"

"

"

" ROTH Capital Partners, LLC, Research Division

" CJS Securities, Inc.

" BofA Securities, Research Division

" B. Riley Securities, Inc., Research Division

" JPMorgan Chase & Co, Research Division

Good day, and thank you for standing by. Welcome to the OSI Systems, Inc. First Quarter 2026 Conference Call. [Operator Instructions] Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Alan Edrick, Chief Financial Officer. Please go ahead.

Thank you. Good afternoon, and thank you for joining us. I'm Alan Edrick, Executive Vice President and CFO of OSI Systems. And I'm here today with Ajay Mehra, OSI's President and CEO. Welcome to the OSI Systems Fiscal 2026 First Quarter Conference Call. We are pleased that you can join us as we review our financial and our operational results. Earlier today, we issued a press release announcing our fiscal '26 first quarter financial results. Before we discuss these results, I would like to remind everyone that today's discussion will include forward-looking statements, and the company wishes to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to such forward-looking statements. All forward-looking statements made on this call are based on currently available information, and the company undertakes no obligation to update any forward-looking statement based on subsequent events or new information or otherwise. During today's call, we will be discussing the company's results using both GAAP and non-GAAP financial measures. For more details on these non-GAAP measures, their comparable GAAP measures and a quantitative reconciliation of the two, please refer to today's earnings release. I will begin with a high-level summary of our financial performance for the first quarter of fiscal '26 and then turn the call over to Ajay for a discussion of our business and operational performance. We will then finish with more detail regarding our financial results and a discussion of our increased guidance for fiscal year '26. We delivered strong first quarter financial results, setting multiple Q1 records across key metrics, and we are excited by the momentum across our businesses. Now for the high-level summary of our Q1 results. First, revenues increased 12% year-over-year to a Q1 record of $385 million. Each of our 3 divisions achieved double-digit top line growth, highlighted by a 13% increase in revenues in the Security division. This top line performance is especially noteworthy given that the prior year Q1 included substantial revenue from major security programs in Mexico. Excluding contributions from those Mexico contracts and revenues generated by businesses acquired in fiscal '25, our underlying consolidated revenues grew roughly 26% in Q1, highlighting robust organic demand across our core businesses. Second, the solid revenue growth led to record Q1 non-GAAP adjusted EPS of $1.42. And third, Q1 bookings were strong. And with a book-to-bill ratio of approximately 1.1 in the quarter, we finished with a record Q1 backlog approaching $1.9 billion. This backlog, coupled with a robust pipeline of opportunities, provides good visibility as we continue into Q2. Before diving more deeply into our financial results and discussing our outlook for fiscal '26, I will turn the call over to Ajay.

Thank you, Alan. Good afternoon, everyone. I want to start by recognizing the outstanding performance of our global OSI team in delivering a record-breaking first quarter. Our results this quarter reflect the strength of our diversified business model and our relentless focus on innovation, operational excellence and customer satisfaction. As Alan mentioned, we achieved 12% revenue growth with solid earnings. Furthermore, our service revenues grew 23% during the quarter as many of our product installations over the last few years are now generating recurring revenue from ongoing service and support. We closed the quarter with a record Q1 backlog and feel confident about the future outlook. Let's jump into the performance and key highlights across our 3 divisions for the first quarter, starting with our Security division. Q1 revenues in this division were $254 million, a solid 13% year-over-year growth. Bookings were strong, resulting in a record Q1 security backlog, setting a strong foundation for continued growth. During the quarter, we continued to successfully perform on our port and border security contracts with Mexico. However, as Alan will elaborate shortly, the impact of these contracts on our overall business has moderated. It has been more than offset by robust growth across other areas of our diverse security portfolio. This dynamic was evident in Q1, where revenues from our aviation, cargo and RF detection offerings, including service, drove double-digit overall growth. Our customers have witnessed our proven expertise in system integration, maintenance, operator training and long-term support, all of which optimize the performance of our inspection equipment during its life cycle. We've also effectively built our turnkey offerings to strengthen our position in global equipment tenders for ports, borders and airport security. As I noted earlier, our bookings remained robust with a book-to-bill ratio of 1.1 in the Security division, supported…

Thank you, Ajay. Now I will review in greater detail the financial results for the first quarter and then discuss our increased fiscal '26 guidance. As mentioned, our Q1 revenues were up 12% compared to the first quarter of the prior fiscal year with strength across the 3 segments. Security division revenues in Q1 were $254 million, an increase of 13% year-over-year. This growth was driven by higher service revenues, robust sales of aviation and checkpoint products and increased revenues from the RF business acquired in Q1 of fiscal '25. As expected and directionally similar to last quarter's trend, revenues related to our large Mexico security contracts decreased to $25 million in Q1 of fiscal '26 from $70 million in Q1 of the prior fiscal year. Excluding acquisition-related growth and the Mexico contracts, Securities revenues surged 39% year-over-year, clearly reflecting healthy demand across the broader security portfolio. Meanwhile, our Optoelectronics and Manufacturing division had another excellent quarter. Opto sales, including intercompany, increased 12% year-over-year to $110 million, which is a new Q1 record for this division. This was driven by growth across our diversified product and customer portfolio. And following a difficult Q4, Healthcare division sales driven primarily by international revenue activity bounced back, posting 10% year-over-year growth. Our Q1 gross margin was 32%. This was down from the same quarter in the prior year as a less favorable revenue mix on product sales outweighed an increase in gross margin from higher service revenues. Our margins can fluctuate based on the product and service mix, volume, supply chain cost, FX, tariffs, among other factors. Moving on to operating expenses. Selling, general and administrative expenses in the 2026 first fiscal quarter were $67 million or 17.4% of sales compared to $72.2 million or 21% of sales in Q1 last year. The…

[Operator Instructions] Our first question comes from Josh Nichols with B. Riley.

Good to see the guidance bump. I know fiscal 1Q is usually a little bit slower for the security business, but bucking the trend with a healthy book-to-bill ratio. I was wondering, could you provide just a little bit more granularity on what products and markets or geographies are really driving that strength, particularly since 1Q is usually a little bit slower, particularly in Europe?

Sure, Josh. Great question. Thank you. Yes, we were really pleased with the performance in our Security business, both on the revenue side and the bookings side and operational as well. We really saw really quite diversified broad growth. We saw both on the revenues and the bookings side throughout the regions when we were looking at the EMEA region, looking at the Americas and even Asia Pac, strength, whether it be in revenues or bookings across the board. Service revenues, of course, were exceptionally strong for us. It's nice. We're receiving this new era of much higher recurring revenues at higher margin on the service side. We had the contribution for a full quarter worth of the RF products versus a partial quarter in the prior fiscal year. And we saw our aviation products doing quite well as well. So all that contributed to really a great quarter for the Security division.

And then just one follow-up question. I mean you mentioned that you now had several quarters, right, the services revenue growth north of 20% here again. When you look at the guidance, the top line guidance for this year, you're guiding to around 8% growth. But I would assume that the services revenue growth would be significantly higher than that. Any kind of additional detail you could provide around that to help us kind of model the growth rate that you may be expecting for that piece of the business this year?

Yes, Josh, when it comes to our guidance, you're correct, though we don't provide guidance on service versus product specifically, directionally, you're absolutely right. We're expecting faster growth than our recurring service revenue in this particular year. Product revenues will be quite strong as well. But remember, we're coming off of a very difficult comp with heavy Mexico product revenues in fiscal '25. So we expect to see very solid revenue growth, both on product and service, but at a more accelerated rate on the service side in this fiscal year.

Just last follow-up for me, and I'll pass it to since you mentioned it. tough comp for Mexico, but the business is still growing very healthy. And just thinking about longer term and next year, the comps are going to get easier against Mexico. I think you might have mentioned it before, but revenue contribution for this year for Mexico, should that be around $100 million type level? Or what are you targeting for this year?

That's a good estimate, probably just slightly below that.

Our next question comes from Jeff Martin with ROTH Capital Partners.

Great to see the results. Congratulations. I wondered if you could follow up with additional detail on your comment about governments worldwide are investing heavily. Has that been in your sights for quite some time now? I know you've talked about a robust and expanding pipeline for quite a while. But is this a newer phenomenon? Because I don't think you've really phrased it that way in the past.

I think -- this is Ajay. We've seen the growth in the past, but it's definitely -- we see a lot more acceleration going on. I think with the big beautiful bill we've all talked about, with the opportunities in the Golden Dome. I think our service business has accelerated and not just on the service side, but we're able to go in and offer what I would say, integration services with our CertScan that we just announced with CVP. We're in almost 20 different countries, and we see the capabilities there and the government sees the capabilities, not just of integrating the NII platforms, but integrating various different technologies and turning that data into real information. And frankly, with all the trade issues going on, they're able to integrate that if they want with U.S. CVP with their data coming through and making them a lot more efficient, making the tariffs less painful in terms of declarations. And obviously, the rest of it as far as security is concerned, -- the geopolitical environment with Ukraine, Gaza, others continues to provide us opportunities. So yes, we think that there's uptick, but we feel very good about it in terms of what opportunities there are, not just in the U.S. but internationally.

Great. And then nice to see the uptick in the guidance even in light of the federal government shutdown here. I was wondering if you could touch on what you're seeing to date in terms of affected activities from the government shutdown.

So from our standpoint, we've had very limited impact. I mean we are in industries such as with CBP, others where it's considered essential. We have to provide our systems, service, keep the borders, the airports open. So I think one of the things maybe things get delayed a little bit in terms of some of the orders coming in. But really, it's not going to affect us in '26. So from our standpoint, so far, so good. It's really not a big deal.

Okay. And then I have two clarifications, if I could. The reference to the 26% growth, excluding acquisitions in Mexico, that was to total company revenue. And then on the security side, it was 39%. Did I hear those correctly?

Jeff, this is Alan. Yes, you've interpreted it exactly right.

Okay. And then you said there's a headwind of 60% from Mexico. I assume you mean $60 million year-over-year.

Effectively, a 60% reduction in revenues of Mexico revenues in fiscal '25 versus fiscal '26.

I think just to comment on that, I would look at that as a positive because we've been more than able to cover those headwinds with the tailwinds we've got in the rest of the product lines.

Our next question comes from Mariana Perez Mora with Bank of America.

So my first question is on Mexico. You mentioned some partial payments and improvement there and also a significant reduction on the revenue side. How should we think about the level of unbilled receivables so far? And how are those unbilled receivables progressing? What are the key milestones we should be looking at when we think about the timing of those payments along the next 9 months of the fiscal year?

Mariana, good question. Really some good progress on the unbilled receivables. We've seen the unbilled receivables in Mexico at September 30 come down nicely from June 30, and we expect to see that continued progress throughout the fiscal year. And the nice part is, of course, as it moves from unbilled into billed, we can then start collecting the cash. So as we look at fiscal '26, we expect some very significant cash flow from Mexico specifically, but from overall business more generally as well, which will lead to very strong free cash flow conversion.

And then when you think about free cash flow and the position you'll have, you have a lot of, I don't know, a deeper pocket to pursue different capital deployment activities. How is the M&A pipeline? What are you looking at when you look at that, especially after the radio frequency product line has been performing so strongly? How is that pipeline? And what type of capabilities are you looking at?

So this is Ajay. We're always looking at expanding our capabilities, not just on the recurring revenue service side, but also on the technology side, complementary technologies that can get us deeper into the government and other customers where we were offering them certain products. Now we can offer them. I've always said this a solution. We're playing in a bigger pond as we go forward. And obviously, and I've said this before, that any acquisition that we look at is going to be carefully looked at. We don't -- we're going to see this 1 plus 1 equal 3 or 4. And obviously, the rest of it to pay any cash we collect to pay down debt, obviously, look at stock buybacks. So we're looking at all 3. And the good news is that we're in a very good position to evaluate what we want to do and look at the right acquisitions as they become available.

And last one from me on the government shutdown. Are you waiting for any meaningful awards that have been delayed by the extended government shutdown? And how do you think about the risk as you think about the rest of the year from that?

So I think that we're working with the agencies during the government shutdown. Like I mentioned in my remarks, we're not as concerned about '26. Really some of the orders we're looking at are for beyond '26. You might have a little bit of delay here or there, but it's more on getting some orders in. It's really nothing significant that should affect our fiscal year.

Our next question comes from Seth Seifman with JPMorgan.

I wanted to ask about the profitability, especially in Security since some of the mix items you talked about offset the increase in the services mix. And so margin was down year-on-year. At what point do you see margin being able to expand again in the security business and kind of reset itself as the Mexico revenue kind of gets to a level where it's stable?

Yes, Seth, this is Alan. Good question. And really the final quarter of the difficult Mexico comps when it comes to a margin perspective, particularly is this upcoming quarter, the December quarter, which is, of course, built into our guidance and much more akin to what we've been seeing in the last couple of quarters. So as we get past the end of this calendar year and move into January, the comps get much more normalized from a Mexico perspective. And we believe that there's ample opportunity to start showing margin expansion again. There'll be quarters where it's very robust and quarters where there might be a different mix going the opposite direction as well. But really, as we move into the next calendar year and beyond, we should be in good shape to start focus on margin expansion again.

Okay. Excellent. Excellent. And one follow-up, I guess, on the funding that's in the reconciliation bill. I mean one of the things we've noticed on the defense side is that, that money has been a little bit slow in flowing out and not -- some of that at this point might have to do with the shutdown, but even just because it comes out of the reconciliation process and tapping into it might be a little bit different for the customers. I was just wondering what your experience has been thus far in terms of discussions about those contracts.

So this is Ajay. I think I mentioned this last time as well. We're expecting that funding to come in probably towards the second half of our fiscal year. And we're still expecting that. I mean, on the other side, could it have come in maybe in December? Maybe. But really, from our standpoint, that's when we're expecting, that's what we're planning on it. And as far as the funding itself, I mean, you got to look at it. It's a big bill and their priorities. And I think from our standpoint, there's -- one of the biggest priorities is really border funding, and we think that's not going to get delayed. I think that's going to come in as we expect it to come in. Anything can happen, but we feel very good about it right now. And so that's kind of the best way to look at it.

[Operator Instructions] Our next question comes from Larry Solow with CJS Securities.

Just a couple of follow-ups. Most of my questions have been answered. Can you just give us, Al, the specific number that the RF sensor business contributed in the quarter? I think it was $17 million last Q1 last year on a partial. So if you can give us that number. And then just more from a higher level, just thoughts on the Golden Dome, just time lines from a higher level, not specific, but when we might see that? Is that like quarters? Or is that years away? And how big of an opportunity could it potentially be for this business?

Larry, I'll take the first part of the question, and I think Ajay, the second part. In terms of the RF, we bought that business in September of 2024. So we had 3 or 4 weeks of operations last year. So last year, we did about $4 million in revenues from that business. And this past quarter, we did about $19 million of revenues. It is, generally speaking, a little bit of a seasonally slower quarter, and we expect that to pick up over the balance of the year.

Yes. So the question on the golden dome, obviously, with our RF technologies, especially in this case, over the horizon radar, we feel that we're well positioned. Everybody is talking about the program being in the billions and billions or tens of billions of dollars. We think we have a pie in there. What it's going to be and how it's going to come across because it's not just the prevention, but it's obviously looking at missiles and missiles and other things. So I think we'll know in the next 2, 3 quarters, like I said before, but we feel good about where we are in the process.

Okay. Great. Question on just on the gross margin, Alan, in Security, I know you mentioned, obviously, mix -- product mix moves around a lot. But this quarter, gross margin on the products was significantly lower than I've seen it going back several years. Was there anything unusual beyond just the mix? Or was it just a really lower margin mix this quarter?

It really did come down to just being a lower margin mix this quarter on the product side, not necessarily reflective of what we would anticipate going forward. It just happened to be the mix of product sales in this particular quarter. Nice part was we made it up on volume to still have very, very nice profitability, but we would expect that that product margin to be better in the future.

And then just lastly on the cash flow, the free cash flow, I know you get this question a lot, but it sounds like you remain confident in a good year. And I guess my question would be Mexico has kind of been the biggest impact. And now that your revenues from Mexico are very modest. As we look out over the next few quarters, assuming even if they're a little bit late, I got to imagine by the end of this year, a lot of that, hopefully, Mexico delayed payment and AR specifically should come down a lot, almost normalized. So I mean, is it possible that we have a free cash flow drop-through conversion rate close to net income this year?

Good question. Yes, we would expect the Mexico cash flows to be very strong over the next few quarters and will position us extremely well. In terms of looking at free cash flow to net income, I think you're right. You might even be conservative. I believe we can exceed 100% of net income and possibly by a significant amount. So it could be a very, very nice free cash flow year for us.

And I'm not showing any further questions at this time. I'd like to turn the call back to Ajay for any further comments.

Okay. Well, I want to thank those in attendance for joining our call. We're excited about the opportunities ahead and look forward to speaking with all of you at our next call. Thank you very much.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.