OSI Systems, Inc. Aktie

Thank you for standing by and welcome to the OSI Systems, Inc.'s fourth quarter 2026 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, Chief Financial Officer. Please go ahead, sir.

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 of Security. Welcome to the OSI Systems Fiscal 2026 Fourth Quarter and Year-End Conference Call. We're pleased that you can join us as we review our financial and our operational 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. Forward-looking statements made in this call are based on currently available information, and the company undertakes no obligation to update any forward-looking statement based on subsequent events, new information, or otherwise. We will also reference both GAAP and non-GAAP financial measures. Applicable reconciliations are available in today's earnings release.

I will begin with a high-level summary of our financial performance for the fourth quarter and the full fiscal year, 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 our outlook for fiscal '27. Before I discuss our fourth quarter records, let me address the revenue results. Full-year revenues of $1.79 billion finished below our guidance range, and fourth quarter revenues of $484 million were down approximately 4% year-over-year.

Importantly, these results were affected by the timing of approximately $50 million of planned security deliveries that moved beyond our June 30th fiscal year-end because of conflict-related delays and site access constraints in the Middle East. I want to emphasize that these expected revenues are deferred, not orders lost. They remain firmly in our backlog and are expected to be delivered on a later schedule.

Setting this aside, we were really pleased with the overall performance as multiple key performance metrics for Q4 and the full fiscal year were extremely strong. We closed fiscal '26 with exceptional cash generation and strong profitability driven by solid adjusted operating margin expansion. We delivered record fourth quarter operating cash flow of $182 million. We grew fourth quarter non-GAAP earnings per share by 17% to a record $3.78. And we ended the year with a record backlog of approximately $1.9 billion.

For the full year, revenues reached a record $1.79 billion, up 4% year-over-year, and adjusted earnings per share grew to a record $10.35, up 11% year-over-year. Bookings were solid across the three divisions, and we finished the year with a record backlog and solid visibility as we enter fiscal '27. We also have a significant opportunity pipeline, and we have recently secured several important program wins.

Our cash conversion was outstanding, allowing us to strengthen the balance sheet while continuing to return capital to shareholders. In the fourth quarter, we repurchased approximately 565,000 shares at an average price of about $219 per share for a total of $123.6 million. Our board recently authorized an additional 1 million shares, leaving approximately 1.1 million shares available under our stock buyback program. Before diving more deeply into our financial results and discussing our outlook for fiscal '27, I'll turn the call over to Ajay.

Thank you, Alan, and thank you to everyone for joining us today. I am pleased to be here to discuss our fourth quarter and full fiscal year 2026 results. Fiscal 2026 was a strong year for OSI Systems, capped by record annual revenues of $1.79 billion, record Q4 and annual non-GAAP earnings per share, and record Q4 and annual operating cash flow. That said, as Alan pointed out as well, we finished 2026 with revenues below expectations, mostly due to delays with the situation in the Middle East.

Overall, I am proud of how our team has performed across the portfolio, delivering solid bookings that translated into a record backlog of approximately $1.9 billion, which gives us good visibility as we enter fiscal 2027. While the Security division faced revenue headwinds in the quarter from the Middle East conflicts that have shifted the timing of certain deliveries, Optoelectronics delivered strong growth on broad-based demand, and Healthcare posted an improved quarter. The security-related deliveries that were pushed out remain in backlog and are expected to be completed in future orders.

So let's discuss our business in more detail, beginning with Security. With DHS reopening in April, following the shutdown, we have seen procurement activity accelerate. Since the close of our fiscal year, CBP has awarded us two 5-year IDIQ contracts, one with a ceiling of approximately $200 million for relocatable rapid scan passenger vehicle inspection systems, and a second with a ceiling of roughly $85 million for van-mounted mobile X-ray inspection systems.

We have already received delivery orders under both these IDIQs, including a task order valued at about $21 million. These IDIQs represent continued funding provided under the omnibus bill. We expect to see some revenue contribution from these awards later in fiscal 2027, but significant contributions are expected in fiscal 2028 and beyond as well. We have also made growing recurring revenue a priority across the Security division, and with the size of our installed base today, we expect that effort to translate into substantial service revenue growth in fiscal 2027.

Recently, we entered into an agreement with LA28 to establish Rapiscan as an official supporter of Team USA and the official physical screening and security technology hardware and software solutions provider of the LA28 Olympic and Paralympic Games. This strategic partnership builds upon our security efforts at major recent events such as the FIFA World Cup, the Paris Olympics, and the Milan Winter Games. Few companies have a comparable track record at this scale, and our experience is a real advantage as we pursue future large venue and event security opportunities.

We continue to see strong momentum in our radio frequency, also known as RF business, and Homeland Security Defense business. Our over-the-horizon radar programs and involvement in multiple Iron Dome initiatives position us at the forefront of some of the nation's most significant defense priorities. Fiscal 2026 was an outstanding year for the RF business. During fiscal '26, we were awarded an undefinitized contract action with a not-to-exceed value of approximately $235 million for the production and integration of a homeland defense over-the-horizon radar transmit subsystems.

RF award today, and we continue to see follow-on opportunities related to this program. We are also a participant in the SHIELD IDIQ, which supports much of the Iron Dome-related initiatives and gives us a vehicle to pursue additional programs as they're defined over the next few years. All that said, the current level of customer engagement across our RF portfolio is the highest we have seen for this product line.

Turning to Optoelectronics and Manufacturing, which delivered another strong performance in fiscal 2026 as full-year revenues grew 9% to $451 million with strong margins. The bookings in Q4 reflected the strength and breadth of our entities' markets, and we expect these underlying trends to continue in fiscal 2027. Our ability to support customers with our highly engineered products, precision manufacturing, and global reach continues to differentiate us across the aerospace, defense, healthcare, and industrial customer base.

Our vertically integrated model and global manufacturing footprint helps us continue to capture business as customers diversify supply chains, and our backlog gives us strong visibility heading into fiscal 2027. Finally, our Healthcare division delivered an improved fourth quarter as revenues grew approximately 5% year-over-year and operating margin expanded to 10% from 1% compared to last year's Q4. These results reflected the operational improvements we've been implementing throughout the year.

We remain focused on expanding our installed base, supporting providers with innovative clinical solutions, and advancing the product development initiatives behind our next-generation patient monitoring platform. We are encouraged by the opportunities ahead. As we enter fiscal 2027, our record backlog, robust pipeline, and disciplined execution give us confidence for the coming years. As always, I would like to thank our employees, customers, and stockholders for their continued support and dedication. With that, I will turn the call over to Alan to discuss our financial results and our fiscal 2027 guidance in more detail before we open the call for questions. Thank you.

Thank you, Ajay. Let's begin with our revenue performance by division. Revenues in each of our Opto and Healthcare divisions increased 5% year-over-year. In Security, revenues declined 7%, reflecting the impact of the conflict in the Middle East, which delayed certain deliveries beyond our fiscal year-end, along with a difficult comparison against higher Mexico program revenues in the prior year quarter. We closed the year with approximately $1.9 billion in backlog. Deliveries that shifted out of the quarter remained in backlog, while certain expected bookings in the affected region were deferred.

As expected, we reported nearly $150 million lower fiscal '26 revenues related to the Mexico security contracts compared to the prior year, which included about a $20 million adverse impact in Q4. As we move into fiscal '27, we expect this headwind to moderate to less than $25 million for the full year, which is expected to be concentrated in the first half. Turning to services. For the full year, service revenues grew 13% to $441 million, though were fairly flat in Q4. Similar to Q3, fourth quarter service revenues in the prior year benefited from significant installation activity related to the Mexico contracts.

Excluding those installation revenues, security service revenues increased 9% year-over-year in Q4. Looking forward, in fiscal '27, we expect strong double-digit growth in service revenues for the full year. Our Q4 fiscal '26 gross margin expanded to 34.7% from 33.3% in the same quarter in the prior year, as a more favorable revenue mix on product sales more than offset the benefit in Q4 of the prior year received from higher installation-related service revenue. Our margins can fluctuate based on product and service mix and volume, supply chain costs, foreign exchange, tariffs, and other factors.

Moving on to operating expenses. We continue to work diligently across all divisions to manage our SG&A cost structure efficiently. SG&A expenses in the 2026 Q4 were $70 million, down 7% from the prior year Q4, representing 14.4% of sales compared to 14.8% of sales in the prior year. R&D expenses in Q4 were $19.5 million, or 4% of revenues, up from $18.8 million, or 3.7% of revenues in the same quarter last year. This increase stems from our commitment to investing in innovation, resulting in market-leading offerings, and positioning OSI well for the future.

We expect to continue our heightened R&D efforts to advance key initiatives. Even with these R&D investments, our combined SG&A and R&D expenses as a percentage of sales have decreased annually for each of the past 8 years, underscoring our ability to drive operating efficiencies while still funding growth initiatives. Now let's move below the operating line. Net interest and other expenses in Q4 were $4.1 million, down from $7.2 million in the same quarter of the prior year, primarily due to reduced borrowing costs coupled with increased interest income on higher cash balances.

Our effective tax rate under GAAP was 20.8% in Q4 of '26 versus 19.8% in Q4 last year. Excluding discrete tax items, our normalized effective tax rate, which is the one used in calculating non-GAAP EPS, was 21.5% in Q4 compared to 21.9% in the same prior year quarter. On a non-GAAP basis, our Q4 '26 adjusted operating margin was 17.7%, up 200 basis points from the 15.7% reported in the prior year fourth fiscal quarter, with each of the three divisions reporting growth.

The Security division's adjusted operating margin expanded from 20.4% to 20.8% in Q4 this year, driven by a stronger gross margin combined with reduced operating expenses. The Opto adjusted operating margin increased to 14.7% in Q4 of '26 from 13.6% in last year's fiscal Q4, primarily from the benefits of economies of scale and a more favorable mix of revenues. And on the heels of stronger revenues, the adjusted operating margin of our Healthcare division, as Ajay said, increased to 10% in Q4 this year, from 1% in Q4 of the last fiscal year, reflecting the operating leverage. And while we would not extrapolate one quarter, it shows what this division can do as volume grows.

Moving to cash flow and the balance sheet. We generated a record $182 million of operating cash flow in Q4 and $276 million for the full fiscal year driven by strong collections across the businesses. This included collecting $159 million from our largest customer in Mexico in Q4. On that customer specifically, the balance stood at $345 million at the end of Q3, representing 40% of the company's total accounts receivable, and declined to $190 million, or 25% of the company's total AR, as of the end of Q4.

This balance should significantly decrease further throughout fiscal '27 as substantial payments are expected to be received, contributing to the strength in the anticipated fiscal '27 operating cash flow and free cash flow conversion. DSO in Q4 decreased 18% from third quarter DSO. CapEx in Q4 was $9.3 million, while depreciation and amortization expense in the quarter was $13.3 million. Our balance sheet remains solid, providing us great flexibility. We ended the year with $360 million in cash, up from $106 million a year ago, and with no amounts drawn under our lines of credit.

During the year, we refinanced our credit facility and extended its maturity while adding low-cost long-term debt. Gross debt increased with these moves, and with the capital we returned to shareholders, our net leverage at the end of Q4 of fiscal '26 was approximately 2.1x as calculated under our credit agreement. This leaves us ample capacity for both organic investment and acquisitions. During the fiscal year, we repurchased and retired 1.1 million shares, reflecting our conviction in the intrinsic value of our business. Our board recently authorized an additional 1 million shares for repurchase with no expiration on this authorization.

Now, turning to our guidance. We are introducing our fiscal '27 guidance for revenues and non-GAAP earnings per share. We currently expect revenues of $1.875 billion to $1.93 billion, or 5% to 8.1% year-over-year growth, and adjusted earnings per share of $11.13 to $11.49, or 7.5% to 11% year-over-year growth. This guidance factors in the expected impact from the conflicts in the Middle East, which have affected near-term bookings, though over a longer horizon the resolution of these matters could represent future opportunities for the company.

Although we are pleased with some notable wins with the Department of Homeland Security over the past few months and expect more, we believe a substantial amount of such bookings will lead to revenue in fiscal '28 and beyond. Thus, we have included a portion of the delivery orders from CBP already in hand rather than the full ceiling value of those programs and assumed a later delivery schedule in the Middle East. Given the timing of each of these items, we currently expect fiscal '27 growth to be strongest in the second half.

We note that our fiscal '27 non-GAAP diluted EPS guidance excludes any impact of potential impairment, restructuring and other costs, amortization of acquired intangible assets and their associated tax effects, and discrete tax and other non-recurring 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 backlogged revenues, new bookings, timing of cash collections, tariffs, the conflicts in the Middle East, and supply chain disruptions, 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, fiscal '26 was a year of record cash generation, record backlog, and strong earnings quality. We strengthened our liquidity, and we returned capital to shareholders. We are committed to operational excellence as we continue to grow our businesses and provide innovative products and solutions to our customers. We aim to invest in key strategic areas with the goal of driving long-term value for our shareholders. Once again, we thank the entire global OSI team for their dedication to supporting our customers and our partners. Their efforts are what makes these results possible. And at this time, we'd like to open the call to questions.

Our first question for today comes from the line of Josh Nichols from B. Riley Securities. Your question, please.

Understand the pushout, not lost orders regarding the Middle East, but I was curious on that. Do you expect that free cash flow generation in fiscal year '27 could similarly exceed net income generally, and how you think about the pace of collections is going to drive that this year?

Josh, thank you. This is Alan. Good question. We are anticipating a strong cash flow year in fiscal '27, strong free cash flow, and we do anticipate that our free cash flow could exceed 100% of net income and fully expect that to occur. With respect to the pace of collections, we expect to be collecting nicely over the course of the fiscal year, hoping it's more front-loaded than back-loaded, but we do anticipate a good, strong overall year.

I think the timing, it's understandable for some of the orders in the Middle East, but there's been a flurry of award activity just over the last couple weeks. I'm curious, how much of that, are you being conservative when you think about how much of that gets factored into the guidance for this fiscal year, given the ongoing conflict? And are you assuming most of that gets pushed out to fiscal year '28 and beyond? I'm just trying to get a little bit better grasp on how you're thinking about these newer awards and IDIQs and the timing in your guidance for this year.

So, this is Ajay. You know, like we pointed out, there's a portion in '27, but the vast majority is in '28 and beyond. You know, these are multiple-year IDIQs. I do want to point out both the $200 million and the $85 million IDIQ with CBP, we're the only awardee on there. So, it gives us a very good confidence that as we look at not just '27, but '28, '29, and beyond, the visibility really is there for us.

Thanks for clarifying. I'll hop back into queue.

Our next question comes from the line of [ Don Gooden ] from Citigroup. Your question, please.

You know, obviously it's a complex situation in the Middle East. I was hoping to revisit, just maybe offer a little more detail on kind of what's going on there from your perspective on the ground, just to kind of give us a better feel for things. And in the release, you used the phrase that demand for products and services remains encouraging. In the prepared remarks, I felt like you used the word strong a few different times when talking about the shape of the business. I'm not trying to wordsmith this, but maybe just revisiting the Middle East and exactly how you see the demand today, a bit of a temperature check would be helpful.

Sure. I think when we talk about strong demand, you've got to look at the overall business, the Security, the Opto, and even the improvements we've had on the Healthcare side. But specifically on Security, we have a lot of strong demand. Finally, like I pointed out, DHS, it's time to release orders. It's been a flurry of activity. We've also had some strong orders, like we pointed out, on the RF side. And international orders continue to be strong.

Now, specifically on the Middle East, yes, I think there's been a delay, deferment of some orders. You know, they're more interested in making sure they protect their people with incoming missiles, et cetera. And we are a partner, we work with them, make sure that whatever they need in the short run, we provide. But we believe in the long run, it's actually an opportunity for us, not just for the Middle East, but really with the DOD and other places where force protection is going to get more and more important, not just our overall security business and perhaps even including RF. So it's a complicated situation, but you know we've got to look at it as an overall business in the entire world, and we remain very confident there.

Got it. That's helpful. And for the RF product line, I think you used the phrase that customer engagement was the highest you've ever seen, and certainly understandable given everything we're seeing in the defense complex and Iron Dome, et cetera. But I was hoping you could talk a little bit more about that and how are you kind of baking in the outlook for RF in the guidance for '27 and might it continue to grow in '28 as well?

So, you know, we don't really break it down, but I will say on the RF side, we see very strong growth, and we see that growth continue into '28. And I think, you know, you talk about the conflict in the Middle East. If anything, what's been going on there, when you talk about the Iron Dome, it only further strengthens the idea of why we need an Iron Dome going forward.

Got it. Appreciate the color.

Our next question comes from the line of Jeff Martin from Roth Capital Partners. Your question, please.

Just was curious if you could clarify whether these were deliveries to customers in the Middle East or whether there were shipments going through the strait that perhaps were intended for non-Middle Eastern customers of other nations that were also impacted.

These were mostly, if not all, customers in the Middle East.

Okay. And then in terms of what you were assuming in your updated fiscal '26 guidance after the third quarter, were you assuming that all of these orders would be delivered in Q4 or was the assumption that some of them would be and some of them would be pushed out further?

Jeff, this is Alan. So following the Q3 release, we assumed a significant portion of these Middle East orders would be delivered in Q4. Not all of them, but a significant portion.

Okay. And it sounds like your assumption is that a good portion of these will be delivered in the second half of fiscal '27. Is that fair to say?

That is fair to say. Not all of it, but a substantial portion in the second half of fiscal '27.

Okay. And then my other question is on the bookings. Could you speak to book-to-bill for the full year and then also kind of give us a sense on Q4? I know there were delays that impacted bookings in the second half in general, but just some contextual reference would be helpful.

Sure, Jeff. So for Q4, our book-to-bill was just shy of 1. It was very strong in our Opto division, solid in our Security division as well, and Healthcare. So giving us a very good book-to-bill in our highest revenue quarter. And for the full year, our bookings were quite solid as well. So the book-to-bill was a little bit north of 1 for the full year, which led to our highest overall backlog at the end of June.

Our next question comes from the line of Christopher Glynn from Oppenheimer. Your question, please.

Just want to talk a little bit about the mechanics of phasing from large project awards, IDIQ and RF into backlog. You know, it was clear that the recent $285 million were subsequent to the quarter end. And I think you talked about $21 million firm order plus others. Should we think about the delivery orders as what goes into backlog and then also, using that framework for the $235 million RF, I think most of that did go in backlog in the prior quarter. So, I guess the implication would be those delivery orders were more coincident with the award, if you could clarify those points.

Sure, Chris. Happy to do so. With respect to the RF order, the $235 million that you referred to that we won in Q3, roughly 80% of that was booked into backlog in the third quarter, meaning we have it and a substantial portion of that is going to get delivered over the next couple of years. With respect to the two large IDIQs that we just won with CBP, the $285 million that you referred to, those are ceiling values where we're the sole awardee, as Ajay mentioned. What goes into our backlog is not the IDIQ value, it would be the firm fixed order, the delivery order or the task order at $21 million that Ajay referred to. So over the course of time, we expect that to significantly increase and move into our backlog and then convert into revenue.

Okay, great. And my understanding is historically that those ceilings have essentially been realized and well within the IDIQ timeframe. And in particular, the context here is there's a much bigger funding than these amounts. So they've got to get through executing these portions in order to further exercise through the overall funding, which I think approximates a billion. Is that about the right understanding?

Yes, that's the right understanding. I mean, keep in mind, these are orders that are being released. There are more orders that will be released in different products as we move along as part of the billion-dollar funding. So these are specifically for the two types of systems that I pointed out in my prepared remarks.

Okay, great. And last one was, wanted to ask about the Opto segment profitability approaching 15%. I know you've brought on some new capacity. You're continuously expanding that business given the share opportunity with customers securing their supply chains. So as you utilize new capacity, are we talking about consistently higher margin opportunities for the O&M than over the past few years?

Yes, Chris, this is Alan. Really good question. The Opto business has been bringing on a stronger customer profile that is leading to improved margins. Our plan for fiscal '27 is to continue to pair revenue growth with operating margin expansion. It will vary from quarter to quarter based upon the revenue mix that we see and what products and which customers we happen to be selling to in that quarter. But we do believe that we'll see further operating margin expansion through the course of fiscal '27.

Our next question comes from the line of Larry Solow from CJS Securities. Your question, please.

I guess the first question, just better frame the outlook for revenue guidance. So it sounds like you are including most of that 50 to come in, but just how about qualitatively from the Middle East? Are you assuming that there's still impacts obviously going on there? So what are your high-level expectations for the Middle East and also what's incorporated in the growth outlook from the United States? Not specifically, but is there some delays? Bookings obviously were delayed a lot. It sounds like most of the benefits from the omnibus bill and the acceleration in the U.S. that everybody's looking for, you're not building most of that in until '28. Is that all fair to say?

Larry, I should probably flip-flop and call you Chris for the moment. Good questions, Larry. You know, so with respect to the Middle East, we've taken a conservative approach in our guidance for fiscal '27, both with the planned deliveries that got deferred out of Q4, as well as for future orders, for obvious reasons, while the conflict is taking place. With respect to the United States, the really exciting part for us is, yes, we're getting nice bookings. We expect to get significantly more bookings. And you're exactly right. There's a portion built into fiscal '27, but a smaller portion. The much, much larger portion is in fiscal '28, '29, and even beyond that. So it really gives us some excellent visibility into real nice growth beyond this fiscal year. So, quite exciting for us. Was there a third element to it, or did I capture that?

I think you got it. I just, the question that, a couple of thoughts just on the omnibus bill, I think it was a well over $6 billion authorization. And obviously I think a billion of that was kind of in the heart of your non-intrusive equipment. But I know that the Secure America Act came out. I think there was another like $3 billion or a little more than that, maybe north of that. Any clarity on how much of that could be funneled down into your kind of sweet spots?

So, you know, it's a great question. We're aware of it. We're working with the customer very closely. Obviously, they're trying to make sure that they award, with all the delays, they award the billion dollars at the fastest pace possible. I think there is still some clarity to be had with what the next 2 or 3 billion would be. And I would add on the omnibus bill, we talk about customs, but there's substantial funding for the RF side as well, which is obviously helping us as well.

Okay, if I can just squeeze one more, just on the margins, you're forecasting 5% to 8.1% revenue growth and a little bit higher on the earnings, 7.5% to 11%, not much, but you're also getting a pretty good benefit from your repurchases, right? You cut down your share count by like 3%. So you're actually building in, adjusted-wise, a little bit less earnings growth versus sales growth. Am I missing something, any reason for that?

Yes, Larry, we're just being a little bit modest and conservative coming out of the gate here, doing a little bit more investments in some OpEx and positioning ourselves for the future as well and some of the new innovative products that are coming out and the associated infrastructure sort of associated with it. But that's the general tone of it.

Okay. So there's no structural change or anything. I mean, Healthcare, which we've talked about, much smaller, and Opto, moderate size, but those, we've talked about margins going up in those segments over the next few years. Any reason to believe that Security shouldn't have upward trends in the margins as well, maybe not so much this year, but just in general?

Yes, that's our plan. Our plan is to pair the top-line growth with operating margin expansion. From a contract-to-contract basis that may change a little bit. So it may change things from a quarter to quarter, but over the long term structurally, our goal is to continue to improve our margins. We expect our service revenues to be growing at a faster clip than our product revenues, and our service revenues inherently carry a higher margin. So as we start to look out beyond '27, '28, '29, and '30, as service revenues become a bigger and bigger proportion of our overall revenues, that can really drive some nice operating margin expansion in Security as well.

As a reminder, ladies and gentlemen, if you do have a question at this time, please press star 11 on your telephone. Our next question comes from the line of Seth Seifman from J.P. Morgan. Your question, please.

This is Rocco on for Seth. On the prior comment on the services revenue growth, should we think about a driver of that growth being the transition of the work in Mexico towards services? And does the services revenue in Mexico carry a stronger margin relative to OSI's typical services revenue, kind of similar to the product revenue being a pretty strong margin?

Yes, Rocco, so nice questions. So our service revenues, the Mexico service revenues are more or less in line with overall service revenue margins, which are quite strong to begin with. So we're encouraged by that. In terms of the service revenue growth, what's driving it, it's kind of multifold. Part of it is the Mexico product revenue rolling off of warranty and more and more of that moving into service revenues. That helps. The larger installed base, though, that we have throughout our cargo and vehicle inspection products, throughout our aviation and checkpoint products, and even some of the RF products will all drive more service revenues with strong margins.

We're also looking at some of the SaaS-type work that we do for our security as a service, our turnkey products, and we think there's some good opportunities going forward there. And also our software as a service, our TruSaaS, for CertScan and otherwise, which carry substantial margins, and we see some nice growth opportunities there as well. So the top-line growth of service could be quite substantial for us at a much higher margin.

Great. That makes sense. And then kind of looking ahead, are there any updates on the TSA checked bag scanner contract that's expected in '27, and when should we start thinking about that kind of coming into focus?

I think we're looking at it and TSA basically is trying to get their checkpoint taken care of first and we think it's still a few years away, but it'll go on for several years, so the opportunity definitely is still there.

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

Once again, thank you all for attending our conference call. We look forward to speaking with you during our next earnings call following the completion of our first fiscal quarter.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

And I'm here with Alan Edrick at OSI Systems. Thank you for being here with us.

Thank you. Nice to be here.

So I'd like to start this fireside chat usually for the audience that sometimes is an industry audience. A little bit of a business overview. What do you guys do?

Yes. So big picture, we have an exciting company. We have 3 divisions. We have a Security division. We have a Healthcare division, and we have an Optoelectronics division, which sort of ties everything together. Really from a big picture perspective, roughly in rough order of magnitude, about 70% of our business is security, a little over 20% is optoelectronics and a little under 10% is our healthcare business. We find that most of the investors are primarily interested in our security business. We believe we're the leading security detection company in the world. And security detection means what we're doing is we're doing security at aviation, at airports, at ports and borders and critical infrastructure, at sporting events and the like.

And over time, we've captured significant market share to become what we believe to be the #1 player in the world. In our optoelectronics space, we do sensors, we make sensors, detectors, other electronic components, and we're an OEM supplier. So we supply to the Fortune 500 in industrials, probably many of the companies who are here at this conference, in aerospace and defense, and medical and a number of other industries. But in addition, our optoelectronics supplies many of the key components that go into our security products and many of the key components are going to our healthcare products.

So through that vertical integration, we're able to enhance the margin and control the supply chain, be a little faster and more responsive to our customer needs. And finally, our healthcare division, the smallest division that we have, we serve hospitals. We make products in patient monitoring and cardiology, and then we have a lot of recurring revenue through service, spare parts and consumables.

So you just touched base on that Opto business, and that is the synergies. When did you realize that it was important to have that vertical integration? And have you seen any needs to actually expand that vertical integration to actually manage your future and your supply chain?

Yes. So interestingly, we started out as an optoelectronics company, and we expanded into security, and we expanded into healthcare. So vertical integration has always been ingrained as part of our DNA. And the more stuff that we can bring in-house and capture that margin and control the supply chain, the better for us. And what we've been seeing through the course of the years is just that. We have brought more and more in-house. We've seen those intercompany sales expand over the years. And while those revenues are ultimately eliminated in consolidation, the margin remains in-house and helps our earnings per share.

So when you think about M&A, how much focus you have into expanding into like new opportunities versus actually managing down your supply chain?

Yes. So when we think about M&A, we look at the entire spectrum. We're looking at acquisitions that will fill a need for us, a channel need, a technology need, perhaps take out a competitor. We may look at stuff that will help on the supply chain side as well, but it's usually much more strategic from a business and a financial perspective.

Perfect. So now I'm going to switch gears to security that mostly about the SEDENA Mexico contracts because honestly, I don't know, 95% of the conversations I got over the last two years were related to these type of contracts. Right now, like in your top line, most of that risk is gone and you have been able to fill that risk. How should we think about from a top line revenue perspective, how much is the Mexico-related services and support revenue that will kick in?

Yes. So you're absolutely right. We've been getting a lot of questions on Mexico lately. Mexico has been a fantastic opportunity for us. We received three contracts totaling north of $800 million a few years ago. We've been fulfilling those in our fiscal '24, '25, this fiscal '26, continue a little bit into fiscal '27. And as we've had that, a lot of the questions from investors were fantastic winning the orders. But as you convert the backlog to revenue, is your backlog going to come down? Are you -- is your revenue is going to come down? And over the years, we had said no. We have a tremendous pipeline of opportunities. And we've seen just that.

Our backlog, even as we've converted significant backlog to revenue, our backlog has gone up. We finished the last quarter at a record backlog, and we filled that hole very successfully. And really, the exciting thing for us as we move into our fiscal '27, which is only 1.5 months away because we're a June 30 fiscal year, is unlike fiscal '25 and '26, where we had very difficult comps and a big hole to fill, which we think we've done.

In fiscal '27, we don't really have any sort of material headwind related to Mexico any longer. So while there will still be a few more product shipments to go there, it does transition primarily to service revenue and our service revenue is very strong revenue and strong margins. So we're excited. So it's kind of a much more minimum headwind in fiscal '27 than we've seen before.

The other piece of those contracts is the receivables though. It's taking longer to actually be able to bill those deliverables and actually collect that money. What is the latest there? And when do you expect to actually recover that money?

Yes. So first off, we've been dealing with Mexico for a couple of decades. And we're dealing with the Mexican federal government, in this case, the Army and the Navy. And over the years, we've had a number of contracts with Mexico. They've paid us every single dollar, every single peso they owed us, generally speaking, not necessarily on time or when it's due, but we've gotten every amount of money we've had. We finished up our last quarter, the March quarter with about a $350 million receivable more or less from our key customer in Mexico. Subsequent to quarter end, I think we mentioned in our last conference call, we collected about $70-plus million on that. So it's come down.

What that means for us and what really, really excites us for this other $270 million roughly is we're going to have extraordinary, we believe, free cash flow here over the next 12 months. The exact timing of which we don't know. I mean we believe because we're owed right now past due is probably something in the neighborhood of about $170 million because some of it isn't billed or isn't due yet. But this is normal course. This is very, very normal course for our contracts in Mexico, and we expect to fully get paid here over the next 12 months, hopefully even sooner.

So once this volatility is out, what is a normalized free cash flow conversion for a business like yours?

Yes. So over the next year, I think our free cash flow conversion is going to be nicely north of 100%, absent other things maybe potentially taking place. But what we've seen traditionally in our business is our free cash flow conversion is pretty close to 100% of net income, sometimes a little higher, sometimes a little lower, but our free cash flow conversion is very strong.

And you mentioned right before that this is normal business for you to deal with these type of like size of contracts, international customers, international governments. How much can you do to prevent this type of volatility from a contractual point of view? And if not, how do you prepare financially to be able to afford these type of opportunities at the end of the day if they were to come?

Yes. The good news is we love these contracts in Mexico. If we were offered these contracts 10 more times, we would take them 10 more times. They're great economically. It may take us a little bit longer to collect our receivables, but that's built into our overall business model. We have a very strong balance sheet. We have low net debt. We're sitting on a good amount of cash. We have a big credit facility that's untapped for our revolver. So we have plenty of capacity in order to take on contracts like this. Now that being said, we don't often get $800 million in 3 contracts like that. But if we did, our balance sheet is so strong that we can afford it. And it's -- if you look at it from a true economic perspective, it's a fantastic business proposition for us.

Have you seen any competitive advantages just from the willingness of taking that risk versus others or...

Oh, sure. So the knowledge we get, the business that we get, the references. So when we win business like that, other countries and other potential customers take note of those wins. Some of these wins were expected to be split amongst multiple parties. And at the end of the day, we ended up sole sourcing this. And that says a lot about our technology, our service offering, our reputation, our ability to deliver. And in fact, we've delivered exceptionally well, we believe.

Perfect. And sticking to international opportunities, we have seen some come from Latin America lately and Mexico has been super strong. Where else in the world are you seeing most of the incoming opportunities from?

No. The international opportunities have been strong for us. Over the last 3, 4, 5 years, the international growth has really driven our overall growth as a company. And the funnel remains robust. And we really see that in most regions in the world, not just Latin America, but the Middle East has been strong for us. Europe has been strong. Asia has generally been strong, not China. We don't do a lot in China, but other parts of Asia. So it's really kind of the entire world that has been strong, and we see tremendous opportunity going forward as well.

So before we jump into domestic opportunities, you just mentioned the Middle East. And in the first quarter, you saw -- you started to see some disruption there. How large is that business? How much it represents? How are you thinking about the disruption in the near term and opportunities as this conflict evolves? I don't know.

Yes. I mean the good news for us is we are the largest player in the Middle East for security detection, and we're the largest player by far. So we do a lot of business in a number of countries there. And when the conflict broke out in really the last month of the -- of our fiscal third quarter or calendar first quarter and continues, that has some impact on us. As you can imagine, in a short-term basis, countries aren't necessarily awarding necessarily new contracts, so it impacts bookings a little bit. But the exciting thing for us is both medium and long term, when these type of conflicts end, it generally means a lot of new business for us.

So we're quite excited about that. We hope the conflict ends sooner than later. Potential impacts near term just could be continued on the bookings as well as certain deliveries. Now we have a lot of ways that we're able to maneuver certain things, but with the Strait of Hormuz closed, certain shipments that may go into the Middle East could be impacted. But that was all kind of built into what we said on our last earnings call.

Perfect. So now moving the focus to the U.S. The one big beautiful bill funded like over $1 billion for nonintrusive inspection machines. And because of the shutdown, that money hasn't flowed through the system yet. What are your expectations there?

Yes. This is super exciting for us. This is the type of money that we're seeing from the one big beautiful bill funneling to CBP, Customs and Border Protection, which is part of the Department of Homeland Security is very, very exciting. We expect very large orders probably starting 6 months ago. And of course, the government got shut down in October. And even when the government was reopened, the Department of Homeland Security, by and large, has been closed most of the time until just about a couple of weeks ago. So as we look forward, we are extremely excited about our positioning to get significant business. You mentioned the $1 billion plus for NII, the nonintrusive inspection scanning equipment, which is exactly what we do.

In past awards, the most recent past awards for some big IDIQs, we got north of 40% of that business. Our hope is that we continue to maintain a very, very significant share. Our understanding is that we continue to be a preferred supplier for CBP. Our delivery and service was outstanding on these past contracts, and we think that plays a nice role. So our hope is that we're going to see some significant awards coming from the one big beautiful bill as well as some of the leftover money from the past IDIQ contracts.

So you mentioned your performance has been outstanding, and this is really interesting to highlight because there are many reports that actually say that in general, there is a lot of these assets and equipment that hasn't been actually installed that everything is lagging where they should be. What makes you unique? What -- where are you differentiated from a performance point of view? And what is your, I don't know, fair share to win from this opportunity considering your unique approach to CBP?

Yes. So on the last big IDIQs, I think there were three parties who received the awards. Again, we got more than 40% of it. While we delivered on time and we were always ready, government wasn't always necessarily ready. So some of the sites were delayed. So consequently, the program shifted a little bit to the right, but our performance was always spot on.

We understand that might not have been the case with some of the other awardees on the contract. And we think that might position us well on new contracts. So what is our right for a fair share to win? We, of course, think the maximum, but the government generally does not sole source awards. So if we can keep the same type of market share percentage or potentially even higher, we'd be very thrilled.

Perfect. So when we think about this international growth supporting the backlog and [indiscernible] really actually most of the growth, the domestic opportunities, this mix between products and services, what does that do to margins? How should we think about like margins 3, 5 years from now?

Yes. So our goal is always to couple top line growth with operating margin expansion. And if you look at what we've done over the past decade, that's generally been our formula. As we look forward, so the last couple of years, we've had very, very strong product revenue growth from a lot of these international sales. And when you sell the products, they generally come with a 1-year warranty, maybe a little bit longer. But as they roll off of warranty, now you get this great recurring service revenue. And to your question, our service revenue generally carries more than 10 percentage points higher of margin.

So we've seen very significant service revenue growth throughout calendar '25, and we expect to see nice continued service revenue growth going forward. So when you look at that, when you couple increasing service revenues at higher margin, coupled with economies of scale on higher product sales, our goal is to continue to grow the operating margins for the foreseeable future.

So how is that split today, like the recurring services versus products? And when you target opportunities, what could be your target in the future?

Yes. So today, our recurring revenue is about 30% in the Security division. We see that we could take that to 40% or higher in the future. All that is also, though, dependent upon the level of product sales we have. So while we expect to see very significant service revenue growth, there may be very strong product revenue growth sort of simultaneous with that.

So that percentage mix may take a little bit longer to get to, but overall, still leads to very significant operating margin expansion. And when I say very significant product revenues, the one big beautiful bill that you just mentioned as well as some big orders that we've gotten on RF for Homeland Defense, Golden Dome, if you will, and the like, which is mostly product revenue at the outset. So very exciting times for us.

Before we touch base on RF because I think that's really interesting and kind of like new to you. When I think about margins on pricing, is there any difference for like international customers or regions versus domestic? What are the dynamics there?

Yes. There's no real set way of saying it. So every product might have a different margin depending upon the region, depending upon the customer and the like. So it's hard to draw sort of across-the-board inferences. At times, there'll be significant margins or at times, margins may be a little bit more compressed and then you get the much larger recurring revenue for many years. So it's not really a great general rule of thumb related to that.

So now switching to RF. You acquired that business, what, like 1.5 years ago. It's performing well like almost like quarterly revenues are matching like the annualized revenues of the business you acquired not so long ago. You just got what is like $230-plus million contract for over-the-horizon sensors. You were selected for the Shield Golden Dome contract. How do you think about like opportunities there? And why have you been investing into increased capacity to be able to afford those?

Yes. So this is a very exciting acquisition that we did about 18 months ago, as you mentioned, this should be sort of a case study in doing acquisitions. It hasn't been a single or double or a home run. It's been a grand slam so far. And the outlook going forward is even stronger than the strong performance that we've shown to date. The over-the-horizon radar technology that we have, the team has an excellent reputation. So as we acquired the company, we took these great technologies and products, some of the strong relationships the incumbent management team had.

We supplemented that with our own internal resources, which were a little bit stronger as a larger company and our balance sheet, and it has afforded us the opportunities to bid on bigger projects and to win some of these bigger projects. And as you just mentioned, most recently, we were awarded this up to $235 million deal with Homeland Defense, very exciting for us. And we don't believe that's the end. We think there's much further opportunity there. So to your question on expanding capacity, we kind of saw this coming, not necessarily the whole Golden Dome award, but just the expansion of the RF business say, 9 months ago.

And we began to expand capacity. We brought on new facilities that we began moving into in November of 2025 that will be completed with this year. This expanded our capacity by 3 to 4x, which proved to be very fortuitous as we're getting these larger orders. There may be opportunities to further expand based upon the strong demand that we're seeing out there today.

So if I were to think -- I'm going to annualize your first quarter revenues and you're running at a $150 million revenue line for that business. How much capacity -- like to what extent you can actually produce with the capacity you just increased?

Yes. So without sort of quantifying that today because we're increasing it today, and we're mostly running on a single shift, but we can move to 2 shifts or 3 shifts. We believe there's adequate capacity to improve -- increase our revenues nicely from there. But there may be potential for taking on additional space and building additional capacity, too, based upon the very exciting level of demand that we're seeing out there.

Perfect. So that's a perfect tie to M&A and investments and expansions and capital deployment. How do you think about that as you think about like investing into these opportunities you have with your current businesses versus actually going after something like these type of businesses that is something adjacent where your, I don't know, scope can actually give you bigger opportunities. How do you see that in the pipeline?

The great -- really the great answer for us is that both of those things are not necessarily mutually exclusive. We think we can do both. With the strong balance sheet that we have, with the strong free cash flow that we expect to generate, we believe we can invest as much as we need, that's appropriate in our business, while simultaneously turbocharging our organic growth with inorganic growth. So we think both of those opportunities lie ahead for us.

Perfect. And within security, we haven't talked about airports. You are usually stronger in the cargo market, but you have been talking about like this renewal wave that is about to come in like three years from now, and you do have better products now.

I'm interested about that. Like how do you think about the opportunities there? Do you see -- think the airports are actually getting like the funding to improve all this equipment? What could delay that or not? And then from a competitive dynamics perspective, a lot is going on, right? Smiths as a stand-alone business, Leidos merging with Analogic., How do you think about your positioning into these like evolving competitive dynamics?

Yes. So the aviation market is exciting to us. We've been growing it at a double-digit mark. It's not as big for us, as you mentioned, as the cargo market for ports and borders, where we're the #1 player. But in aviation, we are a big player, and the opportunities are exciting. Most of the opportunities that we've been pursuing have been international opportunities, and we've been doing quite well there. But as you mentioned, a big replacement cycle is expected to start in a few years here in the United States for check baggage. We have probably a 20% or 25% market share on check baggage outside the United States.

Inside the United States, when these machines were purchased long, long ago, we didn't have a product back then for check baggage, so we don't have an installed base. But similar to Europe, where we also didn't necessarily have an installed base at the time and have taken a significant market share, we would hope to get a fair share of the market when this replacement cycle starts in a few years, which is expected to last for about 5 years or so and then the strong recurring revenue of services goes on top of that.

So we think we're very nicely positioned for aviation. We're improving our products all the time. And we're excited about the aviation market, and we think there might even be some faster growth opportunities come a couple of years from now in that segment of the business.

Perfect. And from the competitive dynamics, are you concerned from a product perspective or pricing power perspective from these businesses actually refocusing on [indiscernible] where we see a lot of penetration from the Analogics of the world, international competitors, right?

Yes. So fundamentally, we don't think the changes that have taken place with one of our competitors in the U.K. being taken private by a sponsor and the combination, as you mentioned, of Analogic and Leidos. I mean, Leidos had all the products that -- most of the products that Analogic had on the aviation side, but Analogic has some nice products, too. Fundamentally, we don't see it really changing the landscape in any material way, but time will tell.

Perfect. And now the other piece and is more volatile is events. How is the opportunity that you have with the World Cup coming? How -- what are the leading like orders there? Like are those already in backlog or last-minute orders? And how do we think about the Olympics as well in a couple of years?

Yes. So one of the nice things is we have been -- seems to be the partner of choice for these key events. We've done things in the Super Bowl. We've done many of the Olympics. We've done many of the World Cups. So we tend to be well situated for those. So with the upcoming World Cup and the upcoming Olympics, we like to believe we're well situated for those as well. The Olympics -- Summer Olympics, I'm referring to in 2028, of course, those decisions will be made down the road. They happen to be in our hometown of Los Angeles, where we're headquartered.

So that's nice for us to see. But both of these things are very exciting for us, partly from a marketing perspective and partly from a financial perspective as well. The Summer Olympics tend to be much larger type of events and require much more product services and generate more revenues than a Winter Olympics or a World Cup.

Perfect. So now I'd like to switch gears to Opto. Opto has also been performing really, really strong. How sustainable is this double-digit growth momentum? And what are the arenas that are actually driving this? Or like what are the end markets that are driving this?

Yes. Hats off to our business teams at Opto. They've really done an exceptional job. Double-digit revenue growth in Opto is not characteristic of this division, but we've seen just extraordinary demand. And we just finished a quarter where despite strong revenue growth, we had a 1.5 book-to-bill ratio, I believe, in Opto. So sitting at a very strong and healthy backlog in the Opto business as well.

Typically, we look at this as kind of a mid-single-digit growth business that we look to have some operating margin expansion on top of that. Sometimes we'll try to turbocharge that as well with some M&A. But those are kind of the characteristics of this business. Overall, we've tended to kind of outperform that.

What is driving -- is there any specific end market that is driving that growth?

Yes. So our Opto business is extremely well diversified. There's no end market that we have a high level of concentration in or any customers with a high level of concentration. That being said, aerospace and defense has been very, very strong for us. And that's a segment that carries high margins as well. So we're really excited about that part of the business. But frankly, across the board has been generally pretty strong for us.

So I could imagine, especially defense was already like not related or like tied to China. But have you seen from the other end markets any demand for you guys to help these customers and industries diversify away from China?

Absolutely. And that's been a real initiative over the last few years. More and more multinational companies would prefer to move their supply chain away from China given some of the challenges there. And I think we've been a beneficiary of that. And that trend continues. It's not accelerating, but the trend continues. So much of it has already been done, but more is still taking place.

How much of your products at Opto are like produced in U.S. and North America versus abroad, Asia and other places?

So when we look at where we manufacture for Opto, we do manufacture in the U.S. and the U.K. and Canada, but we also manufacture in a lot of low-cost jurisdictions such as Indonesia, Malaysia, India, Mexico. From a percentage perspective, the majority is produced outside the United States. It's probably in excess of 2/3.

Perfect. Last, healthcare, new management team has been there for a while. That business has been a little bit disappointing in terms of -- you've made like a huge investment into having the right products. Now you have the right team, but like what is still like lacking? Like is it an opportunity thing? Is the market ready to actually buy these things? What is delaying the recovery of this?

Yes. So we're excited about the future of healthcare. So the new management team, a new President came in just over a year ago. And over the past 6 months or so, he's really built out the entire management team. So it's pretty new. And we're absolutely kind of heading in the right direction. I know the numbers may not show that over the past few quarters. Hopefully, they will this quarter and as we move into fiscal '27. The most exciting thing for us in the healthcare business is a new patient monitoring platform that we're developing and will be coming out. And it's probably more of a -- by the time it has an impact on revenues will not necessarily be fiscal '27, but probably more fiscal '28. But we expect to see the business stabilizing, growing. We're looking at some efficiency improvement initiatives. But we really think we're on the right track.

We believe we have the best management team we've ever seen, not just at the president level but at the operations level and many other positions as well. So while it has been a little bit underwhelming over the recent past, it is a very small part of our business. We do believe the future can be bright, and it does have the strongest contribution margins in our entire business. So as the top line goes up, the operating margins can go up quite significantly.

Perfect. And one question about like that end market. Is this similar like hospitals were like aviation where you actually have like this replacement cycle for hospitals doing this? And what are the macro factors that could determine if that cycle is delayed or not?

Yes. So this is an essential part of all hospitals, and these products generally are out there for 7 to 10 years or so. So there's always a replacement cycle. There's, of course, new hospital construction and new wings where additional opportunities take place as well and then winning some competitive conversions. But yes, it's mostly a replacement cycle business for us on the patient monitoring side. Cardiology, a little bit as well.

Interestingly, the cardiology part of our business is the highest margin part of our business in healthcare. It's also one of the highest margin businesses in all of OSI systems. And we do have a strong share in places like Germany and the U.K. where we tend to be #1. And we think if we can take that leading market share and bring it here to the United States and other locations, it's a real opportunity for the overall division.

Perfect. And I always like to close these conversations with the two questions. Number one, what excites you the most about the future? And on the other side, what -- what keeps you up at night in order to execute this? What is the main problem there?

Yes. So we couldn't be more excited about the future. I think the opportunities that lie ahead of us in our largest division, in particular, security are outstanding. We've had great growth in our international business for a number of years. We continue to see a very strong and robust pipeline internationally. But what we're now seeing in the United States is so exciting between the one big beautiful bill, between some of the stuff going on with the Shield program, as you mentioned, and the homeland defense projects that we're getting, we think the U.S. growth can be outstanding for a number of years. And then you layer on the aviation opportunities that are going to start to take place coming up as well, very exciting for us. That, coupled with just a continued strong steady as she comes optoelectronics business and an improving healthcare business, I think, really lead us to having good top line growth, great earnings power.

Our balance sheet is in phenomenal shape. So we couldn't be more excited about the future. We're looking forward to our new fiscal year starting in about 1.5 months. In terms of what keeps me up at night, probably like many others say, the things within our control, we feel really good about. In the world today, there's all sorts of geopolitical changes that sometimes are outside of our control. So we respond to that, and we're nimble, we're agile, and I think we're -- we've been working through those pretty well.

Amazing. Thank you so much for spending time with us.

Thank you very much.

Ladies and gentlemen, thank you for standing by. At this time, I would like to welcome everyone to the OSI Systems, Inc. Third Quarter 2026 Conference Call. [Operator Instructions]

I will now turn the conference over to Alan Edrick, Chief Financial Officer. You may begin.

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 '26 Third Quarter Conference Call. We are pleased that you can join us as we review our financial and our operational 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 upon subsequent events, new information, or otherwise. We will also reference both GAAP and non-GAAP financial measures. Applicable reconciliations are available in today's earnings release.

We delivered solid third quarter financial results, setting fiscal Q3 records across multiple metrics, despite facing the most challenging year-over-year comparison of fiscal '26, primarily driven by our Mexico contracts. The company's revenues reached a fiscal Q3 record of $453 million, and non-GAAP earnings per diluted share set a fiscal Q3 record of $2.60. Importantly, excluding revenues generated by the large Mexico security contracts in both periods, Security revenues grew 25% year-over-year. Our Optoelectronics and Manufacturing division also performed well, posting 10% growth and a Q3 record for that division. Bookings were strong, with a 1.3x book-to-bill ratio driven by both Security and Opto, resulting in a record backlog, highlighted by the previously announced homeland defense award, about which Ajay will provide more information shortly.

On the cash side, we generated $14 million in fiscal Q3 operating cash flow, despite limited collections in the quarter on the receivables in Mexico. Shortly after quarter end, we collected approximately $74 million of the largest Mexico receivable, a strong start to Q4 cash flow. Before diving more deeply into our financial results and discussing our outlook for fiscal '26, I will turn the call over to Ajay for our business and operational discussion.

Thanks, Alan, and thank you, everyone, for joining us today. I'm pleased to be here to discuss our third quarter results for fiscal 2026. We delivered another quarter of solid execution and ended the quarter with a backlog of approximately $1.9 billion, the highest in the company's history. We remain focused on execution, leveraging our strengths in key markets, and utilizing our global operating model as we finish Q4 and head into fiscal 2027.

Let's turn our businesses to discuss Q3 performance in more detail, starting with Security. As expected, Q3 performance was up against difficult year-over-year comparisons, primarily due to our Mexico programs transitioning from significant product sales to long-term related service and support revenues. Despite that, Security performed well with solid bookings, top line growth, and operating margin expansion. Furthermore, we continue to be very active with customers across aviation, ports and borders, and defense-related applications.

Bookings were highlighted by a sizable award from homeland defense of an Undefinitized Contract Action, or UCA, with a not-to-exceed value of approximately $235 million for the production and integration of a homeland defense over the horizon radar transmit subsystem. We continue to build strong traction with our RF-engineered solutions and are hopeful that there may be additional opportunities in this area for future business. In addition, these capabilities position us well to further support Golden Dome, the U.S. initiative to create an integrated missile defense system. As you know, we are a participant in the $151 billion SHIELD IDIQ, which we announced last quarter, and we look forward to the opportunities that may arise from this initiative.

During Q3, we also received several international awards for cargo and vehicle inspection systems and airport screening solutions. In addition, we were an integral part of the security at the Milan Winter Olympic Games, providing our products to screen participants, officials, fans, as well as their baggage and cargo. Towards the latter half of Q3, we began to see initial impacts from conflict in the Middle East. Certain programs' activities have been delayed by factors such as logistic constraints, travel restrictions, and heightened security protocols. Certain customers in the region are facing pressure from disruptions tied to the conflict. If the situation persists, we could see further impact on the timing of order intake and project completion time lines. That said, once the region stabilizes, we could potentially see even stronger demand for our Security solutions.

In the U.S., the order activity for Security products was impacted during the quarter by the shutdown at DHS, which delayed the procurement of our products and services to support U.S. border initiatives. Now that the shutdown has ended, we are hopeful for order patterns to normalize over the coming weeks and months. And I want to emphasize here that these are timing-related dynamics rather than changes in the underlying demand. In the U.S., we're also excited about the potential of our Security solutions for high-profile upcoming events, such as the FIFA World Cup '26 soccer tournament and the 2028 Olympics. Furthermore, in the U.S., the roughly $1 billion outlined in the One Big Beautiful Bill for NII equipment remains a significant growth opportunity. And, of course, during the shutdown, the spending resulting from this bill was delayed in Q3.

Turning to Optoelectronics and Manufacturing. Q3 performance was again strong as revenues increased 10% year-over-year with the book-to-bill ratio well exceeding 1. In March, Opto received a $40 million award for the electronic subassemblies from a medical OEM, a significant award in a division where most orders are under $5 million. Customers continue to value our vertically integrated model and global manufacturing footprint as they diversify supply chains and launch new products. Our global Manufacturing footprint across Malaysia, Indonesia, India, Canada, Mexico, the U.K., and the U.S. allows us to offer customers attractive combinations of value and scalability. Opto's backlog remains at record levels, providing great long-term visibility across aerospace, defense, medical, industrial, and other end markets.

And finally, our Healthcare division, which continues its path of improving operations and focusing on new product development. In Q3, Healthcare was adversely impacted by order timing, most notably in the U.S., resulting in lower sales and profitability. On the flip side, we did see growth in the EMEA region during the quarter. As you may know, Healthcare's products generally carry the highest contribution margins at OSI. So even modest revenue growth has an outsized impact on profitability.

Looking at OSI Systems overall. Our financial position remains strong. The robust and growing backlog, year-to-date cash flow generation, and a healthy balance sheet give us continued confidence in the company's prospects. In addition to large program opportunities highlighted earlier, we remain focused on increasing our mix of recurring revenues through expanded service and support agreements. As always, I would like to thank our employees, customers, and stockholders for their continued support and dedication.

With that, I will turn the call over to Alan to discuss our financial results in more detail before we open the call for questions. Thank you.

Well, thank you, Ajay. Now let's review in greater detail the financial results for Q3. Let's begin with a look into our revenues by division. Security division revenues in Q3 came in at $319 million, driven by higher service revenues, an increased contribution from the RF business, which has been effectively integrated into our overall operations, and increased aviation product revenues. As expected, revenues from our large Mexico Security contracts decreased to $11 million in Q3 fiscal '26 from $69 million in Q3 of the prior year. Excluding the Mexico contracts, Security's revenues surged 25% year-over-year, reflecting healthy growth across the broader Security portfolio. Fiscal Q4 is expected to experience a reduced revenue impact from Mexico in comparison to Q3, with the magnitude of this headwind expected to largely roll off as the company enters fiscal '27. Our Optoelectronics and Manufacturing division had another excellent quarter. Opto sales, including intercompany, increased 10% year-over-year to $111 million, a new Q3 record for this division. This was driven by sales growth across our diversified product and customer portfolios. And as described earlier, Healthcare division sales were soft. Our Q3 fiscal '26 gross margin was 33%, slightly 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 product and service mix and volume, supply chain cost, FX, tariffs, among other factors.

Moving on to operating expenses. SG&A expenses in the 2026 third fiscal quarter were $71.5 million, down 2% from the prior year fiscal Q3 and representing 15.8% of sales compared to 16.5% of sales in Q3 last fiscal year. We continue to work diligently across all divisions to manage our SG&A cost structure efficiently. R&D expenses in Q3 were $19.5 million, or 4.3% of revenues, up from $18.6 million, or 4.2% of revenues in the same quarter last year. This increase stems from our commitment to investing in innovation, resulting in market-leading offerings in Security and positioning OSI well for the future. We expect to continue our heightened R&D efforts to advance key initiatives. Even with these R&D investments, our combined SG&A and R&D expenses as a percentage of sales have decreased annually for each of the past 8 years, underscoring our ability to drive operating efficiencies while still funding growth initiatives.

Now moving below the operating line. Interest and other expenses, net, in fiscal Q3 was $4 million, down from $8.2 million in the same quarter the prior year, primarily due to reduced borrowing costs. Our effective tax rate under GAAP was 18.3% in this Q3 versus 14.3% in Q3 last year. Excluding discrete tax items, our normalized effective tax rate, which is the rate used in calculating non-GAAP EPS, was 23.6% in Q3 this year compared to 23.7% in the same prior year quarter. On a non-GAAP basis, our Q3 '26 adjusted operating margin of 14% was comparable on a sequential basis from Q2 and slightly below the prior year third fiscal quarter. The Security division's adjusted operating margin expanded from 18.1% in Q3 last year to 18.3% in Q3 of fiscal '26, driven by growth in higher-margin Security service revenues combined with reduced operating expenses. This, though, was offset by the other 2 divisions. The Opto adjusted operating margin decreased to 13.5% in Q3 this fiscal year from 14.0% in last year's fiscal Q3 on a less favorable mix of revenues. The adjusted operating margin of our Healthcare division was negligible due to the sales level. As Ajay mentioned, we expect margin recovery as Healthcare performance improves.

Moving to cash flow and the balance sheet. We generated $14 million in Q3 operating cash flow despite limited collections in the quarter on our largest receivable in Mexico. However, as mentioned earlier, not long after quarter end, we received a payment of approximately $74 million from our largest Mexico customer, providing a strong start to our Q4 cash flow. Operating cash flow for the first 9 months of fiscal '26 was just shy of the amount for all of fiscal '25. DSO increased 7% from fiscal Q2. Current expectations are that DSO will decrease by fiscal year end. We expect substantial cash inflows in Q4 and into fiscal '27 as we continue to collect on the Mexico receivables, which should lead to sizable operating cash flow and strong free cash flow conversion. CapEx in Q3 was $8 million, while depreciation and amortization expense was $9.5 million. Our balance sheet remains solid. We ended the quarter with $345 million in cash. Our net leverage at the end of Q3 fiscal '26 was approximately 2.2x, as calculated under our credit agreement.

Now turning to our guidance. We are maintaining our fiscal '26 guidance for revenues and non-GAAP earnings per share. The recent shutdown of the Department of Homeland Security and the conflicts in the Middle East have impacted short-term bookings and could impact near-term Q4 revenues, but looking out further, resolution of each of these matters, one of which has just been done, could potentially represent future opportunities for the company. We note that our fiscal '26 non-GAAP diluted EPS guidance excludes any impact of potential impairment, restructuring, and other costs, 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, tariffs, the recent DHS shutdown, the conflicts in the Middle East, and supply chain disruptions, 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 EPS 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 delivered a record fiscal Q3, driven by our 2 largest divisions, a record backlog, providing multiperiod visibility, and we also made a meaningful cash collection in the beginning of Q4 that further enhances our balance sheet. We remain committed to operational excellence as we grow our businesses and deliver innovative products and solutions to our customers. We aim to invest in key strategic areas with the goal of driving long-term value for our shareholders. Once again, we thank the entire global OSI team for their dedication to supporting our customers and partners. Their efforts are what make our results possible.

And at this time, we'd like to open the call to questions.

[Operator Instructions] Your first question comes from the line of Larry Solow with CJS Securities.

I guess the first question, we know Mexico is going to be pretty slow. So the 25% growth you've seen outside Mexico, where is that coming from, I guess, geographically? And just on the product mix, is most of that still ports and borders, vehicle inspection? I'm just trying to figure out if you could parse out -- give us a little color on the origin of the growth.

Larry, this is Alan. Good question. We're seeing the growth in a bunch of different areas. First off, geographically, we're seeing most of the growth internationally. As we look forward with the ending of the DHS shutdown, we foresee the U.S. picking up steam significantly as we enter fiscal '27. But to date, most of the growth has been driven internationally. And we're seeing it across a wide variety of our areas. We're seeing our service revenues increase nicely. We're seeing our aviation revenues increase nicely. We're seeing our RF revenues increase nicely. And that's predominantly what's driven most of the growth that we're seeing outside of Mexico, as we mentioned.

And the RF contract that you got, the Golden Dome contract that you announced, you announced at the end of April, but I guess it was in your -- was it actually obtained before the end of the quarter? Is that -- because it sounds like that order is clearly in the backlog and the book-to-bill for the quarter, correct?

Yes, it came in -- this is Ajay -- came in at the end of March.

And I guess you were just delayed because of the government shutdown, or any reason why the release wasn't put out?

Larry, it just takes a little bit of time to go through the various sequences in order to get a press release out and get the appropriate approvals to do so.

And just on the government shutdown or delays and whatnot, it sounds like it certainly has impacted your bookings a little bit to date, maybe a little bit more Q4. And has it impacted revenue at all to-date? It sounds like maybe no, but there is potential in Q4. Is that kind of what I hear?

So I think that what I pointed out earlier was, yes, it's impacted some bookings. But really, it's a timing issue. I mean, that's really what it is. So we think that those bookings and, like I said, the $1 billion Big Beautiful Bill is still sitting there. So yes, it did. I think in Q4, we're hoping things start loosening up for the next few weeks to a few months. And it may have a slight impact, but we'll wait and see.

Your next question comes from the line of Christopher Glynn with Oppenheimer.

Just want to ask about the services revenue. So I know it wasn't going to be totally linear, but it was about 5% growth and had been consistently strong double digits. And my understanding was following significant sustained backlog growth for a few years that this would probably be double-digit grower compound pretty consistently. Is that still an appropriate view? Or should we view it as maybe stepping down to the single-digit profile going forward for services?

This is Alan. Good question. What we saw throughout calendar '25 for 4 straight quarters was very strong double-digit growth in service revenues as our installed base increased significantly. In this particular quarter, we had mid-single-digit growth in our service revenue coming off of a little bit more difficult comp, and it also has to do with some of the timing of some of the installations that were done in prior quarters versus this quarter. As we look forward, we continue to expect to see very strong service revenues. I think there'll be certain periods where we'll see good double-digit growth. There'll be other periods where it's single-digit. But overall, we expect to see nice growth in our service revenues, which is nice because it inherently carries a higher margin associated with it.

Okay. So, Alan, it sounds like you expect it generally over the next 1 year or 2 years to be outgrowing equipment. Is that right?

It can be. It all depends. So for instance, as we begin to...

I get it. It can be a little nebulous, yes. Yes, not trying to pin you down.

And we expect strong product revenue growth as well. And with the strong product revenues we're expected to have as well.

Okay. And then on Security margins, you've effectively run down the Mexico revenues, which you've described as really efficient production runs. And so should services be in a pretty consistent margin expansion trajectory from here?

Is the question, will the service margin continue to increase from here?

Yes. Now that you've had a couple of years where it's been flat to down slightly as you've wound down the Mexico revenue, which you have described as very efficient production runs. And if that's all taken out of the base period and you continue scaling, just wondering if there's any reason why we shouldn't expect consistent margin expansion at Security from here.

The goal in Security is always to couple top line growth with operating margin expansion, and that's what we look to do over the long term. There will be certain quarters or periods where based upon the mix of the revenues, particularly the mix of the product revenues, may not necessarily lead to that end result. But over a longer-term basis, that's absolutely the goal and the intent of the company.

Your next question comes from the line of Josh Nichols with B. Riley.

Great to see the record backlog and book-to-bill yet again. And despite the DHS shutdown, now that that's back open again, just curious, are there any specific mechanisms by which the CBP procurement resumes post shutdown? Or do you expect there to be a relatively quick uptick in order activity between now and your fiscal year end at the end of June?

This is Ajay. I think it's going to be relatively quick over the next few weeks, maybe some months. But there's really no restriction that we can see that they can't resume stuff. It's just people coming back in, takes some time to get everybody working. And concentrating on [ letting out ] orders instead of where the funding is going to come from. So we feel good about it. But I think over the next few weeks, time will tell, but we are very encouraged that the shutdown is over.

And then I wanted to touch on, I guess, 2 things from my last 2-part question. One, this $235 million homeland defense contract, I think that's much larger than anyone was anticipating. You touched on SHIELD. Do you see any other large opportunities within that piece of potential business that you think the company is in good position to secure? And lastly, just, Alan, maybe for you, a question on post this $74 million Mexico account receivable that you guys got, how would you characterize the Mexico-related AR levels today?

I'll take the first part. We obviously are very happy and proud of this contract we got. It basically demonstrates our technical expertise out there, some of the products we have out there were well considered by the government and other customers. Yes, there are opportunities out there. I'm not going to sit here and try to quantify them. It's a very new market. We're all looking at it. But I think by the size of the order and what the future holds, we'll wait and see over the next few quarters. But it's a great start, and we feel very good about it.

And this is Alan. So the second part of your question, Josh, on the Mexico receivable, with the recent receipt of the $74 million, it certainly reduces the Mexico receivable balance. That being said, there's ample opportunities for significant cash flow as we collect on this receivable over the coming months and quarters. So we would expect the free cash flow conversion to be quite outstanding here over the foreseeable future.

Your next question comes from the line of John Godyn with Citi.

This is Bradley Eyster on for John Godyn. So I just want to take a step back and look at the bigger picture on the opportunities you're seeing, particularly around the airport security demand side, and I appreciate that you touched upon the potential supply chain challenge that you're seeing given the dynamic macroenvironment. But that same school of thought with the reduction of flight capacity to various degrees, concerns over jet fuel cost/availability, I know it's still early days, but have you guys seen any impact to the demand for these services? Or is there any timing impacts [ creeping ] up from this?

I mean, it's a great question. I think overall, after a conflict ends, unfortunately, being in the security business, it's always that things tend to pick up. Are there some temporary disruptions in the Middle East, et cetera, because of aviation? Yes. But I think we've got to look at it from an overall standpoint that as and when this gets put behind us, we think we'll see not just aviation, but overall, we think we'll see an uptick potential in our business.

I just want to touch upon the opportunities on Golden Dome and SHIELD that you're pursuing. So I'm just curious, more in the medium to longer term here, potentially. So how would you measure off the competitive landscape here for the RF protection side specifically. Just curious what kind of update you can provide on any kind of traction in interest you're getting from customers here would be helpful.

I think that we've been talking about it for several quarters. Like I said, we're -- this initial contract has been very good for us. We announced smaller contracts last quarter. We think there's a lot of momentum going forward. But honestly, I think there's a limited amount what we can talk about because of what type of contracts these are. But I think the future looks good. The timing, we'll just have to wait and see.

Your next question comes from the line of Seth Seifman with JPMorgan.

This is [ Rocco ] on for Seth. Should we think about the homeland award and possible similar awards in the future as supporting the longer-term growth in the Opto segment? And how should we be thinking about the top line growth in 2027 following the low double-digit pace this year? Could it be one of the faster growers next year?

First of all, this is in the Security segment, the Golden Dome, that's where it falls. On the Opto side, we think that, yes, there is room for potential growth as we go forward. We've talked about it before. There's definitely a movement away from China. And with our capabilities, like I mentioned in my remarks, all over the world, not just in Asia, but in Europe and the U.S., from a Manufacturing basis, we provide a lot of flexibility to our customers. So we feel good as we move forward. Obviously, there are always a little bit of ups and downs there. But overall, I think Opto is in a good position.

[Operator Instructions] Your next question comes from the line of Jeff Martin with ROTH Capital.

I wanted to dive into the RF business a bit more. Are you able -- Alan, are you able to give us the revenue number from that business for the quarter? And then, I believe you were ramping up additional production facilities there. Curious where you're at today in production capacity relative to the homeland defense contract.

I can go through the actual numbers. But we started ramping up the production capabilities and moved into new facilities over the last several months, but we made that decision a while ago. And frankly, it looks like a very good decision. And so we've ramped up that capacity. We'll keep on ramping it up. Like I said, we're in a new facility, and we feel good about what we could do and offer the government in terms of being able to turn around product a lot faster than we were able to maybe 1 year or 2 years ago. You want to take the second part, Alan?

Sure. Yes, we were pleased, Jeff, with the revenues in the RF business. I believe it was a new record for us. We did about $38 million in the quarter. So the run rate of that business has significantly increased since the time of acquisition 18 months or so ago. So we're very pleased with the trajectory.

I know you're not in a position to really give any guidance beyond this year, but just curious qualitatively, how you're thinking about growth and your growth prospects in fiscal '27 and '28.

This is Alan. So good question. And you're right, we'll be giving our guidance for fiscal '27 on our next call in August. That being said, we're optimistic for growth as we move into our new fiscal year, just 2 months from now. So we're excited to close out Q4 and fiscal '26. But with the strong backlog and robust opportunity pipeline that we have out there, fiscal '27 could be a very, very exciting year for us.

And last one for me is, you've been historically a very value-oriented buyer on the M&A front. A lot of those have produced very good returns. I think the RF business is a case in point. Just curious if you're seeing other opportunities out there that are similarly interesting? And are there areas from either a market expansion standpoint or a technology expansion standpoint that you're looking at that could move the needle over the next couple of years here?

We're always looking at opportunities. I mean, that's just part of it. And as Alan has pointed out before, we have a lot of dry powder available for us. And I think we look at, from a technology standpoint, obviously, we want to make sure that 1 plus 1 everybody says 3, I always say maybe more. But there are opportunities. I really don't want to get into specifics, but we're always actively looking. But we're not going to do anything unless we feel it really makes a difference from a strategic as well as from a business perspective as we move forward.

There are no further questions at this time. That concludes the Q&A session.

Once again, thank you all for attending our conference call. We look forward to speaking with you during our next earnings call following the completion of our fiscal year. Thank you.

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.

Good afternoon, everyone. Welcome back to the aerospace and defense track here at the JPMorgan Industrials Conference. I'm Seth Seifman, the aerospace and defense equity analyst here. And we are very grateful to have with us OSI Systems. And we're here with CFO, Alan Edrick. And Alan is going to talk with us about the company. We're going to do a fireside chat, a little bit of Q&A, and we'll ask in the audience for some questions as well. But Alan, thanks very much for coming. I appreciate it.

Thank you. Thank you for having us.

Cool. Maybe stepping back before we get into the detailed questions, if you just kind of want to set the scene in terms of where things stand for the company this year, the growth prospects that you see, kind of what you guys are excited about?

Yes. It's been a great year for OSI Systems. We are a June 30 fiscal year, so we reported half of our year and coming up on our 3-quarter mark right now. Over the last few years, we've experienced very strong growth, both on the top line and the bottom line, and that has continued into this year with strong revenues, strong bookings and strong profits.

So we're excited and the prospects ahead of us are very exciting. We've been growing quite a bit internationally. And while those prospects still remain very, very robust, we think the next few years, the U.S. growth is going to really be outstanding for us. So exciting times for OSI.

Excellent. Excellent. And maybe we'll start off talking about the security business. You mentioned U.S. growth ahead. There was a good amount of money in the reconciliation bill last year for border security equipment. Have we seen -- but we've also had some friction. We had the government shutdown for a period at the end of last year. The Department of Homeland Security still doesn't have funding for fiscal '26. Have you started to see some of the contract activity get going?

Yes, we've certainly seen a lot of RFIs and RFPs. The outlook for us, we believe, with some of the funding coming from the One Big Beautiful Bill and the like is superb. And we think it's going to really set us up nicely for the next few fiscal years for us. So we're very excited about that. We think the orders are on the come there for us and hopefully not in the too-distant future. You're right, the shutdown of the government back in October and November impacted some things from a timing of bookings.

It didn't impact our fiscal year because these were bookings that would generate revenues, we believe, in '27, '28, maybe '29. And even though the government has been opened, as you mentioned, the DHS is still shut down, though we still continue to work with many of the key parties within the government. So we're very excited and are very optimistic about the outlook there.

Okay. Excellent. And when we think about that, I think it was something in the low $1 billion range, $1 billion and change that was in the reconciliation bill for border security equipment?

Yes, there are several categories. And the first category is just over $1 billion for nonintrusive inspection scanning equipment, which is exactly what we do with CBP, Customs and Border Protection. And then there were some other funding in a few other agencies and then additionally, some funding for the Olympics and the World Cup. So all told, it's a very significant and sizable sum that we're trying to play a meaningful role in.

Right, right. And I guess some of that -- I mean, there's a time line attached to some of that. The World Cup funding needs to be coming soon if it's going to happen. So I guess that part of it we can look for in the nearer term. And then when we think about the company's share of that, I know in terms of port and border security equipment, OSI is the global leader. Would we think about the company getting at least half of what's out there?

Well, we're hopeful it will be a very sizable award. The last CBP awards that were given of a sizable nature, I believe we got around 40% to 45% of the awards. We continue to be a very strong provider and have an excellent relationship with CBP. So when the awards come, we're hopeful that we can maintain that share or even grow it. So we are optimistic about that.

Okay. Okay. Excellent. And then on the airport side of the business, I gather there are some opportunities coming as well. How do we think about when those opportunities show up and also the scale of those opportunities versus what's available on the ports and border side?

Yes. Aviation is a very important part of our business. We're larger on the ports and borders and critical infrastructure side and have a higher market share, but we also have a strong market share in aviation. And for the last several years, the biggest part of our aviation business has been international. And I think over the next couple of years, it's going to continue to be outside the United States.

But there'll be a big replacement cycle coming for check baggage in a few years, starting here in the United States. that will likely be roughly a 5-year replacement cycle. And that will all be incremental business for us because when these checked baggage machines were first put out in the United States or installed, we didn't have a product back then. And we then developed the industry's first check baggage machine specifically for security applications. And it's been a great success for us. We've had some great wins outside the United States and some good market share. And we would hope to do the same right here in the United States when that replacement cycle starts here, too.

And is that something where you'd expect awards kind of late in the decade and then for that 5-year cycle to kind of start from there?

I think that's probably a very reasonable time frame. And the timing couldn't be more perfect for us because we believe we'll have some significant awards for -- with CBP and ports and borders and some other government agencies as well. So as those maybe start to wind down a little bit and move more into service, the aviation will kick in, as you mentioned, towards the end of the decade and then beyond.

And then on the international side, what's the demand picture like internationally, both for airports, I guess, and for ports and borders?

Well, unfortunately, the world doesn't get a whole lot safer as we see in the news every day, but it kind of plays well into the business that we participate in. So we continue to see robust activity in our funnel. We're excited about it on the ports and borders and critical infrastructure, but as well as aviation. So all of those areas are very strong opportunities for us. Of course, the most recent conflict in the Middle East could create some medium- and long-term opportunities for us as well. So it's not necessarily always great for certain things going on, but it tends to play well into the business that we're in.

All right. And are there particular regions that seem more promising in terms of demand?

Yes, there are. I mean, in addition to the United States, the Middle East, we look at it as very fertile territory. We have very strong market share in the Middle East. But we also see strength in Latin America, Asia, not China, but other parts of Asia would be notable. And of course, we do business throughout the EU as well. But I'd say between the U.S. and the Middle East and some parts of Latin America, that's probably our strongest growth opportunities.

And what's the competitive environment like these days when you go out to try to win business internationally?

Yes. So on an international basis, the competitive landscape hasn't changed a whole lot. We tend to be, we think, one of the strongest players internationally. Our largest competitor has recently announced that this particular division is -- the Security division is being divested and is being sold to a private equity player that's supposed to close sometime later in 2026.

But the competitive landscape is largely the same, both internationally and the United States, same main competitors that we have that are all good companies, but we seem to compete well and favorably with.

I think one of the interesting things that I learned about the business when I started following the company was there's obviously equipment that you guys sell, but you also sell services. And there's a support aspect to the equipment and okay, that makes sense. There's a lot of equipment that companies sell where there's an aftermarket. But also that you will almost provide the service -- so can you tell us about that offering and how penetrated that is within your sales base right now?

Yes. So maybe I'll talk about sort of service in general, including the aspect you're referring to. But service for us is very exciting. Throughout calendar '25, we saw strong double-digit growth, I think, each quarter on our service revenues. And that's important for us because it can really expand margins.

Our service margins are at least 10 percentage points higher than our product margins on a general basis. So as the service revenue becomes a bigger part of our overall mix or a percentage of our overall revenues, that can lead to nice operating or EBITDA margin expansion. So very, very favorable for us.

And within our service revenues, we really have 4 main areas. We have our field service and maintenance, which is the largest area for us in service revenues, where we have a very high adoption rate where we fulfill the service for our customers. So after we sell the product and let's say, it has a 1-year warranty, if it's out there for 7 to 10 years, we tend to get annual renewal contracts for very strong margin service revenue.

In addition to that, we pioneered a new business model, which you were alluding to that we call turnkey or a different version of SaaS, Security as a Service, where instead of selling the product, we manufacture the product, we place it at the customer location, but it sits in our balance sheet. We own it. We enter into a long-term contract with customers up to 15 years. They've ranged from 6 years to 15 years.

We staff it up with our people, our employees, and then we charge a fee per scan or a fee per site per month. Thus a great source of recurring revenue at strong margins. So it's been a great area for us, primarily focused in the international markets. And from that, we developed a proprietary software called CertScan, which we now are taking out as a stand-alone true SaaS-based product, Software as a Service, which is exciting for us. We're beta testing it with some real orders here in the United States, but we've also gotten some significant orders outside the U.S. for this. So exciting. We're in the very early innings, but we think it can grow substantially at high SaaS-like margins, which is great for us.

And then the final area of service for us is training revenue. So we're doing more and more training initiatives. So these 4 things, we think can contribute to nice size service revenue growth. And again, the service revenues carry substantially higher margins than our product revenues.

Okay. When you take on the operation of the equipment, and this is -- for your customers, this is kind of an important national mission. What kind of risk does the company take on in those cases?

Yes. So we're very careful to, of course, not absorb any additional risk that we need to. So in most of these cases, sitting side-by-side with us when we're doing the operations is a member of the government. And the member of the government makes the final adjudication or decision whether to pass the truck or the car through. We might provide a recommendation, but they make that final decision. So as a result, we have not seen any particular liability associated with this.

Not something that the company is exposed, correct. Okay. Excellent. One of the things, I guess, as we've seen the service portion of revenue grow in recent quarters, we haven't seen an accompanying expansion of the margin. And so why is that? And when do you think that might become -- that service contribution might become more observable?

Sure. So the service revenue growth that we've seen over the last 12 months has led to nice incremental margins on the service side. But on the overall blended side, we had some tough comparisons. So over the past couple of years, we've been fulfilling 3 major contracts that we won in the country of Mexico, totaling about $800 million.

And as we deliver those products, because we are making the same product over and over and over again, there was quite a bit of efficiencies, which led to higher product margins than we would otherwise normally have. So over the last few quarters with that tough comp, as we've replaced the Mexico product revenues with other customer product revenues, it's been at a little bit lower margin. So overall, our margins have been pretty strong, but because the service revenues have kind of offset the change in the product margins. All that being said, the last quarter where we have a more challenging comp on the product revenue side related to Mexico is this quarter in March, which we've outlined in the past. So as we move forward into kind of our June quarter and then into our next fiscal year as we start July 1 and beyond, those tough comps are gone and should lead to an opportunity for nice operating margin expansion.

Right. Okay. And how does the -- when the growth in the business becomes a little bit more U.S.-focused and CBP focused, does that have an impact on the margin mix?

It may. Sometimes margins have been favorable in the United States. It all depends as the bids go out and the like, but that should be very helpful. It should also be very helpful from a working capital perspective as the U.S. government tends to be a faster payer than many international locations.

That's probably a good segue to the cash flow topic. So we'll talk about that now, and then we'll go on and talk about a few other things as well. But I know that waiting for the payments from this $800 million of work in Mexico has dragged on your free cash flow in recent years. Can you talk about where that stands? What kind of remains to be collected? And what's kind of the visibility on when that can arrive?

Yes. So the country of Mexico and the many agencies that we work with the country of Mexico have been long-standing customers of ours for the past couple of decades and have been very, very reliable payers. They paid us every single dollar or peso that they owe us, not always on time, but they always pay us everything they owe us.

So the current large contract that we have outstanding is with the Mexican Army, a group called SEDENA, very -- it's part of the federal government, so as a result, we feel very confident in collecting all the cash as we have with every contract that we've had in Mexico. It's been slower than we would like. There's always some bureaucracies that take place and the like. So they have been paying us.

I just -- we wish it would be a little bit faster. But what that means for us that we think over the next 12 months, our free cash flow has the opportunity to be simply outstanding and the free cash flow conversion can be very, very strong.

Okay. Okay. Is there -- I guess, if we looked at the an unbilled receivable or something like that, that would kind of show what the magnitude of that excess cash?

Yes, really both looking at the unbilled receivable and the billed receivable because each of those balances is substantial. The unbilled receivable is coming down and converting the billed, which then means it can be paid, but the billed receivable itself is significant as well. So we're excited about that. It means we're going to be -- we should be generating very, very significant free cash flow here over the next 12 months.

Okay. Excellent. I guess when we step back and we think about the security business and having a strong market position and demand both domestically and internationally, what's the right growth algorithm to think about for that business?

Yes. It's difficult to put a pure algorithm on it because there are times when we get these outsized contracts, such as the 3 large Mexico contracts. Today, we sit on big opportunities here in the United States with the One Big Beautiful Bill, things like Golden Dome and the like. So there's times where the growth can be very outsized and then the service revenue comes along with it.

But on a big picture scheme, we think on a long-term basis, it's kind of a -- it could be like an upper single-digit type growth business where -- with many years being in the double digits. Yes.

Okay. Okay. And then within that, how do you think about the margin opportunity in a business where you're growing. So there's -- I'm sure there's some leverage. There's a growing service component and a growing installed base. There's also right now, maybe some elevated domestic demand on the OEM side, on the new equipment side. Does that create a path to margin expansion?

No, we think so. I think you just hit on the key elements. As service revenues become a bigger proportion of our overall mix, that drives operating margins. Economies of scale associated with higher revenues and leveraging that fixed cost structure also does. The mix of where the revenues may occur in one country versus another, one product versus another. And all 3 of those type of things, we think, can lead to nice operating margin expansion.

Okay. I'm glad you mentioned Golden Dome, and I'm glad you did because people generally think about security products, and we've talked about ports and borders, and we talked about airports and not necessarily thinking about the company in a military context. Can you talk about what you guys do in radars and how that's relevant to missile defense?

Sure. So about 18 months ago, we completed an acquisition of an RF and a radio frequency solutions company. At the time we did the acquisition, I'm not sure the words Golden Dome existed. So it certainly wasn't part of the underwriting of our acquisition. And this is an acquisition that's performed incredibly well for us out of the gate over the past 18 months, where we've had significant revenue growth, significant bookings.

So we took basically their strong products and technologies, and we put it in and combined it with our larger sales channel, our larger balance sheet and the like, and we've seen just tremendous momentum. I think in the September quarter, we had, I think, a 3.3 book-to-bill ratio in this business, strong bookings again in the December quarter and all this being very exciting.

So the business is doing great. Now we layer on Golden Dome, which came in, we're part of the $151 billion IDIQ, along with numerous other companies. But we believe we are extremely well positioned for it using our over-the-horizon radar products. These are classified programs, so we can't go deep into exactly what we do. But I would say, suffice it to say, we think we're extremely well positioned for Golden Dome and would anticipate we'll be seeing some nice orders in this business, which should be very, very favorable for us.

In that regard, we increased capacity, manufacturing capacity in this business. We moved into -- we began to move into new facilities in November of '25, and we'll be continuing that move throughout calendar '26, and we'll be out of our current facilities by the end of this year. And the timing couldn't have been better. I mean we needed the extra capacity just for our own existing business even before Golden Dome. But with Golden Dome, it provides even more room for us to grow in a significant way.

And is that something where the company is selling directly to a military customer? Or are you part of a team with a prime contractor?

The answer is both avenues are available to us. So we do have direct talks directly with the U.S. government, and we also have discussions with prime contractors.

Okay. Okay. And the growth that you've seen in that business thus far has been mainly domestic. It's with the U.S. DoD?

So it's been a combination. We've seen domestic growth, but we also sell to a number of countries as well. So we've seen broad-based global demand, which is one of the things I think OSI Systems kind of brought to the table being with our global footprint. So the U.S. opportunities are very robust, but international opportunities are nice, too, that we've won and continue to pursue.

When you sell those products internationally, RF and over-the-horizon radar products. Are those foreign military sales? Or can those be direct commercial sales to the customer?

Yes, they have not been part of the FMS program. They are direct sales.

Sales -- very -- I would imagine then very -- profitable.

They are. They are very much in line with our overall security margins, which are nice and strong.

Right. Right. Okay. Okay. And we talked a little bit earlier, you mentioned the demand around the World Cup. When we see events like that, is that something that ever kind of -- we ever would see in the quarterly results? Or is it something that just kind of is in the numbers and part of the business, and we don't -- there's often events going on, and we wouldn't necessarily recognize it.

It depends on the event. We've been very strong winning many of the Summer Olympics, many of the Winter Olympics, many of the World Cups, Super Bowl, things like that. Oftentimes, they're nice revenues, but it won't move the needle in a quarter, but it's great from a marketing perspective and otherwise.

But then there'll be other events such as the Summer Olympics, which can be very meaningful. And we anticipate the '28 Olympics could be meaningful if we're to win that. We recently did the past Olympics in Paris and the like. So great from a marketing perspective, nice from a profit perspective. But in terms of moving the needle, Summer Olympics will probably move it more than other events.

Okay. Okay. I think for most investors, I kind of think about the security products business as kind of the core of the company, but there are 2 other segments within OSI. Maybe you can give us an update on Optoelectronics and prospects for that business.

Yes. We couldn't be more proud and excited of what our Optoelectronics team have done. In Opto, we serve a variety of customers in aerospace and defense, medical, automotive, industrial, technology and the like with no customer concentration. And in addition to serving all these Fortune 500 type companies, we also supply many of the key components that go into our security products and into our health care products, which is how everything is sort of tied together. So through that vertical integration, we end up enhancing the gross margin, control the supply chain, we could be a little bit more responsive to our customers.

Our Opto team has just done a great job. I think in the first 2 quarters of the fiscal year, we grew 11%, 12%, which is fantastic. It's a business that we show a little bit of operating margin expansion mostly on a year-over-year basis, generates very strong free cash flow. The team has done a great job getting new business in a variety of ways. One is, we serve numerous very, very large companies and oftentimes in a program or 2, just mining new business out of those very, very large companies, and the team has done a good job of that. Second is, of course, attracting new customers.

And then the third is there's a number of companies who have had China as part of their supply chain where there's a desire to move away from China. And we have a footprint globally. So if they want to remain in Asia, we have operations in Malaysia, Indonesia and India. If they want to nearshore, we have Mexico in addition to U.S., Canada and the U.K. So the team has done a really great job getting new business, having strong bookings, good book-to-bills and have really just been delivering quarter after quarter.

You mentioned aerospace and defense is one of the key end markets for Opto, and we see the growth that's been in the defense budget, growth that could be ahead of us in the defense budget. Is that something that moves the needle in that business?

Yes. We're very focused on the aerospace and defense business. A lot of the high rail or high reliability products go into that, which while smaller dollars carry a nice margin and the like. So we look at that as a big opportunity, particularly in today's landscape.

Yes. And that's -- if I recall that, that's a fairly global business in terms of the footprint. And so do you -- I mean do increasing European defense budgets create an opportunity for the Opto business or in Asia?

You're absolutely right. We're seeing quite a bit of activity in Europe in addition to the U.S. We don't see quite as much out of Asia, but the EU is a very fertile territory for us there.

Right. Okay. And the -- and I assume there's no -- you have U.S. operations on the defense side that can be completely separate. And so even though it's part of a global business, there's no issue with supplying for U.S. military?

No issue whatsoever.

Yes. Okay. Okay. Excellent. Maybe we'll take a brief pause to see if there's any questions in the room. But we can also continue to talk about the third segment, which is Healthcare. And I guess you guys made an effort to kind of retool that business starting maybe towards the -- I guess, towards the end of '24 or so. Can you talk about the progress there?

Yes. Yes, we're very excited about the progress. We brought on a new President just about a year ago in this business. Over the past 6 or 7 months, he's really retooled his team and brought on a number of new senior management personnel. We think we probably have the highest quality team that we've ever had in a number of different disciplines. And we're seeing that beginning to yield dividends for us.

The excitement for this business is as we launch our next-generation patient monitoring platform, which we hope to launch the first phase towards the end of this calendar year or so, and it's a multiphase approach. But we think that can really get the top line engine going quite nicely. And this business has the highest contribution margins of any of our divisions. So even though it's a small business, under 10% of our revenues and even a smaller percentage of our profits, for every incremental dollar we sell, more drops to the bottom line than any of our other businesses. So we're excited about the future prospects.

Right. Okay. And how long do you think it will take to get a sense of how that's working out?

Yes, it's a good question. I mean I think we'll gain confidence as time goes on. But I think as we get into calendar 2027, we'll start to have a feel for that. But in the meantime, even before the next-generation patient monitor launches, some of the initiatives that are being put into place, we think will drive better results over the next 4 quarters and the like. So we're excited about the business.

Excellent. I guess when you think about cash flow, you talked about the benefits that should be coming from collections from customers in Mexico. When we think about CapEx, a fair amount of growth ahead. Is there a need to step up capital investment in the coming years?

Yes. I guess the good news for us is we're fairly light from a capital intensity perspective. So when you look at our CapEx sort of year-over-year, it's not too significant. Where it can increase and increase in a good way, and we wish this happens more and more is when we do the turnkey programs or the security-as-a-service because as we place the equipment out there and it sits in our balance sheet, that is treated as CapEx. And that's what we actually want to have happened.

Absent that, we don't think there's a massive need for additional capital as we grow. We think we have ample capacity. We'll continue to invest, but CapEx is just not overly significant for OSI as we sit here today.

Right. Okay. Okay. When you -- when we think about some of the strong cash flow that's ahead of us, how do you think about what to do with that cash? What are your capital deployment priorities?

Yes. So kind of from a capital allocation perspective, we kind of look at 3 things principally. And we don't look at these 3 things as necessarily being mutually exclusive. At times, we can do all 3. But the first is M&A. We think we have tremendous organic growth ahead of us. So by no means do we feel compelled to do any acquisitions. But we've always done acquisitions over the last couple of decades, and the acquisitions have contributed very nicely. We're a very disciplined buyer and the like.

But I would envision that M&A, particularly in our Security and Opto divisions, will continue to be a part of our overall growth strategy. Second, we do stock buyback. So we bought back some significant stock in November, a few months ago. And I would imagine that we'll continue to buy back stock over time. And then any excess cash we have, we sometimes use to pay down debt.

Okay. When you look at M&A, when we think about your position in ports and borders, you're the #1 provider and maybe in airports, #2. So leading market position. Is there -- do you think there is an opportunity from a concentration and regulatory perspective for the company to do M&A?

We do think there's a real opportunity. We think there's opportunities to fill channel needs, technology needs, maybe take out a competitor. Of course, we'd always sort of look at antitrust, but we can also look at natural adjacencies, a little bit like the RF business that we bought in 2024 that might not have been straight down the middle of the fairway, but made total sense using a similar customer base and allowing us to greatly expand their business. So we think there's kind of great opportunities for us to continue to pursue M&A and Security.

Okay. And when you -- when things come across your desk that you see, I think in a lot of areas in the A&D space, the sense is that valuations are quite high. Is that something that you've observed as well?

We've always observed that over time. I mean there's always a disconnect between the buyer -- what the buyer thinks it's worth and maybe what the seller thinks it's worth. And it takes time to have a meeting in the minds and sometimes bridging that with contingent consideration like earn-outs and the like. But we're a company that historically has been disciplined, and we're willing to wait it out for the right valuation. And because we have such strong organic growth, we believe, ahead of us, we don't feel compelled to do an acquisition for the sake of growth or for the sake of anything else. So we'll continue to be disciplined in that approach.

What's the right level of leverage for the company?

Yes. So now we're -- I think we're levered just over 2x, which I think most would -- net leverage would be considered very, very modest. We're traditionally more conservative. But for the right acquisition and with the ability to rapidly delever, we would lever up to 3.5 or more times if we saw a path to delevering. We did that when we took out a publicly traded company called American Science and Engineering a few years back, which has been not just a home run, probably a grand slam acquisition for us. And we did just that. I think we levered up to the mid-3s. And within 2 years, we were levered back to approximately where we are today. So we would consider that for anything that we thought was very strategic and value creating for our shareholders.

Excellent. Excellent. Maybe moving back to another topic, which is the top line. We'll be looking out for the orders from Department of Homeland Security. Are there other international opportunities on the horizon that you would point to in the near term that people should be looking out for?

There's a number of opportunities on a global basis outside the United States. However, they just usually are not well known or public. So the sort of the first time investors or the sell side can become aware of them might be the time they're announced because they're just -- they're private -- they're tenders that don't become public until the deal is already done.

Based on what's out there, I mean one of the things that I found kind of -- actually kind of impressive over the last couple of years, we've seen sales grow significantly. I think the backlog has been fairly steady in that $1.8 billion range over a couple of years now. Do you see exiting this year or at some point during '27 seeing sufficient demand to bring that backlog higher?

Yes. So I know some of the concern a couple of years ago was when we won the big Mexico contracts, and we converted that backlog into revenue that our backlog would come down and our revenues would come down. And we said we didn't think that would be the case over this period of time, which has proven to be true. So to your question, yes, we think as we go out through this calendar year, we think there's great opportunities through some of the bookings that we may get to continue to expand the backlog and give us even greater visibility towards the future.

Right. Okay. Okay. Excellent. Well, we're down under 30 seconds here. So I just want to make sure, is there anything we didn't cover that you think we should highlight?

I think you covered all the main things. And with the big game tonight, I'll say go USA in the World Baseball Classic.

Yes. Yes. Okay. Excellent. Very good. Well, Alan, thanks so much for being here. Really appreciate it. Thanks, everyone.

Thank you.

All right. Wonderful. I'm Dave Chen at Morgan Stanley, and I'm really, really pleased to have Alan Edrick, Chief Financial Officer of OSI Systems.

Thank you for having us.

Alan is a veteran of OSI, celebrating actually his 20th anniversary. So is it your just extreme loyalty or you just couldn't find another job?

Maybe a bit of both.

Okay. All right. So let me just -- for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

So look, Alan, great to have you back at the Morgan Stanley TMT. And just like -- maybe just step back for those of you who may not be familiar with OSI, just give us a sense for the company today, the 3 different markets and kind of your competitive position.

Sure. Happy to do so, and thank you for having us back. At OSI Systems, we think we have a really exciting and compelling story. OSI Systems is made up of 3 divisions: a Security division, a Healthcare division and an Optoelectronics division. The Security division is by far our largest. It represents over 2/3 of our revenues and even a higher percentage of our profits. Our brand is called Rapiscan. We are the largest security detection company in the world. We principally focus in cargo and vehicle inspection at the ports and the borders, as well as in aviation, and now in a new field called RF. It's a business that's been growing quite significantly for us. We've seen significant revenue growth, operating margin expansion. We've got a great backlog and a great funnel of opportunities. So very, very exciting for us.

We have a healthcare business called Spacelabs Healthcare. It's the smallest part of our overall business, representing under 10% of our revenues. We sell into hospitals, where we sell patient monitors and cardiology products. And then, about half of our revenue in this business is recurring through service, supplies and accessories. And what ties everything together is our third division, Optoelectronics, where we sell sensors, detectors, electronic components. And unlike Security and Healthcare, where we sell to the end customer, in Opto, we sell to the Fortune 500 predominantly in a variety of industries such as aerospace and defense, technology, medical, automotive, industrial and the like. But in addition to selling to the Fortune 500, our Opto division supplies many of the key components that go into our Security products and many of the key components that go into our Healthcare products. And through that vertical integration, we end up enhancing the company's overall gross margin. We can control the supply chain better, and we can be a little bit faster and more responsive to our customer needs.

Yes. And just kind of rough split of revenues across the 3?

Yes. So roughly 2/3 is our Security business, roughly 25% is our Opto, with the remainder being our Healthcare.

Healthcare?

Yes.

Okay. All right. So, as usual, I'd love to start with Security. So yes, just remind us just like the core pillars of your product platform within Security. I'm going to get to RF and maybe just the core business.

Yes. So sort of the core business of our Security -- most people know us for our aviation business because we all go to airports. Our brand is called Rapiscan. We sell products at the checkpoint where you put your carry-on bags through, your laptop through. We sell products for checked baggage. We do trace instruments as well and walk-through metal detectors. A nice business for us. We have market share estimated probably between 20% and 25% in the business. It's been growing very nicely for us, primarily internationally, though we think there are some great domestic opportunities coming up in the next few years.

But the biggest part of our overall Security business is what we call cargo and vehicle inspection, where we are the #1 player. We have the largest market share. We sell into ports and borders and critical infrastructure. We have the broadest product portfolio in the industry. We integrate that with some proprietary software that we developed called CertScan. And together, it's enabled us to really differentiate ourselves from the competition, which has allowed us to capture significant share. And we have a variety of different business models that we go to market with in this particular part of our business.

Yes. You have some core subsegments that you just mentioned, checked baggage. How has the relative market shares over the last decade have changed for OSI in those subsegments?

Yes. So when we think really the subsegments, if we look at cargo and vehicle inspection, over the last decade, we were a pretty small player. We were -- we only had single-digit market share. Today, we believe we have north of 50% market share. Our team has just done an outstanding job gaining new customers with this broad portfolio of products and service offerings. We have another model that we go to market with called turnkey or a different version of SaaS that we coined Security as a Service, where we can get recurring revenues entering into long-term contracts, which has been quite nice for us.

On the aviation side, I'd say our market share has been more stable. We've kind of grown with the market over time. But the big, big increases that we've seen in our Security business, our revenue growth has principally been driven by the cargo side of our business and the related service, which has been nice for us because it's very strong recurring revenue at substantially higher margin.

How much of it is -- what's driven the leadership? So it sounds like it's a service, but also is it just product excellence? Is it kind of go-to-market focus?

Yes. I think it's a great job by our leadership team in our Security business who decided that rather than some of our competitors, who focused on a particular technology, we really try to bring in all technologies. So we don't have to push a single technology on a customer, but we can see what is right for the customer and sell them that particular product. Our sales team has done an outstanding job in this respect. Our service team has, again, with the different business models of selling the product or doing it through a Security as a Service offering. It provides choices and options. Our service team provides best-in-class service. We all hope our machines never break down. But of course, when they do, how do you respond? And our teams have really done a terrific job there, giving us a big global advantage.

Yes. Obvious question is, just given global conflicts and the geopolitical climate, how has that translated to your pipeline?

Yes. So big picture, what's not great for the world tends to be good for our business. It's hard to turn on the TV these days or any days over the past several years and not see something happening in the world. And while that's unfortunate for the world, it tends to provide some tailwinds for us. And when some of the conflicts die down, it generally results in increased opportunity pipeline and sales for us, even maybe what's taking place here as we sit here today as well. So it's generally been good for our business. Sometimes there can be pressures on defense budgets, but security overall as a percentage of defense is extremely small, and very few places in the world want to be without security. So it's been somewhat immune overall, which is why we've seen such great growth.

Anything specific or that you would point to in terms of the government regulations or new spending proposals that directly hit you or kind of you just benefit generally from the halo of heightened geopolitical?

A little bit of both. We definitely benefit from the heightened halo. But here in the United States, of course, most recently, there's been the One Big Beautiful Bill. And the One Big Beautiful Bill has established significant funding for areas that play straight down the middle of the fairway for what we do, principally with CBP, which is Customs and Border Protection, part of the Department of Homeland Security, where the funding levels they're talking about are at a whole different clip than we've seen over recent years, and this is exactly what we do. So we're extremely excited about it. In addition, there's funding for things such as the Golden Dome which, again, by a way of an acquisition that we did about 1.5 years ago, again, fits squarely into what we do, and we think we're extremely well positioned there. So a lot of different things are coming together, which could prove very beneficial for us.

Can we just unpack both of those really super-interesting, very recent things? So can you just give us a sense for just the One Big Beautiful Bill, what's in it and kind of how does it impact OSI?

Yes. So if we're talking particularly about border funding, there's 4 principal areas within the One Big Beautiful Bill on the borders that we play in. The first is that they allocated somewhere between $1 billion and $1.1 billion to what's called NII, or Non-Intrusive Inspection, scanning equipment at the borders. That's exactly what we do. In past procurements, we've fared very, very well and gotten a nice percentage of those orders, and we would certainly hope to get that again. They've allocated additional money to border patrol sort of between the checkpoints, and that could be very beneficial for us as well. Certain amount of funding also to some biometrics and facial recognition, which we play nicely. And lastly, there's also money allocated to the World Cup and the upcoming Olympic Games in 2028. We've been one of the companies that has been very successful. We did the most recent Paris Olympics and the World Cup in Qatar amongst many, many other sporting events.

That's great. All right. And the Golden Dome?

And Golden Dome, Golden Dome is extremely exciting for us. We're part of the $151 billion IDIQ together with many, many other companies. But the technologies that we have fit squarely for what they're looking at with, we believe, limited competition. So while some folks are skeptical about when that funding may occur, we believe that where we're playing in, we're going to see some near-term funding this calendar year, and we might be the beneficiary of some significant orders for Golden Dome. And it plays extremely well into what we did for -- when we did this acquisition about 18 months ago, it was a smaller business that -- we took their tremendous technologies, put it -- combined it with our sales channel -- they had a good sales team, but combine it with our sales channel, our reach, our balance sheet, our government contacts, we've seen some extraordinary success.

In our September quarter, we had a book-to-bill ratio north of 3 for this product line. We followed it up in the December quarter with a strong book-to-bill as well. And even before the concept of Golden Dome even occurred, we were seeing tremendous growth, leading us to increase our capacity, which has proved fortuitous as we're now looking at upcoming Golden Dome initiatives. So we started increasing the capacity in November of 2025. That will go on throughout 2026. But it's going to put us in a very strong position in order to be able to capture awards and deliver on those awards.

Two questions on that. So first, just drill into the actual product of the company you bought. And then, second, how does it relate or integrate with the rest of the Security portfolio?

Yes. So the product is RF-based, radio frequency-based using over-the-horizon radar. In addition, it has VLF, very low frequency and ultra-low frequency for communications with submersibles, submarines and the like. We work on quite a few classified programs, but the customer set is very, very similar to the customer set that we at Rapiscan, our Security division has worked on for years. So taking our strong relationships and feeding this great product profile and similarly taking some of the relationships that the acquired business have and using it with our products has been very, very synergistic. So we're off to a tremendous start. It's been a tremendous acquisition for us, fits very, very nicely into what we do. It might not be considered straight down the middle of the fairway, but it is a very, very nice adjacency and performing extremely well for us.

Got it. Right. Let's zoom back out to the geographic split of your business, and in particular, what's been in the headlines with you on a quarter-to-quarter basis is Mexico. So maybe just step back and just like -- when did your relationship with Mexico start? Why did they first choose you? How much business have you done with them? And then, kind of over time outlook for the future.

Yes, great question. We've been doing business with Mexico for a few decades. We had some very, very substantial contracts with Mexico that we performed, we believe, exceptionally well on. It led to some new RFPs a few years ago. And we ended up capturing 3 very major contracts: one for $500 million, one for $200 million and one for $100 million. So $800 million of orders over roughly kind of a 1-year period. And from that, we saw a significant spike in our backlog. And there had been some concern that as we converted the backlog into revenue, that our backlog would come down and it would be more difficult to replace that revenue. And we had said at the time, we didn't believe that would be the case, and that has proved to be absolutely true. So, as we saw a very big spike in our revenues in fiscal '24 and fiscal '25 associated with Mexico, we didn't see any reduction in our backlog at all as our sales team continued to capture significant opportunities, primarily outside the United States, during this period of time. So we've kept our backlog, and we've been seeing a nice increase in our revenues.

Over the course of this year, we've been saying that it's going to be a very difficult comp from a Mexico perspective because we had such significant revenues last year but that we would overcome them once again. And that's exactly what we've been doing through the very, very strong revenues that we have really throughout the world, both in our cargo lines and in our aviation lines. And the beautiful thing about all this is, now, as we get this bigger installed base, we have much more recurring revenues as these products roll off of warranty on service. So if you look throughout calendar '25, we were growing at a strong double-digit clip on our service revenues. And that's exciting for us because it's great recurring revenue at substantially higher margin. So it could lead to some very nice operating margin expansion for us in the future.

Okay. Great. So yes, so let's touch on that. I think you've mentioned that recurring can get to -- you can actually move from like 30% to maybe 40% of overall.

Yes, we firmly believe so over time.

So like maybe just step back, and actually, I think Mexico was one of the first to adopt one of your SaaS or your turnkey.

Yes, they were the second customer, exactly right.

Second one. So like just what's the state of play with the industry? Like are -- is the entire industry going through a SaaS transition? Or is it kind of more case by case? Like what's the particular demand setup when you might have, when you might not have that situation?

Yes, it's a great question. And you might say, well, why would somebody choose to have this type of SaaS model versus buying the products? And there might be some customers either that don't have the money or the capital to buy the equipment upfront, or if they do, they might not have the operational expertise to do the whole thing. So we can come in with this great model where we can offer them 100% security with effectively nothing -- no out-of-pocket costs upfront. We enter into a long-term deal. We've done deals as little as 6 years and as much as 15 years. And then, we get this great recurring revenue at a nice margin for us. So that's kind of the customer profile.

We'd love to see more and more customers go this way. We do have an upfront CapEx investment, but there's a nice return on that investment for us. But there will be certain customers that this is ideal for, and there'll be other customers that want to buy the product and do the operations themselves. So we haven't -- we've seen a nice adoption, but we don't see the industry going this way in totality by any means.

We're probably going -- there's definitely an upward trend in terms of turnkey or SaaS throughout the industry.

We think there's that real opportunity. Absolutely.

It doesn't get to, I don't know, majority probably.

I don't believe that.

All right. And then, like, just unpack for us like, you started with turnkey and then you have CertScan. Can you just describe the 2?

Yes. So when we developed our turnkey models, at the same time, we worked hard on developing a proprietary software. We've called that CertScan. And it's a command and control center that's given us a clear product differentiation, not just for our turnkeys, but sometimes when we do an actual product sale itself. For instance, the $500 million sale that we had in Mexico, originally, we thought that might be split 3 ways, and we would have been thrilled to get $150 million or $200 million contract. But as the customer started to look more into it and did customer reference checks and then also learned about the CertScan software, they decided to give us the 100% of the business, which has been outstanding for us.

And from that, we have now taken the CertScan software out onto a traditional SaaS model, Software as a Service. So we're in the very, very early innings of that, but we've gotten some great feedback. We've had a number of wins in that regard, but again, very, very early. And then, we'd hope to get SaaS-like margins for this business as well.

Can they -- do they coexist? Do you do turnkey and SaaS? Or do you do one or the other?

So when we do turnkey, the CertScan is included within that. But we can sell SaaS as a stand-alone product to those who have our...

On-premise or they...

Exactly.

They buy it. Okay. Got it.

Exactly.

Okay. Great. Going back to the -- on the checked baggage side, there is kind of a natural cadence to -- like how long does one of these machines last? Just give us a sense for that.

Generally speaking, we think they last close to 10 years.

10 years. Okay.

Here in the United States, it's gone on a lot longer than that.

I've noticed that.

So many of these machines were put in not long after 9/11. So they've been out there sort of a couple of decades, which is costing the TSA some tremendous amounts in service. We believe there'll be a new procurement coming a few years from now. It will probably run for about 5 years. It will be an outstanding opportunity for us because when the original procurement took place, we didn't have a checked baggage product. We then developed one of the industry's first CT systems, designed specifically for security applications that we call RTT. And we've had great success with that product everywhere in the world outside the United States. So the United States, when the next replacement cycle occurs beginning a few years from now, that's all sort of virgin territory for us, and we're very excited about that opportunity.

Okay. Is there a similar opportunity -- what about the cargo side? What's the kind of lifespan there? And is there a replacement cycle there as well?

Yes. So unlike aviation, where every airport has systems -- and cargo, it's an emerging area. So it's an unregulated market compared to the aviation market. So the cargo products typically also last for about 7 to 10 years. But unlike aviation, which is today is primarily a replacement market, unless there's new airport construction or a new terminal, on the cargo, both at ports and borders, yes, there's replacements. But there are so many opportunities throughout the world at both ports and borders where there is no security scanning right now. So it represents more...

The growth driver there is more just greenfield.

That's exactly right. That's exactly right.

Whereas on the checked baggage side, I'm sure there's greenfield, but we should think about the refresh opportunity as a big growth driver perhaps in the next couple of years?

We believe that. It will start in a few years from now and go on for about 5 years.

Okay. And then, just what about just the overall product development road map for the entire Security division? Can you just give us a sense of what you [indiscernible] publicly and [ direction of travel ]?

Yes. So we invest a considerable amount of R&D for OSI Systems overall. The vast proportion of that goes into Security, though we do quite a bit in Healthcare and smaller percentage in Opto because it's often customer-funded. But within Security, we're always looking to obsolete ourselves. So there's a good amount of attention placed on brand-new products, but quite a bit on software development and the algorithms and using AI in some of the algorithms. And we always want to be ahead of the competition, state-of-the-art, and we think that's one of our clear differentiators. And we have an excellent engineering and R&D team who is coming out with some exciting things. We have not gone public and said what those are, but a number of exciting developments.

Okay. Excellent. Moving to Healthcare, okay, so it's about 10-ish percent of revenues. And so, just patient monitoring, just give a sense for the product and just like the -- maybe the market landscape in terms of like who you're selling into, who you're competing with, et cetera.

Yes. So in Healthcare, unlike Security, where we tend to be the #1 player, sometimes the #2 player in many of the markets, in Healthcare, we compete against some big boys. So we're not the largest player, which leads to our market share there. But in patient monitoring, what is patient monitoring? If you're at a hospital, sitting at your bedside is the monitor that will monitor your vital signs such as your blood pressure, your oxygen levels and others, which is then connected to a central station where a nurse can look at 16 rooms simultaneously, which is then often connected to telemetry products. So, as the patient moves around the hospital, they can be continuously monitored. We make all of those type of monitors. We've typically sold to medium and large hospitals, but we also sell into some small and rural hospitals as well.

We are a -- our competitors are some big boys like GE and Philips. And we're not arrogant or naive enough to believe we're going to overtake them, but we believe we can take some additional market share. And we've been investing very significantly in a new patient monitoring product platform that will come out in multiple phases, the first of which will come out, we believe, sometime closer to 12 months from now. And that's going to be a very, very exciting growth opportunity for us.

But in addition to that, we sell cardiology products. The cardiology products tend to be the highest-margin products in healthcare. They're also amongst the highest-margin products in all of OSI, so very, very high contribution margins. So, as our Healthcare business grows revenues with a very high contribution margins, there's a big -- very big pull-through down to our operating income and our EBITDA. So it's an exciting area for us. We've enhanced our leadership team there quite a bit. We brought on a new President about a year ago. He has brought on a number of new leaders over the last 6 months. So we think the business is in a better position than it's been in quite some time. So exciting for us, but the real growth driver is going to happen when we release our new patient monitoring platform.

Okay. All right. Last quarter, Healthcare was not the strongest performer.

Yes, it was a little disappointing in Q2. Of course, our Security business and Opto business did so well that it more than overcame the Healthcare thing. But we believe that was an aberration, and we're expecting the balance of this fiscal year to be much stronger than we saw in Q2. And as we move into our fiscal '27, we believe there'll be sort of accelerated growth with the new teams and some of these...

And new patient monitoring platform.

That's correct.

Yes. Okay. Great. And then, one final thing just on what -- how much of that -- your Healthcare business is actually services? Like a decent...

Yes, our recurring revenue in Healthcare is about 50%. We define that as our services and our supplies and accessories, which are continuously bought. So it's a very nice recurring revenue model.

Like a printer model?

Exactly.

That's actually a -- is that a larger mix than your Security business?

It is because in our Security business, it's about 30%. In Healthcare, it's about 50%.

Yes. That's great. Let's just round it out with Opto. So just, yes, some of the core products?

Yes. So Opto -- we're extremely excited about our Opto division and the performance of our Opto division. We sell sensors, detectors. What's a sensor? On the medical side, if you ever put your finger in a pulse oximeter to measure your oxygen level -- many of us got familiar with that during COVID. We're the world's largest manufacturer of the pulse oximeters on behalf of some of the largest OEMs in the world. But we make the sensors, detectors and electronic components that we sell to many companies that are here at this conference this past week, as well as many others throughout the world.

It's a business that's done really well for us. In the first 2 quarters of our fiscal year -- we're a June fiscal year -- the business grew 11%, 12% in each of those quarters. But in addition to selling to third parties, we also sell to intercompany, which has been very helpful for us. We manufacture throughout the world. So if you want products made in the United States, we have that. But if you want a little bit lower cost, we manufacture in Malaysia, Indonesia, India, Mexico, and we can share some of those savings with our customers. Importantly, we do not manufacture in China, and many companies out there today are looking for alternatives to China. And with our Asian footprint outside of China, with our Mexico footprint, we provide a very, very nice alternative. So we've seen our team do a great job. We've mined more business out of existing clients, as well as getting brand-new clients, and it's really leading to kind of industry-leading growth and industry-leading margins in this business as well.

That's right. So just give me a sense for -- let's just zoom out, and now we've covered all 3. Maybe just some highlights from last quarter. And what did you like from the quarter?

It seems so long ago now last quarter [ when we ] think about this quarter. But the last quarter was exciting for us. We posted record revenues. We leveraged that to record earnings. Cash flow was pretty strong for us as well. Though the backlog remains solid, but we believe the bookings opportunities for us in the second half of this year are very exciting for us and as we move into fiscal '27. So we were very excited about our overall performance last quarter, but more excited about what's coming up in the future.

Yes. Every company is being asked this at this conference. So let's dive into it. Just like how is -- how are you using AI across your business? Whether it's within the company, or are you doing something interesting and transformational in terms of putting into the product for your customers?

Yes, it's a great question. And we're at, I'd say, a different stage for each of those. I'd say, our biggest focus today has been on the commercial side, both our Security and Healthcare teams on placing AI into our products and differentiating ourselves. In our Security business, we got a little head start on our competitors. We bought a company that was involved in AI about 5 years ago. So it gave us a little bit of a leap, and we've been embedding that in many of the products that we're selling or developing right now. So we think that's going to be a real competitive differentiator for us in Security. And we're doing a similar thing in Healthcare. Within our own business, like many companies looking to get more efficient, we kicked off that journey. I'd say, we're at the very early innings of that internally, but it's a primary focus of our leadership team here in calendar '26 and beyond. So exciting for us. We do think there'll be some transformational breakthroughs from a commercial standpoint, and we think there'll be some great opportunities from us from an internal standpoint.

All right. Great. I have a couple of questions left. So if anyone in the audience has a question for Alan?

You mentioned earlier on the increased service mix. So when can we expect the pull-through into real margin expansion for the company?

Almost immediately. I mean, we saw -- over the last 4 quarters, we've seen a significant increase in our service revenues. That contributes to our margins very nicely. Countering that a little bit was, you mentioned Mexico, and we had more difficult Mexico comps and the like. The most difficult Mexico comp concludes this quarter here in March, and then we get into more normal comps thereafter. So I'd say really beginning in our June quarter and thereafter, the bigger service revenues, coupled with a more favorable mix. Exactly.

Better compare really. It's a clean compare starting you think in like...

In the June quarter. Yes, pretty close to that. Yes.

Kind of a good problem to have.

It's a great problem to have.

Given what Mexico has done for the company.

Exactly.

Yes. Any other questions? Yes.

[indiscernible]

So the question is, medium-term targets for free cash flow, sales, operating margins. We give annual guidance for revenues and earnings. So we haven't provided any targets beyond that. But big picture, our goal is the same as that we've shown over the last decade or so. We want to show good top line growth. We want to leverage our infrastructure to grow our earnings faster than our top line growth. From a free cash flow perspective, it's exciting for us. So we have a little bit of outsized working capital right now, which we think is going to normalize over the course of the next year or so, which should lead to substantial free cash flow generation, much higher than we've seen historically in the past, a conversion well north of 100% of our net income. So it's an exciting time for us.

On the capital allocation side, so your CapEx has remained relatively consistent. You've got a revolver. How do you balance kind of share buyback, acquisitions, et cetera?

Yes. So our capital allocation strategy is what you just described. We look at M&A. We look at stock buyback, any residual cash, maybe paying down a little bit of debt. We don't believe they're mutually exclusive. We've shown in the past that we can do acquisitions, while simultaneously buying back stock and paying down debt. We have very modest net leverage today. We did some significant stock buyback in November. But we're also an acquisitive company. And we've historically done some acquisitions that have filled the channel need, a technology need, maybe taken out a competitor, maybe moved into an adjacency that have created tremendous shareholder value. And although we believe that our organic growth opportunities are fantastic ahead of us, any opportunities that meet our criteria that could even turbocharge that organic growth, we certainly wouldn't be shy to act upon.

Great. Let's just end with -- you've been with the company for so many years. What's the outlook for the company, maybe like priorities for 2026 and beyond?

Yes. I mean, the outlook is fantastic. We're very excited as we move into our fiscal '27 here in about 4 months. The security outlook is tremendous with so many tailwinds at our back. Our Opto business continues to perform well. We believe our Healthcare is undergoing a nice turnaround. So we're excited to continue growing the company, and that's really what we're going to be focused on.

All right. Thank you very much, Alan.

Thank you.

Very excited to have the CFO of OSI here. Alan, thank you for joining us. For those of you that don't know me, my name is John Godin, I'm Citigroup's aerospace and defense analyst. And we're going to have a great discussion on the business, trends in defense, et cetera.

So maybe the best way to kick it off is there may be people who aren't familiar with the business just giving us an overview of the structure of the business, the key divisions and the trends that you're seeing would be just a great starting point.

Sure. Happy to do so. And thank you for having me. So at OSI Systems were 3 divisions. We're a Security business, we're an Optoelectronics business, and we're a Healthcare business. So starting off talking about each of the businesses and maybe how they fit together. So our Security division is our largest business. It represents over 2/3 of our revenue and even a higher percentage of our profit. . And security, what we do is security detection. So we tend to be the #1 player in the world in security detection, looking at both cargo and vehicle inspection at ports and borders trying to stop things like drugs and cash and weapons and explosives.

And then we're also big in aviation at the airports. Many people know us from airports because we all go through airports on a regular basis, our brand being called Rapiscan. And we've got a nice business where we sell the product, but we have an increasingly growing recurring revenue stream in the business, too, which I'm sure we can talk about a little bit later. But the Security business is great for us. We also do quite a bit of events such as the Olympics, which is taking place right now in the World Cup, the Super Bowl, we recently did as well.

We also have a Healthcare business. It's the smallest part of our overall business, but we sell to hospitals. We sell to medium and large hospitals principally. We sell patient monitoring equipment and cardiology equipment and about half of our business there is recurring revenue in nature. And then what ties it all together is our third business called Optoelectronics. So unlike Security and Healthcare where we sell to the end customer, in Opto, we sell to the leading OEMs. We make sensors, detectors and other electronic components. We sell to many of the aerospace and defense companies who are here at this conference this week. We sell the technology companies, industrial companies, automotive companies, medical companies, really a very diverse customer base.

And the nice thing about Opto is in addition to selling to these third-party companies, many of the key components that go into our security products and many of the key components that go into our healthcare products are manufactured by our Opto division. So through that vertical integration, we can enhance the margin, we can control the supply chain, and we can be faster and more responsive to our customer needs. Our Opto business represents about 1/4 of our revenues and has been generating good profits, good cash flow and the like. But that's kind of the big picture OSI Systems.

No, that's fantastic. I appreciate that. I wanted to dig into Security a little bit more. We've had -- the history of the company is that in the last few years, international has been driving an outsized amount of growth. Maybe you could talk a little bit about that and then how the growth drivers are transitioning more toward domestic.

Yes. Yes. Great question. And we're so excited about the future outlook for our Security business. Yes, it's done phenomenally well for us in the last several years and really the last decade, but we think the future is even brighter. As you mentioned, a lot of the growth over the last few years has been driven by international growth, namely in Mexico. We received 2 big contracts the Mexican Army and the Navy or 2 big customers. There's actually 3 contracts totaling about $900 million in aggregate. And that generated significant revenues for us in our fiscal '24 and our fiscal '25, took us to new levels.

And the beautiful thing about that is as we've been delivering on those revenues and converting backlog into revenue, our bookings have been so outstanding that our backlog has actually generally been increasing over that period of time. Again, driven a lot by international growth, big opportunities in the Middle East, other parts of Latin America and Europe. But as you correctly point out, although the international funnel continues to remain strong, we think going forward, there's going to be a shift even stronger growth here domestically in the United States. And we think a lot of that's going to be driven by border initiatives with CBP, Customs and Border Protection.

The one big beautiful bill appears to be a nice windfall coming for us. We expect to be getting substantial orders at the borders from CBP on the one big beautiful bill. There's many different categories that fall into that, and we tend to be a preferred supplier of this particular customer. And then in addition, we see tremendous opportunities with Golden Dome by virtue of an acquisition that we did about 18 months ago that we think places us in great position. So we're really excited about the U.S. opportunities. as we move into our fiscal '27 here in July 1, not too far away, and we think that will sustain us for multiple years to come.

Yes, there's a few things there that you mentioned that I'm excited about that I want to unpack. Maybe a good place to start is the one big beautiful bill. What was in the bill? What kind of awards do you expect? Maybe talk about your award history a little bit and your chances of winning some of these awards. I'd love to just kind of understand that arc a bit.

Sure, sure. So some real exciting areas. So within the one big beautiful bill, there was money allocated for what they call NII or nonintrusive inspection scanning equipment. That's exactly what we do. It's right down the middle of the fairway. So there has been about $1 billion to $1.1 billion allocated for this. And there's initiatives, so a lot of momentum within the current administration of wanting to get this done sooner than later. So we think that's going to result in some substantial bookings for us in the near and the medium term for us.

When we look back, the last big awards that CBP did, we got 40% to 45% of the overall awards. So we think we're well positioned to continue to do well on the future awards as well. In addition to that, there's more money going to Border Patrol, which is quite significant. There's some money going to biometrics that we think we're well positioned for as well. And finally, there's money going to some of the games, both the Olympics and Los Angeles coming up and the World Cup as well. And we're -- we tend to be the preeminent provider for these type of games. We did the Paris Olympics, we did the World Cup in Qatar, and we've done many other games as well.

Yes. That's fantastic. And that's quite a win rate. Can you talk a bit about the competitive dynamics, the landscape out there, who is getting the other 55% awards historically. And I don't know, maybe your hit rate even goes up from here from what it was.

Yes, we're certainly hopeful that's going to be the case. It's a relatively small -- it's a limited number of competitors that we tend to go against in these areas. Historically speaking, the biggest competitors on the kind of the cargo side, which is what would take place with one big beautiful bill would be Leidos and a company in the U.K. called Smiths Detection, and there's also a private company that got a small amount of awards as well. it's a finite set. But yes, we are hopeful that we can expand our share there.

Yes. And technologically, versus some of those competitors, you've done things a little bit differently, right? I think you've approached the product in a little bit of a broader way, combining different technologies. Maybe you can talk a bit about that.

Yes, that's been a big differentiator for us. So some of our competitors in the past have chosen to focus on a particular technology, and they may do very well with that particular technology. But that's the technology they need to sell and push to the customer. We've taken a more expansive approach and we say we wanted all the technologies. And this could encompass what they call low energy, medium energy, high energy. So we have all the different technologies. So we can see what's right for the customers. We approach them for what solution they need. So rather than having to push a single technology, we see what's right for them. And in fact, we can also do combinational technologies. We can combine our low energy backscatter with our high energy x-ray and put it into a single product. And we think all of this has allowed us to capture a very, very significant market share in the cargo and vehicle inspection space.

Yes. That makes a lot of sense. And when you talk about technologies like that, I can't help but ask about AI. Is there an opportunity here to insert AI, other value-added services? Maybe you could talk about that.

You're absolutely right. The future is AI. We think we were an early adopter in this regard. We bought a small company about 4 to 5 years ago in AI. So we got a little bit of a first-mover advantage there in our particular industry. We've been incorporating AI into our products. We're going to continue to do so. We believe it's -- it really is the future, and we want to be at the forefront, and we're investing some significant R&D in that regard for product development as well as some of the cybersecurity protections that go along with all of our products and the AI. So yes, we absolutely believe that that's going to be pivotal to what's going on, and that's what we're focused on.

Yes. That makes a lot of sense. The other thing that you mentioned, a few questions ago, was Golden Dome. I wanted to just focus on that for a little bit. It's a very topical point at this conference. We've had a lot of different defense companies that we cover talk about the opportunities for Golden Dome, talk about the fact that there could be awards in the next few months, medium term, however you want to think about it. I'd love to understand your Golden Dome exposure, what you guys do well? And why you think that you're going to be a big player there as well?

Yes. Yes. A lot of people talk about Golden Dome and how real is it. We think it's extremely real for us. So about 18 months ago, we acquired a company that does RF, radio frequency technology. That's been a very, very successful acquisition for us so far. When we bought them, Golden Dome wasn't even on the horizon. So this is just a plus. But the technology that we acquired is so perfectly suited for Golden Dome. As you know, there was a recent large IDIQ for $151 billion. We're on that IDIQ along with a number of companies, but we think we're extremely well positioned to win business. And we think that business can be one in the near medium term, at least the starting wins of it. So we're extremely excited.

The technology that we do is called over the horizon radar. We think we're relatively uniquely positioned for that. And as a result, we think we might be receiving some substantial awards in that regard. So we're extremely excited about that. Gearing up for that, we've expanded our manufacturing capacity into a new location in the Texas area. We started that process in November. We'll be completing it throughout the course of calendar '26. So we're extremely excited about what Golden Dome and the RF technology in general means for us. We've seen substantial growth in this business. And we think the Golden Dome will only take us to a whole another level.

Yes. That makes a tremendous amount of sense. Just focusing on security and just some of the existing dynamics. There's been a very interesting kind of margin opportunity there as you shift from products to services. Could you expand on that a bit because it does seem like that's inflecting here?

Yes, we're really excited about the margin potential. So we have 2 main revenue sources. We have our product revenue and our service revenue. And our service revenue has -- our product revenue has grown quite substantially, but our service revenue is growing at an accelerated rate right now. And we saw that throughout calendar '25 and the service revenues for us carry north of 10 percentage points higher of margin. So as our service revenues increase our overall operating margins increase as well. So we're quite excited about that.

Countering that over the most recent near term, has been we've had substantial revenues from Mexico, which carried a little bit higher margins. So they've presented some more difficult comps. The final difficult comp for Mexico ends this quarter in March. So as we enter our fiscal fourth quarter here in 45 days and then in our fiscal '27, just substantial opportunities for margin expansion for us by virtue of stronger service revenue growth as well as a lot of these new programs that we're talking about domestically. So very excited about the margin expansion opportunities.

Yes. So domestic programs, margin expansion, service revenue margin expansion and lapping Mexico headwinds, and that's the algorithm. It sounds very interesting. Could we just -- that's for this year, just taking a step back, the idea of monetizing the product with service revenue and then even other approaches that you've had this idea of Security as a Service. Maybe we could just talk a little bit philosophically, what are the approaches to market? What are the right ways to value maximize as you're negotiating with customers?

Yes. So great, great question. Though our basic business model has always been to sell the product and get a nice margin on the product and then get recurring revenues for the next decade while the product is out there at a higher margin. We've also challenged ourselves over the years to say, how can we expand the revenue potential and how can we expand the margins. And we said, well, maybe there's a customer set out there that doesn't have the money or the capital to buy the equipment upfront, or if they do, maybe they don't have the operational expertise.

And this led us to the idea of what you refer to as Security as a Service, another version of SaaS or we sometimes also call turnkey, where instead of selling the equipment, we manufacture the product, we place it at the customer site, but we generally own it as just in our balance sheet. We staff it up with our people, we enter into long-term contracts, contracts ranging from 6 years to as much as 15 years. And then we charge a fee per scan or a fee per site per month. So now we have this great long-term recurring revenue at substantially higher margin. We were the first company to do this. We're still actually the only company to do this, which is fantastic. There has been some companies that have taken an equipment company, combining it with a service company, but it hasn't been successful.

We're the only ones to do the whole thing together ourselves. And from this, we've gotten a tremendous database as well. So we have access to the images that we have. And we were able to develop a proprietary software called CertScan, which has been a big differentiator for us in many of these programs that we've won. And now we're taking CertScan out also as a stand-alone product. So we talked about our SaaS, Security as a Service. We also truly now have a Software as a Service offering through CertScan as well that we've recently launched and will be growing. So very, very exciting for us, but another opportunity for recurring revenue at substantially higher margins.

Yes. Yes. The higher-margin piece there, just sort of caught my attention. Can you just talk about how you price these services and why these services come on at higher margins?

Sure. So while we've never specifically spoken about the exact number of margins, we've always said that the margin is substantially higher than our corporate average. When we go to pricing, it's -- we figure out what it may take for each win. In some cases, the customer actually may pass on some of that cost on to their customer, if you will, so they might be less price sensitive. But when we talk about the big volume that we're doing, the absolute operational expertise that we have, it's made a substantial difference to allow us to receive nice margin. Of course, we want to get returns as well because it requires some upfront CapEx, which we're happy to do every day of the week, but we want to get the returns on that as well, which leads to high margins.

And are these multiyear contracts? Or what kind of visibility does this give us?

Yes, it gives us great visibility. The average contract for us is probably 8 to 10 years. I think the smallest one we have is 6 years, the shortest one and the longest one being 15 years. So it gives us really great revenue and margin visibility. .

Yes. And just one more on this topic, but different contract types, different products, they resonate with different types of customers. Can you talk about international versus domestic, who prefers which structure?

Yes. So throughout the world, all customers seem to like to buy the product. So that's not an issue. But when we talk about Security as a Service, it tends to resonate more with international customers than U.S. customers. And the reason being, one, from a funding perspective, the U.S. has the funds, certain international countries, it may be a little bit more challenged either financially or operationally. And in addition, you might have to deal with things such as unions and the like in certain regions, which may change a jobs perspective.

When we move into these international countries, one of the great value propositions is that we're hiring local people, so we're bringing on all new people in that country. We might put an expat or 2 over there for experience, but we're basically hiring local people to do this, which is a nice sell-side story as well.

Yes. That makes a lot of sense. You mentioned Mexico is just a big win in the last few years on the international side. Can we talk about international a bit more broadly and step through the other regions because you've had historical success outside of just Mexico?

That's absolutely right. Mexico has been great for us the last few years and really the last decade. We've had other contracts in Mexico, too. But we really are strong throughout the world. One of the biggest regions for us is the Middle East and you name it, half a dozen countries over there were extremely strong, particularly on the ports and borders, but also on the aviation side of the equation. We're very strong throughout the EU and in the U.K. other parts of Latin America, both Central America and South America.

We're strong in Asia, not necessarily China, but everywhere else within Asia, we have strength. India has been a fast-growing region as well. We have operations over in India. We've been doing business in India for well over 3 decades and the like, so a very strong region for us. So outside of China and parts of Africa, I would say we're really strong throughout all regions of the world.

Yes. And obviously, in the Americas, border -- controlled border dynamics are playing a big role. Talk a little bit about the demand drivers in some of the other regions? Is it tied to infrastructure spending? Is it more than that? I'd love to understand what's going on in the Middle East and India.

Yes. So unfortunately, it's hard to turn on the news these days without seeing something going on in some parts of the world. So everybody is hyper-focused on security. And although sometimes there's some volatility in defense, defense right now is very, very strong. There never really seems to be a period where there's too much volatility in security because security as a percentage of defense spending is very, very small. But no countries ever want to be caught without doing security. So a lot of the drivers, it depends upon the particular region, country and customer. But with some of the conflicts going on that we've seen in Russian, Ukraine or the Middle East, those things generate more and more demand.

But throughout all areas, they're trying to protect their borders, and they're trying to protect their ports. Many times from whether it be drugs, explosives, weapons or other illicit contraband, there seems to be a great need. So in many places in the world, it's not a replacement cycle because they simply don't have security there or if they have security, it's very manual. And moving to an automated security through nonintrusive inspection has been very, very attractive. And these dynamics just continue to increase really throughout all regions of the world.

But it's not just aviation assets. It sounds like sometimes I speak to investors, and they think of security businesses in that way, it sounds much broader than that.

It really is. And even sometimes our employees and other divisions get confused by that, too, because we all go to airports all the time. So you see our Rapiscan, which is our security brand at the airports and everybody thinks aviation. And aviation is very important to us, and we do very well there. But the bigger part of our business and the faster-growing part of our business and the fastest-growing part of the market is for what we call cargo and vehicle inspection at ports and borders and critical infrastructure. So that really is the biggest part of our overall Security business.

Got it. And we've heard from other companies that we cover that critical infrastructure spending in some of the regions you're talking about just continues to grow, right? So I'm not surprised to hear that there's a security overlay on that as well. One thing I wanted to learn a little bit more about is just the recurring revenue stream, right? You've talked about the transition to service revenue. And I think that, that's powerful. And I'm sure that, that ebb and flows as you have different contracts. But I'd love to just understand the embedded kind of compounding algorithm in there. How does -- over the course of an 8- or 10-year contract, how does that exactly work? Do you have escalators? Do you not? I'm just trying to map that out.

Yes. So today, in Security, our service revenue is about 30% of our overall revenue. And we have goals to make that significantly higher than some of our competitors, that percentage is higher. Now part of the reason that some of our competitors' percentage is higher is they haven't had as much product revenue success we have. But nonetheless, we think it's a tremendous opportunity. So the basic algorithm for a product sale is you sell a product, and then we get the recurring revenue after it rolls off of warranty for the life cycle of that product, which generally 7 to 10 years, probably closer to the 10-year period in most products. And then throughout that, there are inflation clauses and the like for increases in that revenue.

But as our installed base increases, which it has been doing markedly, the service revenue goes up substantially, too. So when we look at our service revenue, we think there's really multiple areas for service revenue growth for us. It's from our installed base. It's from the turnkey, the Security as a Service revenues. It's from the true Software as a Service for the CertScan products. And then we also have a number of initiatives in training. And training carries very substantial margins as well. So between the 4 of these, we think that algorithm will lead to much higher service revenue growth and become a bigger percentage of our overall revenues. And therefore, given the great recurring revenue and it's at nicer margin, will lead to overall operating margin expansion for OSI Systems.

Yes. That makes a lot of sense. And maybe you can talk about a little bit about the replacement cycle when things get to the end of a 10-year contract. What does that look like? And is there a bow wave there that you can tap into?

Yes, absolutely. I mean we always think that the best customer you have is the customer you have, and we have a high -- very high retention rate of our current customers. So when a product is coming to end of life, hopefully, we've done a fantastic job not only with the product but servicing that customer over that entire period. And the evidence has shown that we have a very high renewal rate, so to speak, or a replacement of our customers with new products. So very important.

But yes, we do see -- we do track when that's going to be occurring for each of our customers, much more so on the aviation side because the cargo and vehicle inspections, so much of it has been delivered over the last decade or so. So we still have a few years to go before those replacements start happening. But it really provides us a great, great pipeline of opportunities on the replacement side. But the bigger pipeline of opportunities is really on brand-new opportunities where they're really not doing any security scanning today.

Yes. I wanted to go back to some of the bigger picture themes, one big beautiful bill in Golden Dome just double-click on that, if you don't mind. With these bills, sometimes we see this dynamic where money is allocated, but not spent. It sounds like you feel that there's real urgency to deploy the money and you feel like you have line of sight on that. And I was hoping you could just unpack that a little bit and just give us some color on how you see that dynamic.

Yes, a really good question. And you're right, sometimes money is allocated, and it just seems to be there forever. And we've experienced that sometimes in the past as well. With respect to these 2 programs, though, the one big beautiful bill and Golden Dome our understanding from all of our intelligence and the sources that we're talking to is that there really is the certainty to deploy it. They allocated the money in the one big beautiful bill in order to spend it. .

The current presidential administration has a great deal of urgency in order to do this during their administration. But the one nice thing, and it's important to note this, is while there's always disagreements amongst Republicans and Democrats on a number of different things. One area of agreement is the need for nonintrusive inspection on our borders. So both sides of the -- both sides of Congress are very much in favor of this. So it's not necessarily a political issue, which is great. But there is a great deal of urgency in order to deploy it. So therefore, we believe we're -- we've already been seeing a lot of RFIs, and we believe we're going to be seeing significant purchases taking place from the one big beautiful bill.

But we also believe that's going to be happening on the Golden Dome as well based upon all the activity that we've been seeing, and we think we're extremely well positioned for that. So we believe as we start to enter our fiscal '27, which is just a few months away, being a June 30 year, we're going to have tremendous opportunities winding down this fiscal year or second half of the year. And then as we start out into our new fiscal year for tremendous bookings.

So when we kind of map that narrative on your booking activity, we saw a little bit of a dip recently, and you can kind of expand on that. But that was, I think, primarily because of the government shutdown. Government reopens, activity kind of returns. On top of that, you see some big themes that you're attached to. So you would say that you would probably end the fiscal year at very elevated booking levels. I don't want to steal your thunder, but maybe you can kind of elaborate on that.

Yes. I mean that's certainly our hope. Yes, our December quarter bookings were a little lighter than we've seen in the past, and that is a result of the government shutdown that occurred in October and November. So it was all -- it was mostly principally related to the United States. So we believe our second half bookings here for fiscal '26 have the opportunity to be quite substantial. But we don't think it ends there. We think as we move into fiscal '27, there's going to be substantial continued orders, both on an international basis, more from the one big beautiful bill, more from the Golden Dome, so we feel our opportunity pipeline and our opportunity funnel is quite substantial. And we're very, very excited about where we'll be.

Yes. You're in a special place. Before we move away from Golden Dome, I just wanted to understand the margin characteristics of that business because it's not a huge business for you yet. If we saw kind of some sort of explosive revenue growth over the next few years, are we worried about a margin headwind? Sometimes defense -- proper defense businesses kind of come in at lower margins. And I'm just kind of curious what you're willing to share there?

Yes. So a little bit premature as we don't have the wins just yet. But from -- based on what we see and what we believe, we believe we're so uniquely positioned in this that we don't anticipate a margin headwind. I'm not sure whether it will be necessarily margin accretive, but we think it will be pretty much at the margin levels that our Security division historically operates or possibly higher. So it could potentially be a little bit margin accretive for us. So we're excited about these programs.

Yes. And you would be -- I guess, it sounds like you would be a component supplier into some sort of solution.

That's correct. And maybe 2 different avenues and maybe some direct to the U.S. government and may be some through some prime.

Through a prime, okay. Got it. That makes a tremendous amount of sense. I think that's a good segue into talking about the M&A strategy in general. Obviously, this was a huge win, right, particularly if you're able to get Golden Dome awards on the back of it. But broadly speaking, how have you thought about M&A? How did this business kind of pop up on your radar? And is there more M&A to come?

Yes. So first off, we think we have tremendous organic growth opportunities ahead of us. But we would love to turbocharge those organic growth opportunities with the right M&A. And it's very important to say the right M&A. We don't feel that we're not compelled to do any type of acquisition. M&A is in our DNA. We've been doing acquisitions over the past couple of decades. Generally speaking, smaller acquisitions, bolt-on acquisitions that might fill a technology need that might fill a channel need. We buy them at what we believe to be fair, good prices. We get a lot of synergies. We extract synergies right away.

And on almost all the deals we've done have been accretive almost immediately out of the gate and have done well for us. Sometimes, we've done a little bit more substantial ones where we bought one of our competitors called AS&E, a publicly traded company in Boston. And that's been another grand slam for us, where we took their great products and technologies, combine it with our organization and now has led us to have the #1 position on the cargo and vehicle inspection space. As we look forward, I think we'll do potentially more of the same.

We'd like to be a consolidator in the industry, both with -- from a technology perspective, but we also believe we can expand out doing stuff that may not be straight down the middle of the fairway but it's very close, much like the RF business that we did about 18 months ago. That's been -- we took their tremendous technology, but they were a smaller company, a little bit capital constrained, didn't have the same sales reach and government-type contacts that we had. And we took their great products. We put it into -- we combined it with our sales channel and some of the operational expertise, and we've seen tremendous growth right out of the gate, tremendous bookings right out of the gate and the opportunities to do things like Golden Dome. And we believe we'll do more M&A along those type of lines, but only the right deals.

Yes. No, that makes a lot of sense. And I should have asked it before the M&A question, but it sounds like you're going to have -- if everything that you're describing plays out quite a lot of free cash flow to allocate. And it doesn't necessarily mean it has to go to M&A. But maybe you could talk about free cash flow, free cash flow inflection and what the priorities for that free cash flow may be?

Sure. So we really believe we are at an inflection point, as you say, on free cash flow. As we go throughout calendar '26 and into '27, we think we're going to be generating very substantial free cash flow. And that's going to come from, of course, the strong profits but also a release of some working capital. Our accounts receivable and DSO has been a little bit elevated from these contracts that we had that we talked about in Mexico. And Mexico has been a great customer for us. We've been dealing with Mexico for a couple of decades, and Mexico has always paid us everything they owe us. Sometimes just not exactly on time.

As these programs have been getting to the wind down stage on the product side, they're going to have a nice service revenue tail for the next 10 years. It's now the time that the cash is going to be coming in. So we expect our DSOs and our accounts receivables to normalize sort of throughout this calendar year, which is going to be a source of tremendous, tremendous free cash flow for us. And we'd like to put that free cash flow to good use. Historically, our capital allocation strategy has included M&A, stock buyback and any residual cash paying down debt. And those 3 haven't necessarily been mutually exclusive.

Yes. It sounds like you have plenty of cash for quite a lot there. So that's fantastic. We might have a handful of minutes left. We spent so much time on Security, which was fully appropriate. But I want to talk a little bit about Opto and Healthcare. Maybe just first kicking it off very general. Opto, just give us an overview of the business and what the outlook there is.

Yes. We couldn't be more excited about our Opto business. It's one that sometimes goes under the radar because it's easy to understand our security products, maybe easier to understand healthcare products, but harder to understand a sensor or a detector or some other electronic components. But our Opto team has done a wonderful job growing the business. I think in the first couple of quarters, we grew 12% revenues each quarter. We have a very diverse base of customers. Once we get engineered into a customer program, we tend to be there through their product life cycle. Sometimes that's a couple of years, sometimes it's a couple of decades, which has been fantastic for us.

So again, we sell into defense companies, in aerospace and medical and technology, industrial, automotive, just a great customer base. And hats off to our sales team. What we've been doing there is we've been mining more business out of existing customers. So for instance, some of the primes or the industrial companies that might be at this conference, we might be working with them on particular programs, but they're vast. We've now been getting more programs out of some of these customers as well as gaining brand-new customers. So the Opto division has done great in addition to seeing some growth just by virtue of the strong growth that we've had in our overall Security business. So as our Security business grows, it helps on the Opto side too who is a primary provider to our Security business.

Yes. And international versus domestic dynamics in Opto, maybe you could talk about that a little bit.

Yes. So first, kind of just talking about our global footprint, then I'll talk on the commercial side. So on the Opto side, yes, we manufacture here in the United States and Canada and Mexico, but we also have a lot of low-cost manufacturing in places like India, Indonesia, Malaysia. So as a result, when we're talking to our customers, if they want low volume production, we can do it right here in the United States, but if they want some improvements in pricing and the like, we can move it over to -- over to Indonesia or Malaysia or we can move it more locally to Mexico, and we can share in some of those savings. So it's been a strategy that's worked really well.

We don't have a location in China and that's turned out to be fortuitous for us because many companies have been trying to move away from China, and we've been a little bit of a beneficiary of that, getting some customers who might want a nearshore in Mexico or maybe they want to keep it in the Far East, where we might be in Indonesia or Malaysia, it's been very helpful for us. And in terms of where our overall customer base is, it really is very, very global. In Opto, we're probably -- we're probably about half the United States and half international in terms of where our customers are.

Got it. That's helpful context. Just reflecting on everything we've talked about in Security and Opto, and I will ask one question at the end on Healthcare, but I wanted to slip one in on supply chain because you've talked about how you have global manufacturing footprints. Some of what you're doing on the product side can be very technical as well. Maybe you could just talk about managing the supply chain globally.

Yes. We have a very sophisticated and complex supply chain. Our team is doing an outstanding job. Fortunately, we haven't had any major supply chain issues, being vertically integrated has helped as well. Like many companies, we're not immune to tariffs, but tariffs have not been a material item for us. And hopefully, that will continue. But we really do have an outstanding supply chain team who's made it, I don't want to call the nonissue because nothing is ever a nonissue, but it has not been significant for us.

Okay. That makes a lot of sense. So Healthcare, maybe you could just give us a sense of what's happening in that business and what the outlook there is?

Yes. So we're extremely excited about our Healthcare business, a small business for us. It's less than 10% of our revenues, a smaller percentage of our profits, but we have a meaningful change going on right now. We brought on a new President of the business. This month marks kind of the 1-year anniversary of that new President. Over the last 6 months, he's changed out a high percentage of the leadership team and has brought in really A-level talent throughout the organization and whether it's supply chain, whether it's production, whether it's quality or regulatory or commercial, many, many new faces. And we're really looking at things from a whole new perspective.

We are investing very significantly in R&D to bring out some new platforms, particularly in patient monitoring and that's now beginning to get closer to when that will get rolled out. So as we move into some future years, we're really excited about what Healthcare can bring for us. And the Healthcare business has the highest contribution margins of any of our divisions. So every incremental dollar that we sell in Healthcare, I'll call it a little bit more valuable than what we would sell in Security or in Optoelectronics because you bring a higher percentage right down to the bottom line. So as we get that top line momentum going in Healthcare, it can really meaningfully contribute to the bottom line of Healthcare. Now again, it's a small part of our overall portfolio, but we're encouraged by what we're seeing.

Yes. Can I slip one more in on balance sheet? We talked about free cash flow. But just remind us what are the balance sheet metrics that you manage to leverage, et cetera?

Yes. So our balance sheet is in outstanding shape, very, very clean balance sheet. Our net leverage is very modest. We've been a company who has historically had net leverage being very modest. Not to say we wouldn't lever up for an acquisition if we saw a path to rapidly delevering. So for instance, when we bought AS&E, that publicly traded company in Boston a few years back, we levered up to, I think it was 3.75, and then we delevered very, very rapidly from there. And we've been below 2 most of the time. So a very, very strong balance sheet. And I think we'll continue to manage it that way. For the right opportunity, we would lever up again with a rapid path to delevering.

That's fantastic. Alan, we've got maybe a minute left. I just want to give you the floor to make any kind of concluding statements, points you really want to leave with investors.

Well, thank you. First off, the questions you've asked have been fantastic, right on point. Maybe you should have a new career in facilitating, you're fantastic. But we're really excited from an OSI Systems' perspective. We think the outlook with some of the domestic opportunities are really exciting for us. We lapped the final tough comparison on Mexico this quarter. So as we move into our fourth quarter and as we -- more importantly, as we move into fiscal '27 and beyond, with the opportunities for substantial recurring revenues at much higher margin, it's just great opportunities for top line growth, coupled with operating margin expansion, substantial free cash flow generation and significant value creation. So we think we're at an exciting time here at OSI Systems.

Fantastic. Thank you for joining us, and thank you, everybody, for plugging in and listening to OSI Systems.

Thank you.

Good day, and welcome to the OSI Systems, Inc. Second Quarter 2026 Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Mr. Alan Edrick, Chief Financial Officer. Please go ahead.

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 and second 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 second 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 statements based upon 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 2, please refer to today's earnings press release. I will begin with a high-level summary of our financial performance for the second quarter of fiscal 2016 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 the increased non-GAAP EPS guidance for fiscal year '26. We delivered strong second quarter financial results. setting Q2 records across multiple metrics, and we are excited about the momentum across our biggest divisions.

The company's revenues increased 11% year-over-year to a Q2 record of $464 million. Our 2 largest divisions achieved double-digit top line growth with Security up 15% and Opto up 12%. This top line performance is particularly impressive, given that last year's Q2 included substantial revenue from large security programs in Mexico. The solid revenue growth led to a record Q2 non-GAAP adjusted EPS and of $2.58. These results included a step-up in R&D, reflecting our commitment to innovation.

Additionally, cash flow was solid as we generated $62 million in operating cash flow, and while this number is notable, we believe calendar 2016 cash flow may be even stronger. Before diving more deeply into our financial results and discussing our outlook for fiscal 2016. I will turn the call over to Ajay.

Thank you, Alan, and thank you, everyone, for joining us today. I'm excited to discuss our business and share our Q2 fiscal '26 results with you in more detail. We had another record-breaking quarter in Q2, and with revenues of $464 million, representing 11% year-over-year growth and strong earnings reflecting our continued momentum. Our Security division performed well. and our Optoelectronics and Manufacturing division delivered another solid quarter.

Overall, we continue to see nice demand across many of our markets, and our backlog remains healthy providing confidence for a strong second half of fiscal '26 and visibility going beyond that. Let's discuss each division's performance, starting with security. In our Security division, we delivered overall double-digit revenue growth, driven by increases in both product and service revenues as we continually innovate to drive market leadership.

We also continue to introduce new innovative product features. Security bookings were lower than expected during the quarter, primarily due to delays in receiving anticipated orders in part due to the U.S. government shutdown and some pushout from international customers. These high probability opportunities are still in the pipeline. During the quarter, we announced a $20 million award to deliver a comprehensive radiological threat detection solution to an international customer. This project involves deploying a wide are radiation monitoring network that operates continuously to detect and track radioactive threats.

Also, while the formal announcement came after the quarter, we were informed in Q2 that we were selected to support security screening at a major global sporting event in Europe this winter. These wins further reinforce OSI's position as a trusted global printer of critical security infrastructure supporting national security and high-profile mission-critical environments worldwide.

Switching to RF. We announced shortly after the end of the quarter and international order valued at approximately $30 million to deploy advanced RF-based communication and surveillance systems for naval operations. We are also gaining traction on Golden Dome, the U.S. initiative to create an integrated missile defense system. To that end, our RF business was selected to participate on a massive U.S. missile defense agency contract, known as Shield. This is a multiple award, indefinite delivery, indefinite quantity contract to support the development of Golden Dome. The contract has a ceiling value of $151 billion over a 10-year period making it one of the largest IDIQ contracts ever issued by the U.S. Department of Defense. We were one-off 2,400 awardees and believe delivery orders from the Shield IDIQ could be received in the foreseeable future.

As a result of the Golden dome potential and other growth opportunities for RF solutions, including the recent International naval order, we're enhancing our RF operational footprint. We are expanding into new facilities in Texas, which significantly increases production capacity improves operational efficiency and further demonstrates our commitment to our customers and long-term innovation in this space.

Our overall security pipeline includes a wide range of opportunities, both internationally and domestically, and we are well positioned with a broad range of security offerings. Moving on to Optoelectronics. This division delivered another impressive quarter with double-digit top line growth, achieving a second quarter record for revenues and adjusted operating income. This performance was driven by broad demand across our diversified product and customer base. We are seeing growth across industries ranging from medical diagnostics to semiconductors, driven by the breadth of our offerings. Opto also had a strong book-to-bill ratio this quarter. This division continues to see an expanding opportunity pipeline as OEMs are active in diversifying away from China and derisking their supply chains by shifting to other low-cost manufacturing regions.

By expanding our production capacity with our newest manufacturing facility in Mexico and leveraging our operations across Southeast Asia, India and North America, we are poised to meet rising global demand and continue benefiting from this trend. Given strong bookings and consistent performance, we believe Opto is well positioned to build upon this momentum. And finally, let's discuss the Healthcare division.

While Q2 was a challenging quarter for our Healthcare division, we remain focused on long-term value creation. We have intensified our sales efforts and are focusing our pipeline of new products by continuing to invest in next-generation product development. While it will take time to regain our footing. We are confident that these actions, along with the broader market recovery will improve health care's performance in the coming quarters. Overall, we are pleased with OSI's Q2 and first half results. We grew revenues and profits significantly and continue to drive efficiencies in our business. I will now return the call to Alan to discuss our financial performance further before we open the call for questions. Thank you.

Thank you, Ajay Now I will review in greater detail the financial results for Q2 and then discuss our increased fiscal 2016 non-GAAP EPS guidance. As mentioned, our Q2 revenues were up 11% compared to the second quarter of the prior fiscal year, with strength across our 2 largest segments. Security division revenues in Q2 were $335 million, an increase of 15% year-over-year.

This growth was driven by significantly higher service revenues, increased revenues from the RF business, which continues to be effectively integrated into our overall operations and increased aviation product revenues. As expected, and directionally similar to last quarter's trend, revenues related to our large Mexico security contracts decreased 50% to $27 million in Q2 fiscal '26 from $54 million in Q2 of the prior year. Excluding the Mexico contracts, securities revenue surged 31% year-over-year 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 $113 million, which is a new Q2 record for this division.

This was driven by growth across our diversified product and customer portfolios and as a just suggested, Healthcare division sales were soft. Our Q2 fiscal 2016 gross margin was 33%, and 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 sutuate based on product and service mix and volume, supply chain costs, FX, tariffs, among other factors. Moving on to operating expenses. Expenses in the second fiscal quarter were $70.2 million, down 1% from the prior year Q2 and representing 15.1% of sales compared to 16.8% of sales in Q2 of last fiscal year.

We continue to work diligently across all of our divisions to manage our SG&A cost structure efficiently. R&D expenses in Q2 were $19.8 million or 4.3% of revenues, up from $18.3 million in the same quarter last year. This increase stems from our commitment to investing in innovation, resulting in market-leading offerings, particularly in security and positioning OSI well for the future. We expect to continue our heightened R&D efforts to advance key initiatives through the remainder of the fiscal year.

Even with these investments, our combined SG&A and R&D expenses as a percentage of sales have decreased annually for each of the past 8 years. and this trend is anticipated to continue for fiscal '26, underscoring our ability to drive operating efficiencies while still funding growth initiatives. Now moving below the operating line.

Net interest and other expense in Q2 was $10.7 million, up from $8.6 million in the same quarter of the prior year, while net interest expense decreased from $8.6 million to $6.4 million on reduced borrowing costs, this was offset by a $4.4 million nonrecurring cost for a retirement plan amendment of the former CEO.

Our effective tax rate under GAAP was 19.5% in Q2 of fiscal '20 and versus 23.3% in Q2 last year. However, excluding discrete tax items, our normalized effective tax rate, which is the rate used in calculating non-GAAP EPS was approximately 23.3% this quarter compared to 24.0% in the same prior year quarter. On a non-GAAP basis, our Q2 FY '26 adjusted operating margin of 14% and was up sequentially from Q1, but down from the prior year second quarter as expected due to the tough comp.

The Security Division's adjusted operating margin was 17.8% in Q2 of fiscal '20. And compared to 19.9% in the same prior year period. Strong growth in higher-margin security service revenues was offset by a less favorable mix of product sales and the growth in R&D.

The Opto adjusted operating margin increased 100 basis points to 12.9% from 12.8% in last year's fiscal Q2. We continue to anticipate efficiencies in our newest manufacturing facility in Opto to contribute to expanding margins in the second half of the fiscal year.

Lastly, the adjusted operating margin of our Healthcare division was rather negligible given the sales level. Moving to cash flow and the balance sheet. Our operating cash flow improved in fiscal Q2 on a year-over-year basis. DSO in Q2 decreased 17% from Q1 and is expected to further decrease by the end of the fiscal year. We continue to receive payments from a significant Security division customer in Mexico during the quarter, marking progress, albeit at a slower pace. We expect substantial cash inflows in the second half of fiscal 2016 and beyond as we continue to collect on the Mexico receivables, which should lead to sizable operating cash flow and strong free cash flow conversion.

In Q2 of this year was $7 million, while depreciation and amortization expense in the quarter was $9.6 million. Our balance sheet remains solid. Our net leverage at the end of Q2 fiscal '26 was approximately 2.2 as calculated under our credit agreement. We completed a highly successful convertible notes transaction in November in which we raised $575 million at a coupon of 0.5%.

This transaction increased our liquidity and financial flexibility for future growth initiatives while simultaneously reducing interest expense through the pay down of our revolver. In connection with the transaction, we bought back approximately 547,000 shares at an average price of $267 per share under our stock buyback program.

Now turning to our updated guidance. We are raising our fiscal 2016 guidance for non-GAAP EPS and while maintaining our revenue guidance. We now anticipate non-GAAP earnings per diluted share to be within a range of $10.30 to $10.55 and which would represent 10% to 13% year-over-year growth. This updated outlook factors in a challenging comp from a significant reduction of revenues from our Mexico contracts in fiscal 2016 in our Security division.

This should be more prevalent in Q3 than Q2 with an expected Q3 revenue headwind of over $50 million to year-over-year revenue growth which is expected to be the highest quarterly variance of fiscal '26. Based upon the expected timing of the backlog conversion, Mexico and other factors, we anticipate the growth in our fiscal 2016 Q4 and to be significantly stronger than the growth in Q3.

We note that this fiscal 2016 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, tariffs and potential future government shutdowns, among other factors, is difficult to predict and could vary significantly from the anticipated impact currently reflected in our guidance. Actual revenue 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 are committed to operational excellence. As we continue to grow our businesses and provide innovative products and solutions to our customers. We are pleased with our performance in the first half of fiscal 2016, and we expect a solid second half as we continue to generate significant cash flow and utilize our financial strength to invest in key strategic areas with the goal of driving long-term value for our shareholders.

Once again, we thank the entire global OSI team for their dedication to supporting our customers and partners, their efforts are what make our results possible. And at this time, we would like to open the call to questions.

[Operator Instructions] And we do have our first question from Mr. Jeff Martin.

I wanted to dive into the orders activity in Security comment, softer than expected. The overall backlog was essentially unchanged at $1.8 billion. So is it better to phrase it as the orders were not as strong as you expected rather than soft?

I think -- this is Ajay. The best way to describe it, I think we said it that we expected strong orders. And some of them got pushed to the right because of the government shutdown and a little bit some internationally, but all those are very much alive in our pipeline, and we expect a strong next 6 months.

Great. And then I was curious if you could expand on the IDIQ contract of Golden dome. It sounds like you're expecting something could materialize in the relatively near future. Is this something you could theoretically see orders start to come in, in fiscal '26?

A lot of this is dependent, obviously, the funding came in for the big beautiful bill, and there's a substantial amount of funding in there. Like I said, it's the largest contract one of the largest contracts out there at $151 billion, but there are 2,400 people there. But we feel that we're in a good position with the products that we provide, especially our over the horizon radar.

And we are talking to customers. We are actively pursuing opportunities really can give you a feel for when this will happen. Obviously, timing, dealing with the government sometimes takes longer. But we feel good about the foreseeable future that we'll get some orders and -- like I said, we have also expanded our facilities in Dallas, Texas, and we feel -- we feel positive.

Excellent. And then Alan, how should we think about interest expense on a quarterly basis going forward from here?

Yes, Jeff, good question. With the paydown of our revolver mid-Q2, we would anticipate that the level of interest expense will decrease from Q2 to Q3 a little bit. We got some of the benefit, about half a quarter benefit in Q2. And then Q3 and Q4 should be relatively comparable to one another.

Okay. And then you're going to have quite a bit of excess cash comp on the balance sheet, particularly with Star anticipated free cash flow over the next 12 months, call it. What's the potential for additional share reports received from here?

Well, Jeff, you're right. We have a strong balance sheet. We have nice cash on the balance sheet as of 12/31. And and with the strong expected free cash flow over the period of time you mentioned, that should only increase. Our capital allocation has always consisted of kind of 3 things: M&A, stock buyback, and any paydown of revolver, which we've already done at this point in time. And they're not mutually exclusive necessarily. So stock buyback is certainly an option for us.

We did a sizable buyback in Q2 of about 546,000 shares, but the opportunity to buy back further shares is certainly available to us.

And one moment for our next question. And that will come from the line of Josh Nichols with B. Riley Securities.

Great to see the strong cash flow during the quarter. Just want to dive in a little bit. Obviously, we have the government shutdown that impacted things a little bit. But can you provide a little bit more detail about what you're seeing in terms of the big beautiful bill and RFP timing? Are you seeing some RFPs already in calendar '26? Or do you expect the award activity maybe pick up in like calendar 2Q or 3Q or some of those like procurement time line shifted a bit?

So I think that the shutdown definitely move stuff to the right. We are starting to see some money flow in. We expect some money will flow in, in the first 6 months of this year. But I would say most of it will be towards the latter part of calendar '26 and beyond. So it's really been more of an effect of timing than anything else.

Got it. That makes sense. And then, Alan, I know you mentioned, look, the receivables on the DSO have been improving. You said Mexico was part of that. Like can you just elaborate a little bit more maybe on where we stand in terms of Mexico DSO? Or is that going to continue to be a significant free cash flow driver in the fiscal second half relative to where the rest of the business is?

Yes, Josh. Good question. And you're absolutely right. though we collected some nice payments from Mexico in Q2, it still represents, by far, our largest receivable at the overall company. And we would expect, based on the due dates and when we think cash is coming in, that really over the course of the balance of fiscal '26 and really part of fiscal '27 to kind of have some potential outsized free cash flow conversion as the Mexico receivable normalizes, which will drive down our DSO quite significantly, resulting in the cash flow.

And then last question for me. I know the comps aspect, right, with Mexico for the margins have been a little bit challenging, but they are easing. I think by the time we get to like the end of this fiscal year, you're probably in a pretty good position, particularly with the service revenue trajectory that we have seen.

Any more detail you can provide about like the guidance outlook in terms of the margin and the growth potential for the service revenue relative to hardware from where we stand today?

Yes, Jeff -- excuse me, Josh, this is Alan. Good question again. Absolutely. We're highly encouraged about where we're heading on margins. Our service revenues growth has been outstanding. Of course, we started seeing real strong service revenue growth in the third quarter of last fiscal year. So we'll start coming on to a little bit more difficult comps on the service revenue growth. but we still expect it to be growing at a much faster rate than that of products in most cases.

And the service revenues carry a higher margin than our product revenues. So as a result, we see some real nice room for operating margin expansion. We see that more tilted to Q4 for the reasons I outlined during sort of the prepared remarks. But yes, we see some good opportunity for operating margin expansion in Q4 and beyond.

Thank you. One moment for our next question. And that will come from the line of Christopher Glynn with Opheimer.

Alan, just was hoping you could revisit that kind of tilt to 4Q that you just referenced outlined in the prepared remarks. I missed a little bit of it. And then just in terms of a finer point, the midpoint of your guidance basically gives us exactly $1 billion revenue in the back half. Should we think about that as like 55% across the remaining 2 quarters? Or is that a little extreme.

Good question, Chris. Really kind of what's driving a much stronger Q4 than Q3 are a couple of things. One, of course, is the U.S. government shutdown, which pushed a few things a little bit to the right. But the much bigger impact is Mexico.

I had mentioned that the Mexico revenue variance between last year and this year of the 4 quarters is most prevalent in Q3 itself. So there's a big headwind, if you will, on the Q3 revenues related to Mexico. That then begins to subside substantially in Q4 and of course, as we move into the next fiscal year. So yes, I would anticipate when you're looking at the splits, the revenues being significantly higher in Q4 than Q3, and therefore, the same would hold true to the bottom line.

Okay. Great. And then on the expected strong second half bookings, is that essentially a CBP factor that we're talking about there?

Well -- this is A.J. Obviously, CBP is one of them. We get a lot of orders from the rest of the government. And like I said, we're pursuing a lot of international orders as well. So it's a combination of a few customers.

Okay. Great. And then I know you don't announce everything. But aviation orders, I think if we're tracking correctly been a little bit quiet. So just wondering if you could comment on the pipeline for the aviation market. And might there be some announcements in the second half in that vertical?

Well, the aviation market remains strong for us. The pipeline remains strong. And just bear in mind with Aviation. Sometimes it takes a little longer. The airport sometimes are not ready because of construction, et cetera. But we feel good about the pipeline right now.

And maybe to add on to that, Chris. This is Alan. The aviation business has been very good for us. The aviation orders, we tend to get a large volume of aviation orders but sometimes they're of a lesser amount, not necessarily to the rise to the level of a press release, if you will. But the overall business has been [indiscernible].

Okay. And sorry, if I could fit in a bookkeeping one. Someone already asked about the interest expense bridge from the refi there and the converts. Could you level set the shares, how to think about those or even give us a plug for the third quarter? I know option exercise is probably up a little bit with the really strong stock performance.

Yes. So from the diluted shares perspective, with the stock buyback, it came down a bit in Q2. We'll probably see a little bit more impact of that in Q3 and then stabilize. Of course, with the rising stock price, that will have a little bit opposite effect countering that a little bit on diluted shares. But overall, we would anticipate the diluted share count will be reducing a little bit in Q3 and Q4 should be pretty comparable to Q3.

One moment for our next question. And that will come from the line of Mariana Perez Mora with Bank of America.

Thank you so much. Good afternoon, everyone. I wanted to touch base on the radio frequency business. And you mentioned opportunities for Golden dome, and investments being made to expand to new facilities in Texas. Like could you mind given us some color around like how large is that business today? And how should we think about when we look at that business like 3 to 5 years from now?

Well, great question. I think the best way for us to answer that is you've heard in the news, what they're looking to do in Golden Dome. We have a portion of it. So we think we have a good opportunity over the next 2, 3, 4 years to really get some very good solid growth as this program continues. So I can't really get into specifics, maybe 6 months down the road, 3 months down the road, whatever as we get more color on what they're doing, we'll be able to answer that question.

But right now, we feel very good about the growth prospects in that business, and that's one of the reasons we decided to expand and move into a brand-new facility that gives us the opportunity to be able to meet that demand and really showcase to the customer all the innovative technologies that we have.

And then I wanted to tap or like dig a little bit deeper as well on CBP opportunities. there has been like all this government accountability office reports about like how CBPs lagging in their effort to have large noninterest inspection systems, putting like the land ports. And they are -- they have been progressing just like, I don't know, 40% over the last 10 years on a goal that was like due next year. And they say that there is a problem with the civil works and that's why they have a lot of like systems in inventory.

Like how that affects orders for you guys, how that affects your market share as you take care of both the systems and the civil works, how should we think about like opportunity from those efforts in the next couple of years?

So great question. I mean, keep in mind, if you've been down to the border, how complicated the border crossings can be and civil works is not an easy thing. You need to go through as far as the government is concerned, a lot of different agencies and through GSA and others. Having said that, we have been, I think, the most efficient supplier to the CBP in terms of equipment.

We continue to see some of that equipment orders that we think are going to come in, not just for water crossings, but for ports for other areas, such as airports. And so we think it's going to continue. Is it going to speed up. The best way to put it is, as you put new systems in on both sides, not just from us, but from the government, you learn. So things get things get more efficient. And that's what we're hoping as we move forward.

Great. And last one from me is sports event. So you mentioned a European one and an award on that end, but could you mind reminding us how is the pipeline of opportunities for the FIFA World Cup this summer? And then how should we think about the Olympics as well.

So we definitely are a premier player over there, and we feel very good about the announcement we made. We feel very good about the upcoming major events in the U.S. and internationally. And as you know, we won the -- we did another major event 1.5 years ago in the summer in Europe. So we feel very good.

And I think that we are uniquely qualified to do it because we've done it so many times, number one. And number two, we have a breadth of technology that is really unmatched with other people.

One moment for our next question. And that will come from the line of Seth Seifman with JPMorgan.

This is Rocco on for Seth. There's been a lot of conversation of increasing international demand for the security products. Are there any specific kind of regions or countries that are leading the pack on either urgency or size of the opportunity?

Well, U.S., obviously, is one. We see a lot internationally and, frankly, in the Middle East. And we're seeing a lot of countries starting to pay more attention, especially with some of the trade issues that are going on to see can they scan more, to be able to potentially if they want share information with the U.S., so the trade becomes a little easier. So it really -- it's really across the board, but it varies depending on year by year, one country might do it and another country will do it. But it's all -- it's still in the second, third inning. It's not in the -- it's not a mature market yet.

Great. That makes sense. And then funding around DHS and CBP has become a bit more contentious after the events of last weekend ahead of the CR expiration on Saturday. Does the near-term funding have a notable impact in either the revenue or cash outlook heading into the back half of the year?

No. I think the issues there are, I'm not going to get into it, but it's really not a by border security. It's about other things related to ICE and other issues.

[Operator Instructions] One moment for our next question, and that will come from Larry Solow with CJS Securities.

All right. Just a couple of follow-ups. So the bookings and security, was that essentially close to flat, about 1%. Is that about right? I know it feels like it. Do you actually give a number there. .

Larry, this is Alan. They were -- it was a bit below 1.0 this quarter.

Okay. And I'm just curious, and you kind of -- I think I answered my question in your remarks, but does the somewhat less-than-expected orders and it sounds like timing related.

Does that actually impact your sales in the back half, I guess, a little bit because you had a strong quarter, but you didn't raise guidance and your -- you kind of mentioned a little slower Q3, Q4 year-over-year because of Mexico, but also what you already knew about, but maybe a little bit because maybe some of these bookings would have trickled through that fast? Or I'm just kind of curious if the if there's any slower -- you have your guidance the same on a revenue basis, but would you have increased it at all if bookings matched your expectations?

Yes, Larry, we -- this is Alan. We might have. We just thought it was prudent to maintain our revenue range at this time given the items that you just mentioned with some things moving a little bit to the right and any potential shutdowns and the like. But yes, overall, we feel very strong about our business.

And just the margin -- I know mix -- there's a lot of moving parts there. But I guess, is it fair to say that Mexico obviously is a driver of that. Is that the substantial driver Mexico is just better, higher-margin revenue? I know last year, Q2, you had a substantially good quarter.

So I'm not necessarily looking year-over-year, but just curious with a nice revenue jump, service revenue up really nice, and you're still below full year margins from last year versus this quarter. So curious, is it really just Mexico? Are there a lot of factors? Any way you could kind of help with that?

Larry, it's Alan. Yes, there are multiple factors, but Mexico plays a role in it. Of course, given the size of that contract and when we are manufacturing the same product over and over and over again, there's inherent operational efficiencies, which drive the margin up quite nicely, which is fantastic.

And we recognize coming into the year that we'd be facing that sort of margin headwind. And despite that, the company has been growing quite nicely. That big impact of Mexico year-over-year comparison subsides after the third quarter, so really after the March quarter. So as we move forward in Q4 and beyond, I think that's really where you see the real opportunity for margin expansion for the business again. So only 2 months away from that.

That's fair. And on the Golden dome age, I know you can't really give much specifics and maybe there's some things you just don't know. But it feels like -- I mean, is this something that could be a over a 3- to 5-year period, a several hundred million dollar potential opportunity for you. Obviously, the $151 billion divided by 2,400 would be but I'm sure we can't do that math.

But -- any color there magnitude potential size without you actually -- without putting words in amount?

Yes. I mean I think that we feel it's a substantial opportunity that's going to be meaningful overall to the company. What that number is going to be. I mean it's substantial. I don't want to get into specifics, but you may not be that far off. But at the end of the day, we'll give more color on that as we get closer on what those opportunities are.

Got you. And just switching gears real fast, if I may, just on Opto. I think it was up like 9% externally. You said the book-to-bill was greater than 1. Is it -- the same driver still onshore and companies getting out of Mexico out of China, excuse me. Is that the drivers? Any color there would be great.

Yes, Larry, it's Alan. The drivers remain similar to what you just mentioned. Just a good diverse customer base, strong demand from business within our existing customers and new business within our existing customers as well as gaining traction with some new customers who are trying to move out of different parts of the world and into the manufacturing locations that we have.

So we're really pleased with seeing overall 12% revenue growth in each of Q1 and Q2, which included the 9% external that you mentioned in this past quarter, and we see strong demand continuing in this business as we move forward in the next couple of quarters, the balance of the fiscal year.

Great. And just cash flow, obviously, a nice quarter. and it sounds like you have expectations for the nicer quarters in the back half. Do you think on a full year basis that could come close or even exceed net income?

Larry, I think that's entirely possible. in the event that the DSOs come down to the place that we believe it could, that could very well be the case. And yes, we think there's every opportunity for that to occur.

I'm showing no further questions in the queue at this time. I would now like to turn the call back over to management for any closing remarks.

Well, I want to thank our shareholders, of course, our customers. And last but not least, all our employees for everything that we've been able to accomplish the last months and looking forward to the next 6 months. And once again, thank you all for participating in our conference call. We look forward to speaking with you at our next earnings call. Thank you.

This concludes today's program. Thank you all for participating. You may now disconnect.

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" 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 by several significant wins, some of which we announced recently. We announced approximately $75 million in nonintrusive inspection product and integration orders and more than $60 million in RF product orders that we received during Q1. These orders reflect our growing momentum in critical areas such as cargo and vehicle inspection and advanced RF detection technologies. More importantly, they reinforce the stability and depth of our relationships with our customers.

Driven by factors like geopolitical conflicts, terrorism and crime, governments worldwide are investing heavily in advanced systems to enhance detection, deterrence and response capabilities. These escalating global threats are being addressed by increasing focus on technology innovation and in turn, shifting policy priorities supported by targeted funding. During the quarter, we also announced an award of a 5-year contract from CBP for its NII Common Integration Platform program, also referred to as SIP.

The SIP program is designed to enhance national border security by enabling sufficient screening and strengthening collaboration among CBP, the Department of Homeland Security and other stakeholders. We are providing our CertScan platform to support CVP's strategic goals by modernizing its inspection capabilities. Therefore, as part of the SIP program, we will support various integration efforts, not only on our platforms, but also with inspection technologies and solutions from other providers. This SaaS-based offering is expected to increase annual recurring revenues over time. We're also gaining significant traction in our RF product line and anticipate further momentum from opportunities tied to Golden dome-related expenditures highlighted in the one big beautiful bill. Once the government resumes full operations, we anticipate heightened demand for a number of our core offerings. The successes in Q1 instill great confidence in our robust growth prospects as we advance through the remainder of fiscal 2026 and beyond.

Turning now to our Optoelectronics and Manufacturing division. Opto delivered record Q1 revenues, including intercompany sales, while achieving strong profitability. We experienced notable strength and expansion across our product lines in North America, where many of our customers are leading OEMs in their industries. Our operations in Mexico continue to play an important role amid ongoing global tariff uncertainties. We fielded numerous inquiries from both existing and prospective OEMs seeking to realign their supply chains toward the U.S. and nearshore options. Our robust global manufacturing footprint spanning North America, Europe and Southeast Asia positions us as a compelling alternative for capitalizing on this potential supply chain shift.

Finally, turning to our Healthcare division. Q1 sales rose a solid 10% year-over-year. As we've discussed on prior calls, we're executing on the improvement plans we put in place under a new leadership team and beginning to see tangible benefits in both sales and operations. That said, while this Q1 performance reinforces that we are on a good path, we still have considerable way to go before meeting our high performance standards. Looking ahead, we'll continue to drive product innovation in health care with continued R&D investments while advancing operational efficiencies to enhance profitability.

In summary, OSI Systems has tremendous momentum. We are a thriving business, diverse and substantial backlog and a robust balance sheet that supports both organic growth and strategic investments. We remain disciplined in managing our cost structure. We expect to generate strong cash flow this year, which combined with our ample credit capacity affords us significant flexibility in capital allocation. I want to thank our employees, customers and shareholders for their continued support. With a strong foundation and expanding opportunities, we are well positioned to deliver long-term value. With that, I will turn the call over to Alan to discuss our financial performance and updated guidance in more detail before opening the call for questions. Thank you.

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 reduction was aided by more favorable FX in Q1 this year compared to Q1 in the prior year. We continue to work diligently across all divisions to manage our SG&A cost structure efficiently as we grow. R&D expenses in Q1 were above -- slightly above $20 million or 5.3% of revenues, up from $17.8 million or 5.2% of revenues in the same quarter last year. This increase reflects our decision to invest in innovation, yielding market-leading products, particularly in security and positioning OSI well for the future. We expect to continue this heightened focus on R&D to advance key projects through the remainder of fiscal '26. Even with these investments, our combined SG&A and R&D expenses as a percentage of sales have decreased annually for each of the past 8 years, and this trend is anticipated to continue for fiscal '26, underscoring our ability to drive operating efficiencies while still funding growth initiatives.

Now moving below the operating line. Net interest and other expense in Q1 was $7.4 million, similar to the amount in the same quarter of the prior year. Our effective tax rate under GAAP was 19.9% in Q1 of fiscal '26 versus 21.9% in Q1 of last year. Excluding discrete tax items, our normalized effective tax rate, which is used in calculating non-GAAP EPS was approximately 23.3% this quarter compared to 24.0% in the prior year quarter. On a non-GAAP basis, our Q1 fiscal '26 adjusted operating margin of 10.3% was consistent with that of the same quarter last year. The securities adjusted -- Security division's adjusted operating margin was 13.5% in Q1 compared to 14.4% a year ago. Strong growth in high-margin security service revenues was offset by a less favorable mix of product sales and growth in R&D. While Opto's adjusted operating margin of 11.9% was similar to the 12.0% in last year's Q1, we anticipate efficiencies in our newest manufacturing facility to contribute to expanding margins in the second half of the fiscal year. Lastly, the adjusted operating margin of our Healthcare division improved 260 basis points, driven in part by revenue growth.

Moving to cash flow and the balance sheet. Our year-over-year operating cash flow improved in Q1. That being said, there was opportunity for it to be notably larger. We received partial payments from a significant Security division customer in Mexico during the quarter, marking encouraging progress. We continue to expect substantial cash inflows in fiscal '26 as we continue to collect those remaining receivables, which should lead to sizable operating cash flow this fiscal year and very strong free cash flow conversion. CapEx in the 2026 first fiscal quarter was $7 million, while depreciation and amortization expense was $10.3 million.

Our balance sheet remains solid. At the end of the quarter, our net leverage was approximately 1.9x as calculated under our credit agreement. We amended our credit facility during Q1 to, among other things, extend the maturity date to July 2030 and increase the borrowing capacity to $825 million. This expanded facility increases our liquidity and financial flexibility.

Now turning to our updated guidance. We are raising our fiscal '26 guidance for both revenues and adjusted earnings per share. We now anticipate year-over-year revenue of $1.825 billion to $1.867 billion, representing a growth rate of 6.5% to 9.0%, up from the previous growth range of 5.4% to 8%. This updated outlook factors in an approximate 60% headwind from a reduction of revenues from our Mexico contracts in fiscal '26 in our Security division. We are also raising our non-GAAP adjusted earnings per diluted share guidance from a range of $10.11 to $10.39 to a range of $10.20 to $10.48, which represents 9% to 12% year-over-year growth. We note that 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, tariffs and the government shutdown, 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 are committed to operational excellence as we continue to grow our businesses and provide innovative products and solutions to our customers. We are excited about the solid start to fiscal '26 and anticipate building momentum throughout the year. We expect to generate strong cash flow and have the financial strength to invest in key strategic areas that will drive long-term value for our shareholders. Once again, and as A.J. 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.

[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.

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 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 ZBx, multi-energy inspection systems and ZBV, Z Backscatter vehicle screening systems targeted for port and border security, a $36 million contract to supply our Orion 920CT checkpoint screening solution and 935Dx air cargo pallet screening to a Middle East international airport. $50 million awards from U.S. customer for new developments of Rapiscan inspection systems as well as a $47 million service contract from a U.S. customer for ongoing maintenance of installed systems.

The sheer volume, diversity and quality of orders in fiscal '25, combined with a growing opportunity pipeline, particularly in the U.S., which I will discuss further, and favorable marketing trends position us for sustained success in the Security division.

Now let's discuss the significant security opportunities that have been unlocked by the Big Beautiful Bill Act also known as the Reconciliation Bill enacted just last month. This landmark legislation provides extensive funding in domains for which our solutions and capabilities are well suited. At the forefront, the Act allocates significant funds for U.S. water security agencies, especially for CBP. These funds are deployable over multiple years, and we anticipate that over $1 billion will be used for procurement and integration of new nonintrusive inspection equipment and associated civil works, encompassing AI, machine learning, innovative technologies and mission support to combat narcotic smugglings at ports of entry.

Security isn't just about borders, it's about protecting the nation's biggest stages. The U.S. government's focus on enhancing people and infrastructure security becomes increasingly important as the country hosts the 2026 FIFA World Cup and 2028 Summer Olympics. And significant amounts for security have been budgeted in this act. As you may be aware, we served as a security provider for the 2022 FIFA World Cup in Qatar and the 2024 Summer Olympics in France. So we are a compelling fit to play a meaningful role in these upcoming events. The beautiful -- Big Beautiful Bill also contains significant funds for Golden Dome program, which will be a complex system of sensor networks, weapons platforms and command and control networks. We expect the program to seek to incorporate RF sensors, such as ground-based radar that can be fused with data from other sensors to provide operators with a comprehensive view of the Continental U.S. threat landscape.

We are well positioned with our RF products for ground-based or over-the-horizon radar applications. These U.S. budget commitments in defense and security have expanded our existing pipeline. And these new opportunities alongside robust international demand from the Middle East and other dynamic regions for cargo and aviation inspection systems and a growing recurring revenue stream solidify our long-term outlook.

Now let's turn to Optoelectronics. The Optoelectronics division has set yet another Q4 record, achieving an impressive $113 million including intercompany sales. We believe that most of the OEM customers have stabilized their inventories over the last 12 to 18 months. And thus, we are now on firmer ground for more predictable demand. During the quarter, we announced a $7 billion Opto order from a leading health care innovator, specializing in patient diagnostics and care applications.

In 2025, our Mexico operations continued to gain traction, offering near shore production optionality as we expand our order book with existing and new customers seeking to minimize the U.S. tariff impact. Tariffs aside our key markets appears poised for continued growth as many OEMs in aerospace, defense, security, consumer technology, telecommunications and test and measurement sectors continue to forecast positive momentum in the marketplace. Overall, we're pleased with Opto's performance and expect continued strength in fiscal '26.

Finally, let's discuss Healthcare. While its financial performance was disappointing in the quarter, the plans put in place are beginning to show results, and we anticipate stronger performance going forward. We're continuing to make investments to advance our next-generation patient monitoring platform paired with predictive health and alarm management solutions to differentiate ourselves from our competitors.

Moving forward, we'll sustain product innovation while implementing operational efficiencies and to improve profitability. In summary, OSI Systems enters fiscal '26 with tremendous momentum. We have a thriving business, diverse and substantial backlog and a robust balance sheet that can drive both organic growth and strategic acquisitions. We're poised to build on fiscal '25 success to deliver further value. I want to thank our dedicated employees, valued customers and stockholders for making OSI Systems achievements possible. With that, I'll hand it back to Alan for a deeper dive into our financials and fiscal '26 guidance before we take questions. Thank you.

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 health care 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 [indiscernible] 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 that 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.

Yes. 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 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 Larry Solow from CJS Securities.

Great. 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 [indiscernible] from Sadana, 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 1 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 built 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 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 -- round 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 [indiscernible] 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.

Thank you all once again for attending our conference call. Great to speak to all of you. We look forward to speaking with you on our call following the completion of our next quarter. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.