OSI Systems' Q1 2026: Contradictions on Growth Without Mexico, Government Shutdown Impact, and Service Revenue Outlook

Date of Call: October 30, 2025

Financials Results

• Revenue: $385M, up 12% YOY
• EPS: $1.42 non-GAAP adjusted EPS (Q1), record Q1
• Gross Margin: 32%, down from the same quarter in the prior year
• Operating Margin: 10.3% non-GAAP adjusted operating margin, consistent with prior-year quarter

Guidance:

• Raised FY'26 revenue guidance to $1.825B–$1.867B (growth 6.5%–9.0% vs prior year; prior guide 5.4%–8%).
• Raised FY'26 non-GAAP adjusted EPS guidance to $10.20–$10.48 (9%–12% YoY); excludes impairment, acquired intangibles amortization and discrete items.
• Guidance assumes ~60% reduction in Mexico contract revenues as a headwind; timing of backlog conversion, bookings, cash collections, tariffs and government shutdown could materially affect results.

Business Commentary:

• Strong Financial Performance and Revenue Growth:
• OSI Systems reported revenue of $385 million for fiscal Q1 2026, marking a 12% year-over-year increase and a new record for the first quarter.

• This growth was supported by double-digit top-line growth across all three divisions, with the Security division achieving a 13% increase in revenue.

• Security Division Performance:

• The Security division's revenue reached $254 million, indicating a 13% year-over-year increase.

• The growth was driven by robust sales of aviation and checkpoint products, increased revenues from RF products acquired in fiscal '25, and a strong book-to-bill ratio of 1.1.

• Service Revenue Expansion:

• Service revenues grew by 23% during the quarter, contributing significantly to overall revenue growth.

• This increase reflects installations from the past few years now generating recurring revenue from ongoing service and support.

• Guidance and Future Outlook:

• The company raised its fiscal '26 guidance for revenues to a range of $1.825 billion to $1.867 billion, representing a growth rate of 6.5% to 9.0%.
• Despite a 60% reduction in Mexico revenue estimates, the company maintains a positive outlook due to robust growth in other product lines and a strong backlog.

Sentiment Analysis:

Overall Tone: Positive

• Management highlighted record Q1 performance: "revenues increased 12% year‑over‑year to a Q1 record of $385 million," "record Q1 non‑GAAP adjusted EPS of $1.42," a "record Q1 backlog approaching $1.9 billion," and an upward revision to FY'26 revenue and EPS guidance.

Q&A:

• Question from Josh Nichols (B. Riley Securities, Inc., Research Division): 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?
  Response: Strength was broad and global—EMEA, Americas and APAC—with outsized contributions from higher‑margin service revenues, a full quarter of RF product sales and strong aviation product demand.

• Question from Josh Nichols (B. Riley Securities, Inc., Research 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?
  Response: They don't break out service vs product guidance, but management expects service revenue to grow faster than overall revenue this year while product revenues also remain strong.

• Question from Josh Nichols (B. Riley Securities, Inc., Research Division): 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?
  Response: Management expects Mexico revenue for the year to be just below ~$100 million.

• Question from Jeff Martin (ROTH Capital Partners, LLC, Research Division): 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.
  Response: Management sees an acceleration in government spending (domestic and international) driven by legislation and geopolitical risks, creating growing opportunities for integration, services and RF technologies.

• Question from Jeff Martin (ROTH Capital Partners, LLC, Research Division): 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.
  Response: Impact has been limited because many customers are essential agencies; some order timing may slip but management does not expect material impact to FY'26.

• Question from Jeff Martin (ROTH Capital Partners, LLC, Research Division): 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?
  Response: Yes — underlying consolidated revenue grew roughly 26% excluding acquisitions and Mexico, and Security ex‑Mexico grew about 39%.

• Question from Jeff Martin (ROTH Capital Partners, LLC, Research Division): Okay. And then you said there's a headwind of 60% from Mexico. I assume you mean $60 million year-over-year.
  Response: They clarified it as an approximate 60% reduction in Mexico revenues year‑over‑year (i.e., a sizable decline versus fiscal '25).

• Question from Mariana Perez Mora (BofA Securities, Research Division): 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?
  Response: Unbilled receivables from Mexico have declined since June 30, are expected to continue converting to billed, and should drive substantial cash collections through fiscal '26.

• Question from Mariana Perez Mora (BofA Securities, Research Division): 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?
  Response: They are actively evaluating acquisitions to add recurring‑revenue/service and complementary tech capabilities; potential uses of cash include M&A, debt paydown or buybacks depending on opportunities.

• Question from Mariana Perez Mora (BofA Securities, Research Division): 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?
  Response: Working with agencies; some awards beyond FY'26 may be delayed but management is not currently concerned about material FY'26 impacts.

• Question from Seth Seifman (JPMorgan Chase & Co, Research Division): 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?
  Response: Margins should begin to expand after the December quarter as Mexico comps normalize, with further improvement into the next calendar year though quarter‑to‑quarter mix variability will persist.

• Question from Seth Seifman (JPMorgan Chase & Co, Research Division): 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.
  Response: Management expects reconciliation bill funding to flow in the back half of the fiscal year and anticipates border‑related funding will be prioritized.

• Question from Lawrence Solow (CJS Securities, Inc.): 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?
  Response: RF contributed about $19M in Q1 (versus ~$4M in prior‑year partial quarter); management expects clarity on Golden Dome opportunities within 2–3 quarters and believes OSI is well positioned to capture a share.

• Question from Lawrence Solow (CJS Securities, Inc.): 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?
  Response: It was driven by a lower‑margin product mix this quarter; management expects product margins to improve going forward.

• Question from Lawrence Solow (CJS Securities, Inc.): 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?
  Response: Yes — management expects Mexico collections to drive very strong cash flow; free cash flow could exceed 100% of net income this year.

Contradiction Point 1

Expectation of Double-Digit Growth without Mexico

It involves the company's expectation for growth rates excluding the revenue from Mexico, which is crucial for investor expectations.

Can you break down which products and markets are driving your Security business growth, given that Q1 is typically slower? - Josh Nichols(B. Riley Securities, Inc.)

2026Q1: if you pro forma out Mexico, our guidance would suggest that we would have a double-digit growth rate for OSI Systems overall. - Alan Edrick(CFO)

Without Mexico, can top-line growth exceed double digits? - Michael Joshua Nichols(B. Riley)

2025Q4: Yes, if you pro forma out Mexico, our guidance would suggest that we would have a double-digit growth rate for OSI Systems overall. - Alan I. Edrick(CFO)

Contradiction Point 2

Impact of Government Shutdown on Business Activities

It involves the company's assessment of the impact of the government shutdown on their operations, which could affect revenue and cash flow.

How is the government shutdown affecting your business? - Jeff Martin(ROTH Capital Partners, LLC)

2026Q1: The impact of the shutdown has been limited. We're in essential industries and must maintain operations. Some orders might be delayed, but it's not affecting our fiscal year significantly. - Ajay Mehra(CEO)

Any impact from the government shutdown or delays in orders? - Christopher John Barbero(JPMorgan)

2025Q4: We are aware that there will be some orders that are delayed and some payments that may be delayed. - Ajay Mehra(CEO)

Contradiction Point 3

Service Revenue Growth as a New Baseline

It pertains to the sustainability and expectations of service revenue growth, which is crucial for understanding the company's revenue mix and growth potential.

How has the growth rate of service revenues compared to that of product revenues this year? - Josh Nichols (B. Riley Securities, Inc.)

2026Q1: We expect faster growth in service revenues than product revenues. - Alan Edrick(CFO)

Are there any one-time items contributing to the service revenue growth, and is this growth a new baseline? - Larry Solow (CJS Securities)

2025Q3: This could be a new baseline for service revenue. - Alan Edrick(CFO)

Contradiction Point 4

Security Business Growth and Revenue Contributors

It involves the characterization and expected growth of the Security business, which is a critical part of OSI Systems' revenue and strategy.

What products and markets are driving the Security business's strength, especially during typically slower Q1? - Josh Nichols (B. Riley Securities, Inc.)

2026Q1: The Security business saw broad growth across revenues and bookings. Service revenues were exceptionally strong, as well as contributions from the RF products and aviation products. - Alan Edrick(CFO)

How is the increase in business opportunities related to your U.S. border operations? How might increased agency budget allocations impact opportunities? - Josh Nichols (B. Riley)

2025Q2: Border security is a significant issue, with both houses working to reconcile bills for increased funding. This is positive for us as our technology, especially our CertScan software, is a plus. We are the dominant player with CBP and expect more opportunities over the next 3-6 months. - Ajay Mehra(CEO)

Contradiction Point 5

Margin Expansion Expectations

It involves the company's expectations for margin expansion, which is a critical indicator for investors.

When do you expect margin expansion in the Security business? - Seth Seifman(JPMorgan Chase & Co, Research Division)

2026Q1: Beyond that, we should see margin expansion starting in January. We believe we'll be in good shape to focus on margin expansion again. - Alan Edrick(CFO)

Explain the accounts receivable increase and potential cash flow for fiscal 2026? - Lawrence Scott Solow(CJS Securities)

2025Q4: The gross margin will be around 43.5%, which is up 60 basis points from the 42.9% in the prior year and in line with our guidance. - Alan I. Edrick(CFO)