OSI Systems Signals Strong Outlook Despite Q3 Drag

OSI Systems ((OSIS)) has held its Q2 earnings call. Read on for the main highlights of the call.

OSI Systems used its latest earnings call to deliver a broadly upbeat message, emphasizing record quarterly revenue and earnings per share alongside robust cash generation and a strong backlog. Management acknowledged several near-term headwinds—most notably a steep drop in Mexico-related security revenues, softer bookings in the Security division, and continued weakness in Healthcare—but maintained confidence that underlying demand, operational discipline, and a healthy pipeline will support double-digit earnings growth over the coming year.

Record Q2 Revenue Underscores Broad-Based Growth

OSI Systems reported second-quarter revenue of $464 million, an 11% year-over-year increase and a Q2 record for the company. Growth was driven by broad demand across its businesses and supported by a sizable $1.8 billion backlog, giving investors visibility into future revenue. The performance signals resilient end-market demand despite macro uncertainty and timing-related delays in certain contracts.

Security Division Delivers Double-Digit Gains

The Security division remained the company’s growth engine, with Q2 revenues rising 15% year-over-year to $335 million. Stripping out large Mexico contracts, Security revenue would have jumped roughly 31%, highlighting strong underlying demand for screening and detection technologies. Management highlighted notable wins, including a $20 million international radiological detection contract and, after quarter-end, an approximately $30 million RF/naval order, reinforcing OSI’s positioning in critical infrastructure and defense-related security.

Optoelectronics & Manufacturing Maintains Momentum

The Optoelectronics & Manufacturing segment posted another record Q2, with revenues climbing 12% to $113 million. The book-to-bill ratio exceeded 1, indicating orders are outpacing shipments and supporting future growth. Adjusted operating margin edged up to 12.9% from 12.8%, showing the business is scaling efficiently and contributing solid profitability to the overall portfolio.

Record Non-GAAP EPS and Upgraded Earnings Outlook

OSI Systems delivered record Q2 non-GAAP adjusted EPS of $2.58, reflecting both top-line growth and disciplined cost control. On the back of this performance, management raised its fiscal 2026 non-GAAP EPS guidance to a range of $10.30 to $10.55, implying 10% to 13% year-over-year growth. The upgraded earnings outlook, without changing revenue guidance, suggests confidence in mix, margin, and efficiency improvements despite short-term noise.

Cash Flow Strength and Balance Sheet Optimization

The company generated about $62 million in operating cash flow during the quarter, underscoring solid cash conversion from its record results. Management further optimized the balance sheet by issuing $575 million of convertible notes at a low 0.5% coupon, using the proceeds to reduce borrowings on its revolving credit facility and repurchase roughly 547,000 shares at an average price of $267. Net leverage stands at about 2.2x, and the combination of lower interest costs and reduced share count supports future EPS growth.

Strategic Pipeline: Golden Dome, RF Expansion and Event Security

Beyond current results, OSI Systems emphasized its growing pipeline of strategic security opportunities. The company is participating in the Shield IDIQ (“Golden Dome”) program, which carries a large reported ceiling and could translate into significant long-term awards over time. Additional wins supporting major sporting events and continued expansion of its RF business—including new facilities in Texas to increase production capacity—highlight the company’s deepening role in high-end security and defense technology markets.

Cost Discipline Drives SG&A Efficiency

Operating expenses were tightly managed, falling 1% year-over-year to $70.2 million and declining to 15.1% of sales from 16.8% a year earlier. Management noted that combined SG&A and R&D as a percentage of sales has decreased every year for the past eight years, underscoring a culture of cost discipline. This ongoing efficiency supports margin resilience and contributes to the company’s ability to grow EPS faster than revenue.

Mexico Revenue Drop Creates Near-Term Drag

One of the most notable headwinds is the sharp decline in revenue from large Mexico-related security contracts. Q2 revenue from these contracts fell 50% year-over-year to $27 million from $54 million. Management expects this to produce a Q3 revenue headwind of more than $50 million versus last year, resulting in pronounced pressure in the upcoming quarter before conditions ease in Q4 as comparisons normalize and other parts of the backlog convert.

Security Bookings Soft but Seen as Timing Issue

Despite strong Security revenue, bookings came in softer than expected, with a book-to-bill slightly below 1.0 for the quarter. Management attributed the shortfall largely to timing factors, including delays related to U.S. government funding dynamics and international pushouts, rather than lost business. The company pointed to a still-robust pipeline and reiterated confidence that these opportunities will convert into orders over time.

Margin Pressure from Product Mix and External Factors

Overall gross margin slipped to 33% in Q2, driven by a less favorable mix of products and services as well as external factors such as foreign exchange and tariffs. Security’s adjusted operating margin declined to 17.8% from 19.9% year-over-year, reflecting these mix effects. Management stressed that margins are inherently variable quarter to quarter, influenced by volume, contract type and geographic mix, and indicated that the underlying business remains healthy.

Healthcare Division Remains a Weak Spot

The Healthcare division continued to lag, with soft sales and a negligible adjusted operating margin at current revenue levels. OSI Systems is ramping up sales efforts and investing in next-generation products to reinvigorate the business, but management cautioned that any meaningful recovery will take time. For investors, Healthcare remains an area to watch, with potential upside if product and commercial initiatives start to gain traction.

Higher Non-Operating Charges Temper Bottom Line

Non-operating expenses increased to $10.7 million from $8.6 million a year earlier, partly due to a one-time $4.4 million cost tied to a retirement plan amendment for the former CEO. While lower net interest expense from balance sheet actions provided some offset, this non-operating burden tempered the full benefit of operating performance on GAAP earnings, even as non-GAAP EPS set a Q2 record.

Guidance: EPS Raised, Q3 Headwinds but Stronger H2

Looking ahead, OSI Systems raised its fiscal-year non-GAAP EPS guidance to $10.30–$10.55, implying 10%–13% growth, while keeping revenue guidance unchanged. The outlook is underpinned by a roughly unchanged $1.8 billion backlog, strong Q2 performance in Security and Optoelectronics, and solid cash generation metrics, including Q2 operating cash flow of $62 million and net leverage of about 2.2x. Management warned that Q3 will face a revenue headwind of more than $50 million, mostly from the Mexico contracts, leading to near-term pressure. However, they anticipate significantly stronger growth in Q4 and the second half as Mexico comparisons ease and backlog converts, supported by ongoing R&D investment and capital deployment via low-cost convertible debt and share repurchases.

In closing, OSI Systems’ earnings call painted a picture of a company balancing impressive operational execution and strategic positioning against a handful of temporary headwinds. Record revenue and EPS, strong Security and Optoelectronics growth, disciplined cost control, and a bolstered balance sheet all support management’s more optimistic earnings outlook. While investors will need to navigate a choppy Q3 shaped by Mexico-related revenue declines and Healthcare softness, the company’s large backlog and growing pipeline suggest that the longer-term story remains firmly positive.