Executive Summary / Key Takeaways

• OSI Systems (NASDAQ:OSIS) is demonstrating robust organic growth and strategic diversification, successfully offsetting headwinds from maturing contracts while leveraging a record backlog and investing in cutting-edge technology.
• The company achieved record Q1 fiscal 2026 revenues of $385 million and non-GAAP adjusted EPS of $1.42, driven by double-digit growth across all three divisions and a significant increase in higher-margin service revenues.
• Strategic acquisitions, particularly in RF-based solutions, and a global manufacturing footprint are enhancing competitive positioning and capitalizing on evolving market dynamics like nearshoring and increasing government security spending.
• OSI Systems has raised its fiscal 2026 guidance, anticipating revenues between $1.825 billion and $1.867 billion and non-GAAP adjusted EPS of $10.20 to $10.48, underpinned by strong operational execution and substantial free cash flow generation.
• Key catalysts for future growth include significant U.S. government funding for border security and the "Golden Dome" program, alongside ongoing global demand for advanced security and healthcare solutions.

A Foundation of Innovation and Diversified Strength

OSI Systems, Inc., incorporated in 1987, has evolved into a vertically integrated designer and manufacturer of specialized electronic systems and components crucial for homeland security, healthcare, defense, and aerospace applications. The company's overarching strategy centers on innovation, operational excellence, and customer satisfaction, a philosophy that has consistently driven its performance. This foundational approach is reflected in its historical journey, including its 1997 initial public offering, and its sustained focus on efficiency, with combined selling, general and administrative (SG&A) and research and development (R&D) expenses as a percentage of sales decreasing annually for eight consecutive years, from 27.6% in fiscal year 2017 to 21.3% in fiscal year 2025.

The company operates through three distinct yet synergistic segments: Security, Optoelectronics and Manufacturing, and Healthcare. This diversified structure provides resilience and allows OSI Systems to leverage its technological expertise across various critical sectors. In the competitive landscape, OSI Systems faces formidable rivals such as L3Harris Technologies (LHX), Smiths Group (SMIN), GE Healthcare (GEHC), and Teledyne Technologies (TDY), each with significant presences in overlapping markets. OSI Systems differentiates itself through its proprietary technology, comprehensive service ecosystem, and a strategic focus on specialized, integrated solutions.

Technological Edge and Strategic Innovation

OSI Systems' competitive moat is significantly strengthened by its differentiated technologies across its segments. In the Security division, the company offers its Rapiscan systems for baggage, parcel, cargo, vehicle, hold baggage, and people inspection, alongside advanced radiation monitoring and explosive/narcotics trace detection. These systems provide tangible benefits through enhanced reliability and detection capabilities in challenging environments. The company's S2 Global subsidiary provides turnkey security screening solutions, emphasizing system integration, maintenance, and operator training to optimize equipment performance over its 7-to-10-year typical lifecycle, thereby creating a predictable stream of recurring service revenues.

A key technological differentiator is the CertScan platform, a non-intrusive inspection (NII) Common Integration Platform (SIP) that integrates multi-site operations. This SaaS-based offering is designed to increase annual recurring revenues over time and supports critical functions like drug interdiction by enabling efficient screening and collaboration among various stakeholders, including U.S. Customs and Border Protection (CBP). The company's strategic acquisition in September 2024 of an RF-based solutions provider further bolstered its capabilities, introducing advanced radio frequency (RF) equipment, including over-the-horizon radar. This technology is crucial for broad-range surveillance, enabling the tracking of aircraft, drones, surface ships, and vehicles across borders, and is well-positioned for opportunities tied to the multi-billion-dollar "Golden Dome" program.

In the Healthcare division, OSI Systems' Spacelabs brand offers patient monitoring, cardiology, remote monitoring, and connected care systems. The company is investing significantly in R&D to advance its next-generation patient monitoring platform, which will be paired with predictive health and alarm management solutions. These innovations are aimed at differentiating OSI Systems from competitors like GE Healthcare by offering enhanced data integration and specialized solutions for critical care settings, with a projected rollout in fiscal year 2026 and beyond. While precise quantitative metrics for all new technologies are not publicly disclosed, the strategic intent is clear: to enhance competitive positioning, drive higher average selling prices (ASPs), and secure long-term growth.

The Optoelectronics and Manufacturing division provides optoelectronic devices and flex circuits, serving a broad range of applications including aerospace, defense, and medical imaging. This segment benefits from a vertically integrated structure and a robust global manufacturing footprint spanning North America, Europe, and Southeast Asia. This geographical diversification is a strategic advantage, allowing OSI Systems to offer nearshore production options and capitalize on supply chain realignments driven by global tariff uncertainties, thereby potentially gaining market share from OEMs seeking to diversify away from China.

Financial Momentum and Operational Excellence

OSI Systems has demonstrated impressive financial momentum, culminating in a record-breaking first quarter for fiscal year 2026. For the three months ended September 30, 2025, the company reported total net revenues of $384.62 million, marking a 12% year-over-year increase. This growth was broad-based, with all three divisions achieving double-digit top-line expansion. Notably, underlying consolidated revenues, excluding the impact of Mexico contracts and fiscal 2025 acquisitions, surged approximately 26% in Q1 fiscal 2026, highlighting robust organic demand. Service revenues were a significant driver, growing 23% year-over-year, reflecting the increasing installed base of products transitioning from warranty to recurring service contracts, which typically carry higher gross margins.

The Security division, accounting for 66% of consolidated revenues, saw its revenues climb 13% year-over-year to $254.25 million. This was achieved despite a significant headwind from Mexico contracts, which decreased to $25 million in Q1 fiscal 2026 from $70 million in the prior-year period. The Optoelectronics and Manufacturing division delivered record Q1 revenues of $110 million (including intercompany sales), up 12% year-over-year, driven by strong performance in North America and its contract manufacturing business. The Healthcare division also bounced back, posting a 10% year-over-year sales increase to $40.74 million, primarily due to international revenue activity and increased patient monitoring and cardiology product sales.

Profitability metrics for Q1 fiscal 2026 showed a gross profit margin of 32%. While this was a slight decrease from the prior year due to a less favorable product revenue mix in the Security division, it was partially offset by the higher gross margins from increased service revenues. The company's commitment to operational efficiency is evident in its SG&A expenses, which decreased by $5.2 million year-over-year to $67 million, aided by favorable foreign currency exchange rates. R&D expenses increased by $2.6 million to $20.4 million, reflecting strategic investments in new product development, particularly in the Security and Healthcare divisions. The Security division's adjusted operating margin was 13.5%, while Optoelectronics maintained a solid 11.9%, and Healthcare improved by 260 basis points.

OSI Systems concluded Q1 fiscal 2026 with strong bookings, achieving a book-to-bill ratio of approximately 1.1, and a record Q1 backlog approaching $1.9 billion. This substantial backlog provides excellent revenue visibility for the coming periods.

Liquidity and Capital Allocation

OSI Systems maintains a solid financial position, with cash and cash equivalents totaling $124.4 million as of September 30, 2025. The company's principal sources of liquidity are its cash reserves, cash generated from operations, and its credit facilities. In July 2025, the company successfully amended and extended its revolving credit facility, increasing the borrowing capacity from $600 million to $725 million and extending its maturity to July 2030. As of September 30, 2025, the company had $377.5 million available under its revolving credit facility, with a net leverage ratio of approximately 1.9x.

Operating cash flow saw a significant improvement in Q1 fiscal 2026, generating $17.1 million compared to a use of $37.2 million in the prior-year period. This improvement was driven by higher net income and favorable working capital dynamics, including a decrease in accounts receivable. Management anticipates substantial cash inflows in fiscal 2026, particularly from the collection of remaining receivables from Mexico, which were elevated at the end of fiscal 2025. This is expected to lead to sizable operating cash flow and a very strong free cash flow conversion, potentially exceeding 100% of net income for the fiscal year. The company has not paid dividends since its 1997 IPO and did not repurchase any common stock in Q1 fiscal 2026, with 1.19 million shares remaining under its authorized repurchase program, indicating a focus on reinvestment and debt management.

Outlook and Growth Catalysts

OSI Systems has raised its fiscal 2026 guidance, reflecting confidence in its continued momentum. The company now anticipates year-over-year revenue in the range of $1.825 billion to $1.867 billion, representing a growth rate of 6.5% to 9.0%. Non-GAAP adjusted earnings per diluted share are projected to be between $10.20 and $10.48, indicating 9% to 12% year-over-year growth. This updated outlook accounts for an approximate 60% reduction in revenues from Mexico contracts in the Security division, which the company expects to more than offset with growth in other product lines and services.

A significant catalyst for future growth is the "One Big Beautiful Bill Act" (OBBBA), signed on July 4, 2025. This legislation allocates substantial funds for U.S. water security agencies, particularly CBP, for the procurement and integration of new non-intrusive inspection equipment, including AI and machine learning capabilities, over multiple years. OSI Systems is well-positioned to benefit from this, as well as from increased security spending related to major events like the 2026 FIFA World Cup and 2028 Summer Olympics. The "Golden Dome" program, with its focus on complex sensor networks and RF sensors like ground-based radar, presents another multi-billion-dollar opportunity where OSI Systems' recently acquired RF technologies are highly relevant.

Management anticipates faster growth in recurring service revenues, which will contribute to margin expansion. The Optoelectronics division is expected to see expanding margins in the second half of fiscal 2026 as its newest manufacturing facility ramps up efficiencies. The Healthcare division is also on a path to stronger performance under new leadership and continued R&D investments.

Risks and Competitive Dynamics

Despite a strong outlook, OSI Systems faces several risks. Global macroeconomic factors, including inflationary pressures, rising interest rates, and labor shortages, could impact demand and operating costs. Geopolitical conflicts, such as those in Gaza and Russia-Ukraine, introduce economic and political uncertainty, potentially disrupting supply chains and increasing cyber threats. The U.S. federal government shutdown, while having a limited impact on fiscal 2026, could delay future contract awards. In the healthcare sector, hospitals' financial pressures may adversely affect capital equipment spending.

In the competitive arena, OSI Systems' proprietary technology in security detection systems offers superior reliability, translating to stronger customer loyalty and potentially higher margins through recurring service revenue. This helps counter the scale of larger rivals like L3Harris Technologies, which benefits from extensive resources for R&D and rapid prototyping. OSI Systems' diversified segments provide risk mitigation and capital efficiency, offering an advantage over more narrowly focused competitors like Smiths Group. However, OSI Systems' potential scale limitations and R&D investment compared to larger players could lead to higher per-unit costs and slower innovation in some areas. While direct quantitative comparisons with all competitors are challenging to ascertain, OSI Systems' strong performance in specialized segments suggests effective competitive positioning. The company's global manufacturing footprint also provides a strategic advantage in navigating global trade and tariff uncertainties, offering flexible production options to customers.

Conclusion

OSI Systems stands as a compelling investment thesis, characterized by its strategic diversification, technological leadership, and robust financial performance. The company's ability to generate record revenues and earnings, even while absorbing significant headwinds from maturing contracts, underscores its operational resilience and the strength of its core businesses. With a record backlog, a strong pipeline of opportunities, and strategic investments in cutting-edge technologies like CertScan and advanced RF solutions, OSI Systems is well-positioned to capitalize on increasing global demand for security and healthcare solutions. The substantial funding allocated by the U.S. government for border security and the "Golden Dome" program represents a significant tailwind, promising multi-year growth opportunities. While macroeconomic and geopolitical risks persist, OSI Systems' proactive management of its cost structure, strong liquidity, and commitment to innovation are expected to drive sustained value creation for shareholders, reinforcing its position as a leader in critical electronic systems and components.