OSIS - NASDAQ

Thank you for standing by, and welcome to the OSI Systems Fourth Quarter 2025 Conference Call. [Operator Instructions] As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Alan Edrick, Executive Vice President, Chief Financial Officer. Please go ahead.

Good morning, 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 '25 Fourth Quarter and Year-End 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 '25 fourth quarter and full year financial results. Before we discuss these results, I'd 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 refer to both GAAP and non-GAAP financial measures when describing the company's results. For further information regarding non-GAAP measures and comparable GAAP measures of the company's results and a quantitative reconciliation of those figures, please refer to today's earnings press release. I will begin with a high-level summary of our financial performance for Q4 and then turn the call over to Ajay for a discussion of our business and our operational performance. We will then finish with more detail regarding our financial results and a discussion of our outlook for fiscal year '26. Our fourth quarter financial results were strong with multiple Q4 records across key metrics and the strong finish capped off an exceptional year for OSI Systems. We are excited by the momentum across our businesses as we kick off fiscal '26. Now for the high-level summary of our fiscal 2025 Q4 results. First, revenues increased 5% year-over-year against a difficult comparison to a Q4 record of $505 million, driven primarily by a 28% increase in Security division service revenues and a 10% increase in Optoelectronics division revenues, including intercompany sales. This top line growth is particularly noteworthy given that the prior year Q4 included exceptionally large revenues from major security programs in Mexico. Excluding contributions from those Mexico contracts and fiscal '25 acquisitions, OSI revenues grew roughly 30% in Q4, demonstrating the strong organic demand across our core businesses. Second, the solid revenue growth along with effective cost management, led to record Q4 non-GAAP adjusted earnings per share of $3.24. This is the highest quarterly adjusted EPS in our history. And third, bookings were significant in the quarter. And with a book-to-bill ratio of approximately 1.0 in Q4, we finished with a record year-end backlog of over $1.8 billion. This robust backlog coupled with a strong pipeline of opportunities provides excellent visibility as we head into the new fiscal year. Before diving more deeply into our financial results and discussing our outlook for fiscal '26, I'll turn the call over to Ajay.

Thanks, Alan. Good morning, everyone, and welcome to OSI Systems Earnings Call. I am pleased to share our strong results for the fourth quarter and full fiscal year underscoring the unwavering strength, relentless execution and innovation in our business. As Alan mentioned, we delivered record revenues and adjusted EPS for both Q4 and fiscal '25 driven by our Security and Optoelectronics divisions. During the quarter, the Security division maintained strong momentum in core markets like ports, orders, aviation and critical infrastructure, with Optoelectronics achieved double-digit revenue growth. We closed Q4 with robust bookings and a book-to-bill ratio of approximately 1 culminating in a year-end backlog of approximately $1.8 billion. Let's dive into some key highlights. Our Security division delivered impressive growth once again with Q4 revenues up 7.1% year- over-year on a tough comp and a full year revenues surging 14.7%. This was driven by broad-based demand across our portfolio especially from airport and international border security customers. We advanced several major programs in the quarter, including our large-scale contracts in Mexico, as Mexico-related revenues became a lower percentage of our total revenues throughout '25, we balanced the portfolio with revenue gains from a diverse base of global clients. Our turnkey projects worldwide are performing well, generating reliable and recurring revenues and showcasing our expertise in developing novel customized solutions for our customers. Several of these programs utilize our CertScan platform, which integrates multisite operations and is being increasingly adopted by customs authorities at ports and borders globally. Security book-to-bill had approximately 1.0 in Q4, bolstered by major awards in aviation, ports, borders and infrastructures. Recent examples of security orders include a $56 million order from an international customer for our Eagle M60

Thank you, Ajay. Now I'll review in greater detail the financial results for fiscal '25 Q4 and then discuss our fiscal '26 guidance, as Ajay mentioned. Our Q4 revenues were up 5% compared to the fourth quarter of the prior fiscal year. This growth was fueled by our security division and strong execution in our Opto division partially offset by a decline in health care. Security division revenues in Q4 were $367 million, an increase of 7% year-over-year. This growth was driven by higher service revenues, robust sales of aviation and checkpoint products and contributions from the RF detection business we acquired in Q1. As expected and consistent with last quarter's trend, revenues from our large Mexico security contracts decreased in Q4 '25 to $40 million from $145 million in Q4 of the prior fiscal year. Excluding acquisitions and excluding the Mexico contracts, securities revenues grew approximately 50% in the quarter, which underscores the healthy demand in the rest of our security portfolio. Meanwhile, our Optoelectronics and Manufacturing division had a great quarter. Third-party Opto sales increased 10% year-over-year to $95 million, which is a new Q4 record for this division. This was driven by growth in our Flex contract manufacturing business and solid performance in our core Optoelectronics operations. And then on the other hand, as Ajay mentioned, we were disappointed by the decrease in Healthcare division sales. That softness in Healthcare impacted our consolidated growth rate, but we are optimistic about improving it going forward. Turning to profitability. Our Q4 '25 gross margin was 33.3%, up 120 basis points from 32.1% in Q4 of last year. The gross margin increase was largely due to a favorable revenue mix, including higher service revenues, which carry better margins as well as improved efficiencies. Of course, our margins can fluctuate based on product/service mix, volume, supply chain costs, FX, tariffs, among other factors. Operating expenses in Q4 were well controlled. SG&A was $74.7 million, or 14.8% of sales compared to $71.7 million or 14.9% of sales in Q4 last year. We continue to work diligently across all divisions, to manage our SG&A cost structure efficiently as we grow. Research and development expenses in Q4 were $18.8 million or 3.7% of revenue, up from $15.9 million or 3.3% of revenues in the same quarter last year. This increase reflects our commitment to invest in innovation, particularly in the Security and Healthcare divisions as we remain focused on developing new market-leading products that we view as vital for our long-term success. We expect this heightened focus on R&D to continue into fiscal '26 as we advance key projects such as our computed tomography scanning technology and next- gen patient monitors. Even with these investments, we have successfully leveraged our expense structure over many years. In fact, our combined SG&A and R&D expenses as a percentage of sales have decreased annually for the past 8 years from 27.6% of sales in fiscal '17 to 21.3% of sales in fiscal '25. This underscores our ability to drive operating efficiencies while still funding growth initiatives. Now moving below the operating line. Net interest and other expense in Q4 was $7.2 million, decreasing from $8.2 million in Q4 of fiscal '24. This reduction was due to lower average debt levels during the quarter and a reduced average interest rate aided by the favorable impact of the convertible notes we issued in Q1 of fiscal '25, the proceeds of which were used in part to repay higher cost borrowings. Our effective tax rate under GAAP was 19.8% in Q4 of fiscal '25 versus 18.3% in the same quarter last year. Excluding discrete tax items, our normalized effective tax rate, which is what we used in calculating non-GAAP EPS was 21.9% this quarter compared to 21.2% in the prior year quarter. On a non-GAAP basis, our adjusted operating margin for Q4 of fiscal '25 was 15.7%, up from 14.8% in Q4 last year. By segment, the Security division's adjusted operating margin was 20.4% in Q4, improving from 18.5% a year ago, thanks to the significant increase in higher-margin service revenues we discussed. Opto's adjusted operating margin was 13.6%, slightly down from 13.9% in last year's Q4. This slight decrease was due to short-term inefficiencies as our new manufacturing facility is still ramping up. We expect Opto margins to improve as that operation scales. Lastly, the adjusted operating margin of our Healthcare division was negligible in Q4. Moving to cash flow and the balance sheet. We did see improvement in operating cash flow in Q4 compared to the prior year, but it was lower than what we had anticipated. This was largely because our largest security division customer located in Mexico pushed payments that we expected in Q4 into fiscal '26. Consequently, our accounts receivable balance increased to approximately $837 million as of June 30. The good news is that we expect a substantial cash inflow in fiscal '26 as those receivables are collected. We anticipate that the receivables from Mexico customers to decline over the course of the year which should contribute to sizable operating cash flow in fiscal '26. Additionally, recent tax legislation regarding R&D expense capitalization and accelerated depreciation on capital expenditures may provide some near-term cash savings for us, further bolstering cash flow. CapEx in Q4 of fiscal '25 was $6 million, while depreciation and amortization expense was $10.9 million. Our balance sheet remains solid. At the end of fiscal '25, our net leverage was approximately 1.8 as calculated under our credit agreement. Subsequent to fiscal year-end, we amended our credit facility to extend the maturity date to July 2030 and increased the borrowing capacity at $825 million. This expanded facility enhances our liquidity and financial flexibility, we believe this positions us well to support growth initiatives and navigate any unexpected needs. Now turning to our fiscal '26 outlook. For fiscal '26, we anticipate revenues in the range of $1.805 billion to $1.85 billion, which represents year-over-year revenue growth of 5.4% to 8%. We are also expecting non-GAAP adjusted earnings per diluted share in the range of $10.11 to $10.39, which represents 8% to 11% year-over-year growth. We note this fiscal '26 non-GAAP diluted EPS guidance excludes any impact of potential impairment, restructuring and other charges, amortization of acquired intangible assets and their associated tax effects and discrete tax and other nonrecurring items. We currently believe this guidance reflects reasonable estimates. The actual impact on the company's financial results of timing changes on the expected conversion of backlog to revenues new bookings, timing of cash collections and tariffs, among other factors, is difficult to predict and could vary significantly from the anticipated impact currently reflected in our guidance. Actual revenues and non-GAAP earnings per diluted share could also vary from the guidance indicated above due to other risks and uncertainties discussed in our SEC filings. In summary, we remain focused on growing our businesses and continuing to provide innovative products and solutions to our customers. Fiscal '25 was an outstanding year for OSI, and we are carrying that momentum forward. We expect to generate strong cash flow and have the financial strength to invest in key strategic areas that will drive long-term value. Once again, as Ajay mentioned, we thank the entire global OSI team for their dedication to supporting our customers and partners, their efforts are what make these results possible. And at this time, we'd like to open the call to questions.

And our first question for today comes from the line of Josh Nichols from B. Riley.

And great to see the company executing well despite being up against that tough comp. Revenue guidance for fiscal year '26 came in better than expected. And as you kind of highlighted that ex Mexico, that Security division has been a pretty standout performer. If we take that logic and apply it to fiscal '26, do you think it's fair to assume that the top line would be growing at a double-digit clip like ex Mexico?

Josh, thank you. This is Alan. Good question. You're exactly right. We'll have a little bit of a headwind in fiscal '26 for Mexico as we did in fiscal '25, which we overcame nicely. But if you pro forma out Mexico, our guidance would suggest that we would have a double-digit growth rate for OSI Systems overall.

And then just one follow-up question for me. I mean -- I think the Security division. When you look specifically like the services revenue growth pretty phenomenal 24% year-over-year in the fourth quarter and had an exceptionally strong second half here. Do you think it's fair to assume that, that type of outperformance of the services piece of the business is likely to continue to grow faster than the product piece and that should be accretive to gross margins in fiscal year '26 as well.

Josh, very good question. Yes, we're really pleased with the strong service revenue growth. That recurring revenue is high quality revenue at higher margins than our product revenues typically. As we look forward with the strong installed base that we have out there and some of these products coming off of warranty, we would anticipate that our service revenue growth will continue to be strong and it may vary from quarter-to-quarter, but our service revenues could certainly outpace the product revenue in terms of overall growth percentage. But we expect both strong service revenue growth, and we expect strong product revenues as well.

Yes. Just to -- just to add on to that, I think that Alan is absolutely 100% correct. On top of that, as we look at our growth -- it's not just in cargo, it's in aviation, and we expect the service and aviation to contribute quite a bit as well as we go forward. So all sides of the business really from a service standpoint will be going on also and just going forward.

And our next question comes from the line of Larry Solow from CJS Securities.

I guess first question, just on the full year, security obviously grew, I think, about 7% on an organic basis, but it was roughly flat in the back half of the year. Everything else, it seems like it's just timing and a tough year-over-year comp, but just any more color on that. It sounds like your guidance certainly implies a reacceleration in '26, but I think that might be a concern of some people that the growth is basically -- or basically flattish in the back half of this year.

Larry, good question. This is Alan. As you know and as I suggested in the prepared remarks, we had very, very significant revenues in the back half of fiscal '24, Q3 and Q4 in Mexico. We mentioned it on the last quarterly earnings call and mentioned at this one as well, for instance, I think we said we went from $145 million in revenues this quarter to $40 million in Mexico. So that had a major, major impact on the growth rate, but when you sort of strip that out and look at kind of the core business overall, the core security revenues, if you strip out Mexico and you strip out the acquisitions, so you're just looking at sort of the core, it grew over 50% in this past quarter. So our sales teams have really done an outstanding job, as Ajay mentioned, kind of diversifying our global customer base throughout cargo and aviation and otherwise, to really give us some strong core business growth.

Yes. And just to add on to that, I think that if you look at -- as Alan pointed out, the core business is growing very well. And if you look at our pipeline, not just domestically, internationally and with some of the funding that's going to come up going into '26 and frankly beyond, I think, is -- bodes very well for us.

Great. And I think just the Mexican piece. Obviously, there's been some concern from some folks out there that Mexico continues to decline. Can you -- obviously, when you first got this big Mexico order from SEDENA, I think that $500 million order was like half of your backlog of like $1 billion or plus or minus 3 or 4 years ago. Can you just give us an idea -- I think your backlog, you said totally was $1.8 billion, about what that -- how much of that is security and it feels like Mexico is very little of that, which I would view as a positive, but just trying to get a little more cross-sectional look at what your backlog is today made up of?

Sure, Larry, this is Alan. Good question. Of our $1.8 billion backlog, about $1.5 billion is security. So it's heavily dominated by security. You might recall when we got three Mexico contracts totaling about $800 million a few years ago, that represented a very substantial portion of our backlog. As we've delivered on that contract starting at the end of fiscal '23, but much more significantly in fiscal '24, and then as well in '25. Obviously, the backlog from Mexico has come significantly down, and yet our overall backlog is at a record level for year-end. So again, it sort of points to the strength of the sales team and the global diversification efforts. So we think we're in great shape. The -- the decrease in Mexico sales, of course, has been expected and anticipated, and we've been talking about this for some time. And what's really encouraging is how great the team has done in filling up that hole to continue to grow the business. And with that outstanding pipeline of opportunities that Ajay was mentioning, both domestically and internationally, the outlook looks great, not just for fiscal '26, but for years beyond that.

Okay, great. And then just lastly, just on the accounts receivable. Obviously, it went off, I think $250-ish million sequentially. Can you just give us a little more color because obviously, Mexico wasn't $250 million of sales this quarter, but -- so you called out Mexico is the biggest driver of that. Any more just clarification on that. And if that's just a timing thing, should we expect a significant drop in receivables in fiscal '26 and just on the free cash flow, can you just quantify maybe a little better? Do you expect it to be directionally around net income? Is that a good starting point?

Sure. Sure. Good question. So yes, our receivables at June 30 were higher than we typically see. What drove that? Sort of a few factors. One, as mentioned, we didn't collect any money from Mexico in the fourth quarter. We collected well over $100 million in the previous quarter. We've already collected some money here in the first half of Q1 and expect to collect significantly more in this quarter and throughout the fiscal year. So that was sort of one contributor. So we recognized Mexico revenues in Q4, but we did not recognize any collections from that account in the year -- in the quarter, excuse me. But the bigger thing what drove the receivables is we had a record quarter. We had a record quarter of revenues. Those revenues tend to always be a little bit more back-weighted to month 2 and month 3 of the quarter, which means we predominantly collect that in the following quarter or two. So as a result, we saw our receivables significantly rise at the end of June. None of this is even remotely a concern for us. When it spells out is just huge opportunity for strong free cash flow as we look forward. To your question on what could our free cash flow be? Could it be equivalent to net income. We think the answer is absolutely yes. In fact, we think our free cash flow conversion could be north of 100% of net income in fiscal '26. So yes, we would expect to see our receivables reducing throughout the fiscal year, seeing our DSOs begin to normalize, and that should generate very, very sizable cash flow for us.

There hasn't been any change in like credit terms with sovereign debt. I mean, are you guys getting any -- are you having to offer better looser terms? Or is it just strictly Mexico, which you've said in the past, they're generally a little bit slower, but their payment is always pretty much comes -- it's just a little late. Is that still the same? Or is the overall just in this economy and whatnot, things gotten a little bit more tough.

I think that we've been dealing with Mexico for 10-plus years and never had an issue. I think it's more paperwork, bureaucracy, getting things done. So we don't have a concern about the payment. It's just -- we just have to be patient and work with the customer.

In general payment terms, we're not seeing anything change. It's always a little different with these customers, but we don't see any notable difference today versus what we've seen in the past.

And our next question comes from the line Mariana Perez Mora from Bank of America.

So if I may, can we follow up on the receivables? Because you mentioned part of that was related to the Mexican contracts, but other stuff was not related to it. Like how much is that? And then so far into this fiscal year, kind of like July and like this half of -- first half of August, have you seen any meaningful collections? Have you seen any improvement on the audits that I think it was a main bottleneck for the Mexico contracts and sites getting approved? Could you please give us color around that?

Sure, Mariana, this is Alan. Thanks for the question. Yes, we have indeed seen collections from Mexico in the first half of this quarter, and we anticipate we could see even much more meaningful collections throughout the second half of this quarter. So the receivable increase in Q4 was a little bit related to Mexico as we had $40 million or so of revenue in the quarter. but more of it was just driven by the strength of the overall revenues to other customers during that period of time. But we feel very strong about that. I think there was a -- oh, you're talking about the audits. Yes, the audits have gone extremely well. As a result, we're seeing more and more of the unbilled receivable getting billed out. And so we've seen our unbilled receivables decline. They are down 28% year-over-year. They're down 12% sequentially from Q3. And as we -- of course, as we build out the unbilled, that puts it into a position to be able to collect the cash as well. So we feel pretty good that we're going to see some meaningful cash collections here in the near term and see the receivables begin to decline, which should generate very substantial cash flow for us.

And my next one is you mentioned strategic investments and that you have like the strong balance sheet to pursue them. Could you mind like giving us an update on the M&A pipeline and how you think about CapEx and investments as you prepare to grow and actually fulfill the requirements for the U.S. government and border and port security and all those opportunities that you have ahead?

This is Ajay. Great question. First of all, I want to emphasize, we feel very good about our organic growth next year. We think that we're well suited, but obviously, with our new credit line, we have a lot of dry powder out there. We're always looking, whether it's in security, whether it's in complementary technologies, there are some assets out there. So we are going to look. We're going to see what makes sense. And we always say 1 plus 1 should equal at least 3. So we feel good, and we're constantly looking at different opportunities, but I want to emphasize, we're not just going to go do an acquisition because we feel we have to we feel comfortable with what we have, but we are actively always looking to see how we can improve overall our product base and especially on the recurring services side, what we can do there.

And one last one, if I may. You mentioned the One Big Beautiful Bill and the funding for border security. When you think about timing of those opportunities, when do you think all that money will start to convert into real awards? And how fast can we see that converting to revenues for you guys?

So obviously, the funding has not got to the agencies yet for the Big Beautiful Bill. We are hearing, talking to different agencies that it could be hopefully by the end of the government fiscal year or maybe a little later. We would anticipate orders coming out the latter part of our fiscal year, which is after January 1. And really, I mean, this is what I was saying earlier, it bodes very well for us for '27 and beyond, and it gives us a potential upside in '26 depending on their timing.

And our next question comes from the line of Jeff Martin from ROTH Capital Partners.

Alan, could we dive into the RF business, how that performed this year? And also how you're thinking about that business in terms of opportunities to really grow that business meaningfully as a result of the Golden Dome project.

Sure, Jeff. Good question. we're thrilled with the performance of the RF business this fiscal year. In our Q4, we did about $30 million of revenue for the full year. It was about $80 million of revenue. The business performed well on the bottom line as well. Our expectations is that we'll grow this business here in fiscal '26 and beyond. The team has really done a great job of building out the infrastructure and everything for the planned growth Golden Dome is a great opportunity for us. Maybe I'll -- Ajay can talk a little bit more about that.

Yes. I mean I think to just echo Alan, we're very happy with their performance so far and really significant opportunities. Number one, I think that we are playing in a bigger field because I think I mentioned this in the last conference call as well, is having the -- having OSI financial muscle and some of the contacts in Washington that we have as a small company, they did not. So they're able to take advantage of that. Their technology definitely is something that is -- there's a lot of replacement going on. But Golden Dome, which is billions of dollars are being spent and people are starting to realize that it's not all about satellites. It's about what we -- what else do we do? And our radar -- ground radar, especially over the horizon radar applications very much fit into what the government is looking for. And I think we'll see more color over the next 2, 3 quarters. But again, the Big Beautiful Bill has a substantial amount in there, and we feel that we're sitting well to be able to benefit from that.

Great. And then if I recall correctly, there was a few, if not -- one very large potential turnkey contracts in the pipeline. Could you give us an update on how you're thinking about turnkey? And is that something that could become a meaningful contributor to growth in the coming years?

So we're always looking at turnkeys. And there's not one, there's multiple contracts out there that we're always pursuing. And these are contracts that don't happen over the next -- over a month or 2. They take a year or 2. And I think that as we go to some of our customers and not just sell them an operational -- sell them equipment and operations, but sell them solutions with operations. I think it's getting received very well. The customers are getting more and more educated on what the advantages of a turnkey contracts are, so we're pursuing them, and we feel good about the prospects.

[Operator Instructions] Our next question comes from the line of Seth Seifman from JPMorgan.

This is Rocco on for Seth. How should we think about the timing of cash flow in fiscal year '26. It seems like the payments from Mexico have come in strong so far in Q1. So should the first half have stronger cash generation in the second half? Or should we think about some payments having been pushed into the second half?

Rocco, this is Alan. Always a difficult question to answer because we're not in complete control of the timing of the payments by our customers. All that being said, we do believe that the cash flow can be very strong throughout the year, meaning both the first half and the second half of the year. So while we don't provide guidance on what quarter that might come in, we do think it can be strong throughout the year.

Great. And then earlier, the double-digit top line growth ex Mexico was highlighted. Are there any specific contracts or geographies that are driving that growth?

I think that a lot of the growth this year, definitely international has been very strong. Domestically, we've done well as well. And going forward, really, the international markets, both on aviation cargo, a lot of opportunities out there. We're seeing a lot of activity. Our pipeline is very strong. And obviously, domestically, we've already talked about all the funding dropping into CBP. And not to mention down the road what else could be happening with TSA 2, 3 years down the road. So we feel good not just about '26, but really beyond as well.

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Ajay Mehra for any further remarks.

call following the completion of our next quarter. Thank you.