollars and growth percentages are approximate. We delivered first quarter revenue, adjusted operating income and adjusted earnings per share at or above the high end of our expectations despite volatility in our end markets. As Stephan noted, this demonstrates a continuation of the momentum and consistency of execution that we achieved last year. We reported first quarter revenue of $935 million, an increase of $24 million or 3% from $911 million in the first quarter prior year. On an organic basis, revenue grew 4% year-over-year as we had a $34 million inorganic revenue headwind from divestitures, which was partially offset by a $20 million revenue tailwind from FX. This was the final quarter of meaningful revenue impacts from the initiatives we began in 2024 to exit $200 million of annual revenues related to underperforming products. Adjusted operating income was $174 million and adjusted operating margin was 18.6%, compared with $167 million and a margin of 18.3% in the prior year quarter. This year-over-year improvement of 30 basis points was attributable to stronger revenues and improved productivity. Margin benefits from the divestiture of underperforming products approximately offset headwinds for tariffs on a year-over-year basis. Adjusted earnings per share was $0.86, an increase of $0.08 year-over-year, exceeding the high end of our first quarter guidance range by $0.01. We delivered $105 million of free cash flow in the quarter, which was an increase of $18 million or 21% year-over-year. Our free cash flow conversion rate was 83% of adjusted net income, an increase of 9 percentage points compared to 74% in the prior year period. This was an encouraging start to the year in what is typically our most challenging quarter for free cash flow as we have timing-related headwinds attributable to interest and variable compensation payments, the latter of which was a $20 million headwind year-over-year. Let's move to Slide 9 to unpack this further. Free cash flow of $105 million not only exceeded our expectations, it was a record first quarter result for Sensata. This outperformance was driven by the momentum we are gaining on working capital efficiency with our initiatives to reduce inventory and optimize supplier payment terms. We are thrilled to have such a strong start to the year particularly after the record full year results that we delivered last year. As we move to Slide 10, I will discuss capital deployment. We returned $43 million of capital to shareholders in the quarter. In addition to our quarterly dividend, we repurchased $25 million of shares to offset the impact of share-based compensation. Our net leverage ratio at the end of the first quarter was 2.65x trailing 12 months adjusted EBITDA compared to 3.06x for the prior year quarter. Deleveraging will continue to be our capital allocation priority. We have conviction in this approach, and we are pleased with the improvements we are delivering in return on invested capital, which improved by 70 basis points to 10.8% for the 12 months ended March 31, 2026, compared to 10.1% for the 12 months ended March 31, 2025. Earlier this month, we announced our second quarter dividend of $0.12 per share payable on May 27 to shareholders of record as of May 13. Now let's turn to Slide 11 to discuss our segments. All three of our segments delivered organic revenue growth and operating margin expansion in the first quarter. We see this as an encouraging proof point for the traction we are gaining from our reorganization. Our Automotive segment delivered $525 million of revenue in the quarter, a decrease of 1% year-over-year on a reported basis. On an organic basis, we delivered 1% growth year-over-year and 4% outgrowth against the market that decreased by 3%. Our market outgrowth was driven by both content gains and production mix as our versatile portfolio of ICE, EV and powertrain-agnostic products continues to perform in a market with uneven powertrain adoption rates. Automotive segment operating margin was 23.5% in the quarter, a year-over-year increase of 70 basis points from 22.8% driven by both productivity and portfolio optimization measures. Our Industrial segment delivered $184 million of revenue in the quarter, which was a year-over-year decrease of approximately 1% on a reported basis and a year-over-year increase of 1% on an organic basis. Organic growth was enabled by share gains despite ongoing softness in U.S. residential and construction markets. Industrial's operating margin was 27.1% in the first quarter, a year-over-year increase of 100 basis points from 26.1%, primarily due to productivity gains. Aerospace, Defense and Commercial Equipment segment delivered $226 million of revenue in the quarter, an increase of 15% year-over-year or approximately 17% on an organic basis. We had revenue growth across every market vertical, including aerospace, defense, on-road trucks and off-highway equipment. Segment operating margin was 28.1%, a year-over-year increase of 260 basis points from 25.5% as we gained operating leverage from strong volume growth. Adjusted corporate operating expenses were $63 million, an increase of $10 million year-over-year primarily due to higher variable compensation expense, which was supported by stronger underlying performance. Now let's turn to Slide 12 to discuss what we are seeing in our end markets. Global auto production decreased by approximately 3% in the first quarter. For the full year, third-party forecasters are expecting a production decrease of approximately 2%. Recent downward revisions to third-party forecasts are primarily attributable to China and the Middle East and we do not expect these revisions to have a meaningful impact on our business. In our industrial end markets, U.S. residential and construction markets remained soft in the first quarter, which was evident in the year-over-year decrease in U.S. residential HVAC shipments. We expect HVAC shipments to stabilize in the second quarter and return to growth in the second half of 2026. In aerospace, defense and commercial equipment, commercial aircraft backlogs are strong, defense spending is accelerating and on-highway trucks are starting to show signs of recovery. In the first quarter, although North American truck build rates did not improve, our order book increased. We are optimistic that this is a leading indicator for a replenishment cycle in the second half of 2026 as lead times generally result in our revenue growth preceding truck build rates. With that backdrop, let's move to Slide 13, and I will share our guidance for the second quarter of 2026 and some color on our outlook for the year. For the second quarter, we expect revenue of $950 million to $980 million; adjusted operating income of $182 million to $190 million; adjusted operating margin of 19.2% to 19.4%; adjusted net income of $131 million to $139 million; and adjusted earnings per share of $0.89 to $0.95. Our second quarter guidance includes approximately $8 million in tariff costs and associated pass-through revenues. This is approximately $4 million lower than our prior run rate due to recent changes in U.S. tariff rates. Our tariff expectations are based on trade policies in effect as of April 27, 2026. Our second quarter guidance does not include any potential tariff refunds related to the recent EPA tariff ruling nor does it reflect any possible pass-through of such refunds. Due to geopolitical uncertainty and end market volatility, we are continuing our practice of providing guidance one quarter at a time. That said, we do want to share our view that current consensus estimates for adjusted operating margin expansion of approximately 30 basis points per quarter in the back half are consistent with our view, provided that end market demand holds up. Should end market demand deteriorate materially, we are prepared to take reasonable measures to defend the 19% annual margin floor that we committed to last year. Now I'd like to turn the call back to Stephan for closing remarks.

Stephan Von Schuckmann, Chief Executive Officer

Thank you, Andrew. Before we move to Q&A, I would like to leave you with some closing thoughts. As we progress through 2026, we do not expect our path ahead to be free of challenges. Sensata is prepared. The operational principles we brought into the organization have proven effective over the last five quarters. Just as we did last year, we will operate our business in a manner to overcome challenges and perform in line with the expectations we set and to deliver margin expansion for the year. As we do so, the underlying earnings power in our business will continue to strengthen, and we are primed for accelerated earnings expansion as market cycles turn more favorable. We are proud of what we have accomplished so far, and I have conviction that our business is primed for excellence. We have an outstanding leadership team and a committed organization that is running behind them. We have achieved organization-wide operational discipline, our productivity engine is delivering. Our strategic initiatives are accelerating and our growth opportunities are robust. I will now turn the call back over to James.

James Entwistle, Senior Director of Investor Relations

Thank you, Stephan and Andrew. We will now begin Q&A. Operator, please introduce the first question.

Operator, Operator

Operator is now introducing the Q&A session. Our first question today comes from Wamsi Mohan from Bank of America.

Ryan Show, Analyst, Bank of America

This is Ryan Show on for Wamsi. Two questions for me. One, on auto content outgrowth of 4% in the quarter. Stephan, I know you gave some details earlier in the call, but can you share any further color about the region? And as our production declines 2% year-over-year, is that the right outgrowth to think about? Second question: the 60 to 80 basis points of operating margin expansion sequentially seems pretty high versus prior quarters. Can you give us a bridge of the drivers leading to this?

Stephan Von Schuckmann, Chief Executive Officer

So thanks for the question. Let me start a bit broader by referencing the IHS forecast which is roughly 91 million vehicles for the year of 2026. That's around 2% down from what we saw in 2025. I think it's important to mention there are two factors that need to be considered that can substantially influence this forecast. The first one is geopolitical tensions and their relation to oil price. And the second factor that's important is tax and car subsidies in China. As we know, these subsidies were in place in Q3 and Q4 of 2025, which led to strong demand. Since Q1 of 2026 subsidy policies have changed, and this has obviously resulted in weaker demand in China. Nevertheless, the automotive segment and the segment leads around Marcus and the team, and also our China President, Jackie, they have a very clear and accountable growth mandate. To get to your question around regions, they are winning meaningful business in each and every region. So in China with contactors, in Southeast Asia, for example, in Japan, we made good progress on winning new business, as we've mentioned in the call, and so in South Korea we've been winning. We've been winning in all types of powertrain platforms from ICE to battery electric vehicles. I think it's also important to mention that we've been winning with new products. The two products that I mentioned in the call, the high-efficiency contactor which was the fifth win for this new product with a German OEM and also the Folta contactor, and then there's additional opportunities in China with battery system manufacturers where I feel we're gaining good momentum and making good progress. So overall, I'd say we've got strong conviction that the team will outgrow the market in 2026. Regarding margins and your second question, I'll hand that to Andrew for the sequential bridge.

Andrew Lynch, Chief Financial Officer

Yes. On the margin point, operating margins did not expand sequentially as a matter of course—margins typically contract from Q4 to Q1 due to timing-related items. However, we've seen less contraction than we have historically because we've gotten a head start on productivity compared to prior years. So we had a stronger start to the year and that gives us a lift into the second quarter. If your question relates to the step-up in margins from Q1 to Q2, the themes are the same: earlier productivity gains, improved factory performance and higher volumes in certain segments. Those factors are the main drivers of the sequential margin improvement you're seeing in our guidance.

Operator, Operator

Our next question comes from Mark Delaney from Goldman Sachs.

Mark Delaney, Analyst, Goldman Sachs

I had one to start also on the margin topic. The company mentioned that it expects margin improvement of about 30 basis points per quarter in the back half provided that market conditions don't meaningfully deteriorate. Given all the supply chain and geopolitical volatility that's occurred over the last 90 days and pressure on input costs, can you speak more on the actions that Sensata is already taking to navigate this environment and the company's levers to expand margins in the back half? And then, Stephan, you spoke about a number of areas where you're seeing progress in the data center market. Based on all these engagements that are underway, are you able to give more context of how much incremental revenue this market could add in 2027 and the types of margins investors can anticipate as that data center revenue grows?

Stephan Von Schuckmann, Chief Executive Officer

So let me start with the margin playbook. Despite the challenges, we have a clear playbook to respond, and we've been working through that playbook throughout 2025 and we're using the same playbook for 2026. Sensata thinks in scenarios which prepares us for current or future headwinds like material inflation, tariffs and other pressures. Equally important is that we are designed into mission-critical applications, which gives us leverage on pricing and customer discussions. We are prepared to defend margins, which differentiates us. On the data center question, we are focused on the architecture transition in data centers to higher-voltage DC and liquid cooling driven by GPU platform evolution, which aligns with our product set. That creates opportunities in electrical protection and sensing—pressure, flow and temperature sensors, high-voltage contactors, and circuit breakers. We have a right to win given our automotive-grade reliability and experience with robust specifications. We'll share more progress as we get further into customer qualification and revenue visibility.

Andrew Lynch, Chief Financial Officer

Mark, I would add that while we're not providing a dollar revenue forecast for data centers at this point, an important point is that we do not anticipate the need for significant incremental investment to pursue this trend. Many of the relevant products are existing technologies that we already have; the primary effort is getting them specified in customer designs. That reduces the capital intensity and risk of pursuing these opportunities. We see the demand, the spec momentum, and the primary risk is timing versus the need for heavy investment.

Operator, Operator

Our next question comes from Christopher Glynn from Oppenheimer.

Christopher Glynn, Analyst, Oppenheimer

Just wanted to follow up on timing of being able to speak with more specificity about some of the data center opportunities in cooling and UPS. There's an element of next-gen architecture that's playing into it, and an element of the posture to be more purposeful about what you're going after. How much of this is catch-up versus the current-gen data center architectures where maybe there's just not as much opportunity?

Andrew Lynch, Chief Financial Officer

As I explained earlier, the opportunity is more pronounced with next-gen liquid-cooled, higher-voltage DC architectures than with current air-cooled AC architectures. On the air-cooled architectures, the opportunities are around temperature sensors and circuit protection where we already have incumbency and are gaining momentum. When you move to high-voltage liquid-cooled concepts, around 800-volt DC, that expands the product set meaningfully to include pressure sensors, flow sensors, temperature sensors, circuit breakers and contactors. We are getting specified into these newer concepts, and our expectation is that these new architectures will start to meaningfully show up as revenue around mid-2027, particularly in high-density AI and HPC deployments.

Christopher Glynn, Analyst, Oppenheimer

Appreciate the detail. To what extent are the products represented as integrated solutions or co-packaged solutions for you versus independent design wins into the liquid cooling and other targeted applications?

Andrew Lynch, Chief Financial Officer

It's more technology-oriented. Electrical protection product wins will tend to be grouped and driven by power architects, whereas the thermal management products will be driven by cooling and mechanical decision makers. I would expect these to scale at relatively similar rates because the architectures interconnect power and thermal requirements. Some wins will be alongside integrated solutions and some will be independent components specified into the design; both approaches are in play.

Operator, Operator

Our next question comes from Joe Giordano from TD Cowen.

Joseph Giordano, Analyst, TD Cowen

Want to start on China automotive. Given the improvements you've made on the ground in terms of getting content with local players and the dramatic mix shift in recent years, what's the opportunity set as you add first-time content with these new customers? What magnitude should you be outgrowing that market? It seems like it should be very large given where you're coming from and adding content for the first time. And last quarter, you started talking about drones a little bit. I'm curious how much of the aerospace growth was attributable to some of those faster-growing, newer areas for you?

Stephan Von Schuckmann, Chief Executive Officer

First, on China automotive, historically we were focused on international OEMs and have shifted to win more business with local OEMs, particularly on contactors and electrification products. We've won significant contract wins in China and are ramping production—this business will place us in a strong position within the market in China. We're also seeing opportunities with battery and battery systems manufacturers, which are beginning to materialize and are complementary to the contactor opportunities. There are not many suppliers who can deliver contactors at scale with high quality, and Sensata can. That combination allows us to position ourselves strongly and grow quickly on the electrification side. On aerospace and newer areas like drones, the growth we are seeing this quarter is primarily attributable to our core aerospace and defense business and acceleration in defense demand. The newer opportunities like drones are promising and are part of our medium-term pipeline, but the current quarter’s growth was driven mostly by our core end markets and defense-related demand.

Andrew Lynch, Chief Financial Officer

Joe, on the outgrowth math: on a global basis, pricing headwinds typically are low-single-digit price-downs, roughly 1% to 2% a year, which means to deliver low-single-digit outgrowth requires underlying content growth in the mid-single-digits. In China, pricing pressure tends to be higher—mid-single-digit price-downs—so to outgrow China requires underlying content growth in the high-single-digits. That's what we saw last year and we expect underlying content growth in China to be stronger, even if net reported outgrowth isn't materially different from our global outgrowth rate due to the stronger pricing headwind in China. On the drone point, the acceleration in aerospace and defense is primarily core business and defense demand acceleration. The newer areas like drones are more medium-term. We are seeing opportunities to bid on that business, but it's not the primary driver of the current quarter's strong growth.

Stephan Von Schuckmann, Chief Executive Officer

We were recently selected for a circuit breaker program for a German manufacturer of armored ground transport vehicles, which is an important win in Europe and demonstrates the type of defense opportunities we are pursuing. We see similar opportunities in the pipeline and are building our order book in defense, which looks promising.

Operator, Operator

Our next question comes from Guy Hardwick from Barclays.

Guy Drummond Hardwick, Analyst, Barclays

Question on the HVAC side. You said in your prepared remarks that HVAC revenues are down, the market was down double digits in Q1, and expected to be down again in Q2 before returning to growth in the second half. How much do you think you outperformed in Q1? Is that outperformance implicit in Q2 guidance? And as the market stabilizes in the second half, could that outperformance continue? Also, there was strong margin performance in AE&CE and margin moves in Industrial even though revenues were flattish—was there any positive mix effect in those segments that contributed to margins?

Stephan Von Schuckmann, Chief Executive Officer

The HVAC business is about 25% of our overall industrial business. Despite the market being down double digits in Q1, we delivered net organic growth of about 1% in Industrial, so there was certainly some outgrowth driven primarily by new content that we launched last year with our HL leak detection and other products. Moving forward, we expect to continue to outgrow the market with new content and participate in market growth as the market recovers. If we get recovery in the back half, that would be an accelerator for us. At the same time, we built an operating plan that does not rely solely on market growth for us to deliver on our margin expansion aspirations, so we're not super dependent on the timing of the market recovery. Regarding margins in AE&CE, the growth we saw in Aerospace, which is a higher-margin end market, contributed meaningful incremental contribution margin. When you see high-growth rates, the operating leverage is stronger and that results in better margin expansion. Mix contributed in the sense that more of the revenue growth came from higher-margin aerospace and defense activity, but most of the margin improvement was from volume-driven operating leverage and productivity gains across the business.

Operator, Operator

Our next question comes from Amit Daryani from Evercore ISI. Irvin Liu is on for Amit.

Irvin Liu, Analyst, Evercore ISI (on behalf of Amit Daryani)

This is Irvin Liu on for Amit. I had a financial question for Andrew. It's good to see free cash flow conversion higher than we've historically seen for Q1 at 83%, though CapEx was lower than expected. Can you give us a sense of how CapEx should trend through the year, especially given the lower-than-expected CapEx in Q1? Also, related to the data center opportunities, you mentioned products specced by two hyperscalers—can you give a sense of total TAM or perhaps per-megawatt TAM for electrical and sensing products across data center and adjacent opportunities?

Andrew Lynch, Chief Financial Officer

Yes. We're still targeting CapEx in the 3% to 3.5% range of revenue. The lower CapEx in Q1 was largely because of acceleration of factory automation work we implemented last year and more flexible line concepts, which reduced near-term capital needs. We expect CapEx to normalize back toward that 3% to 3.5% range over the year. To the extent that CapEx runs lower, that will continue to benefit free cash flow, but we don't expect it to be structurally below 3%. On the data center TAM per megawatt question, we'll take that for further consideration and plan to provide more detail as we develop clearer visibility on customer adoption and program timing.

Stephan Von Schuckmann, Chief Executive Officer

To add, we've been systematically optimizing CapEx. For example, we're pursuing more machine and equipment purchases from Southeast Asia and China where costs can be substantially lower versus equipment sourced from Europe or North America. Additionally, we've optimized maintenance and sustaining CapEx across our factories. Those actions have reduced near-term CapEx needs and allowed us to redeploy capital into automation and other productivity initiatives.

Operator, Operator

Our next question comes from Joseph Spak from UBS.

Joseph Spak, Analyst, UBS

Andrew, just a couple questions on tariffs. First, I'm aware that in the past you said you source a large portion from Mexico with significant USMCA compliance. There was a change on Section 232 metal tariffs—any impact there? Second, regarding the EPA tariff ruling, I know you said guidance doesn't include any repayments, but have you filed for any reimbursements or do you plan to? Can you give a sense of how big that could be if it occurs? And as a follow-up, you saw CE growth of 16%—is some of that inventory build or pull-through ahead of future builds, and should we expect that outgrowth to normalize as builds improve over the course of the year?

Andrew Lynch, Chief Financial Officer

On the Section 232 metal tariffs changes, we're not seeing any meaningful direct impact to our sourcing from Mexico. We are monitoring potential impacts on end market demand, but there's no material direct impact on the metals or commodities we source. With the cancellation of the EPA tariffs, our run rate moving forward would be approximately $8 million per quarter, which is about one-third lower than the roughly $12 million per quarter run rate we had previously. On refunds, we are following the government-prescribed process and will share more when we have greater visibility. We're not going to speculate on the size or timing of any potential recovery at this time. For context, we paid a little over $40 million in tariffs last year, and the vast majority of that—more than two-thirds—was EPA-related. Regarding the CE segment outperformance, the 15% or so growth we reported for the segment was across aerospace, defense and commercial equipment. About one-quarter of the segment is aerospace and three-quarters is commercial equipment. On the commercial equipment side, we believe the market was down roughly 1% and our outgrowth was primarily driven by an inventory replenishment ahead of an expected production acceleration in the back half. When you come out of a period of suppressed production, replenishment often leads revenues to increase before production recovers. We expect to continue to outgrow the market but likely not at the same clip as the inventory replenishment quarter.

Operator, Operator

Our next question comes from Konstandinos Tasoulis from Wells Fargo.

Konstandinos Tasoulis, Analyst, Wells Fargo

I want to ask about the roughly 100% precious metal inflation you referenced in the quarter, and yet you were able to get 30 basis points of margin expansion year-over-year. Can you frame the puts and takes of that impact—what the headwind was and what the offsets were? Also, you had good success winning drone-related business—what learnings from winning those designs can you apply to getting more business in data centers?

Andrew Lynch, Chief Financial Officer

We did face multiple challenges in Q1. In addition to significant precious metal cost increases, we had about a 40 basis point headwind from FX. We had about $20 million of lift on FX on the top line with effective drop-through on the bottom line. We were pleased to have margin expansion year-over-year despite those headwinds, which points to improved underlying earnings power. For precious metals, we have roughly $40 million of annual precious metals purchases. From a year-over-year perspective in Q1, those rates were up approximately 100%. Through the first half of the year, we have about 80% hedge coverage on these metals, which mitigates some near-term volatility and gives us time to execute more permanent, structural mitigations. Those mitigations include design changes to reduce metal content where feasible, negotiations with suppliers to share cost burdens, and discussions with customers for appropriate compensation. I'll turn to Stephan to add color on structural actions.

Stephan Von Schuckmann, Chief Executive Officer

Thanks, Andrew. How we manage metals inflation differs across our product portfolio. We are actively negotiating with suppliers to mitigate the pass-through to Sensata. We're also undertaking design-for-value activities to reduce precious metal content in some products where technically feasible. For certain industrial products with deep silver content, for example, this is a more challenging engineering task and will take longer, but it is part of our multi-pronged approach. And as Andrew mentioned, we are in continuous discussions with customers about cost impacts and compensation where appropriate. These three levers—supplier negotiations, product design optimization and customer discussions—are how we manage metals inflation structurally.

Konstandinos Tasoulis, Analyst, Wells Fargo

You guys were able to get into drone design cycles fairly quickly. What learnings from getting those design wins can you apply to getting more data center business?

Stephan Von Schuckmann, Chief Executive Officer

It's similar in approach. In the drone space we leveraged existing technologies—position sensors, temperature sensors, actuators and other components—that were not originally developed for drones but fit the application due to fast design cycles. For data centers, it's similar: many of the products we are proposing—electrical protection, sensing and thermal management devices—are existing products from our automotive portfolio that translate well to data center specifications. The key is to engage earlier in the design cycle with hyperscalers and ODMs, get specified into reference designs, and then benefit from downstream volume pull-through. That playbook—leverage existing technical capabilities, engage early in specifications, and demonstrate robust performance—applies to both drones and data centers.

Operator, Operator

Our next question comes from Luke Junk from Robert W. Baird.

Luke Junk, Analyst, Baird

A bigger-picture question on market structure within the data center business. How important is taking share with reference designs? Are these jump-ball dynamics among many suppliers, or does market share matter heavily for the data center story, particularly with the 800-volt opportunity?

Andrew Lynch, Chief Financial Officer

Thanks for the question. The nice thing about the architecture change is that it's not purely a share-take scenario. It's creating fundamentally new sockets and needs. Moving from AC to higher-voltage DC architectures creates a different electrical protection and sensing architecture—there will be a shift from some legacy designs to high-voltage contactors and different sensing requirements. So the primary task is to have products that meet the specifications and get specified into the design. That's different from needing to displace an entrenched incumbent in a mature socket. The architecture change opens room for new suppliers who meet the spec. That's why we have conviction in our right to win—these architectures move into our wheelhouse in terms of product set and reliability requirements.

Stephan Von Schuckmann, Chief Executive Officer

To add, many of the new designs require different product types—pressure and flow sensors, contactors and circuit protection suited for high-voltage liquid-cooled systems. These are not simply direct share swaps of existing AC sockets; they are new application needs that align with Sensata's product portfolio. Our task is to be specified into the hyperscaler concepts, which then creates the downstream revenue opportunities starting around mid-2027 as adoption scales.

Operator, Operator

Our next question comes from Shreyas Patil from Wolfe Research.

Shreyas Patil, Analyst, Wolfe Research

Just one question. Could you provide some color on segment outgrowth expectations? Given that AE&CE was double-digit organic in Q1, shouldn't organic growth in Q2 be above the 1% to 4% range that you're guiding? How should we think about segment-level contributions versus consolidated guidance?

Andrew Lynch, Chief Financial Officer

Let me frame that generally. Sensata has multiple growth factors across segments. We are seeing traction from many new wins and initiatives, and our segment leaders have clear growth mandates. For Q2, third-party forecasters expect global auto production down roughly 2% year-over-year. If we deliver similar outgrowth in Automotive that we had in Q1, that puts Automotive organic growth for the quarter in the 1% to 2% range. For Aerospace, Defense and Commercial Equipment, we do not expect to sustain double-digit growth in Q2 at the same rate; that will likely moderate to mid- to high-single digits as some of the replenishment effect normalizes. Industrial will likely remain soft in Q2 and be more of a contributor in the second half. When you aggregate those dynamics, they align with our consolidated guidance of 1% to 4% revenue growth for Q2.

Stephan Von Schuckmann, Chief Executive Officer

As Andrew summarized, even though one segment had a very strong quarter, each segment's cadence and timing differ. Aerospace and commercial equipment benefited from a replenishment dynamic and aerospace backlog strength; automotive outgrowth continues but is influenced by production forecasts and regional dynamics; industrial has near-term softness but content gains. Aggregating these puts Q2 in the guided range.

Operator, Operator

And with that, we'll be concluding today's question-and-answer session. I'd like to turn the floor back over to James Entwistle for closing remarks.

James Entwistle, Senior Director of Investor Relations

Thanks, Jamie, and thanks to everyone who joined us on today's call. Before we conclude, I'd just like to announce some upcoming conferences that we'll be attending during the second quarter. We will be at the Oppenheimer Industrial Growth Conference on Tuesday, May 5, which is virtual; the TD Cowen Technology, Media and Telecom Conference on Wednesday, May 27 in New York City; and the Wells Fargo Industrials Conference on Wednesday, June 10 in Chicago. We look forward to connecting with many of you at those conferences in the coming months. Jamie, you may now conclude the call.

Operator, Operator

And with that, ladies and gentlemen, we'll conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your lines.