OSI Systems (OSIS) Q2 2026: Security Division Surges 15% as Service Mix Drives Margin Upside
OSI Systems delivered double-digit growth in its two largest divisions, led by a 15% security revenue jump driven by service and RF momentum. The company’s operating leverage and cash generation are accelerating, even as a tough Mexico contract compare weighs on near-term margins and Q3 growth. With a rising service mix, robust Opto demand, and a multi-year Golden Dome opportunity in RF, OSIS is positioning for margin expansion and strategic flexibility into fiscal 2027.
Summary
- Security Service Outperformance: Higher-margin service revenues are reshaping margin structure and offsetting product mix headwinds.
- Optoelectronics Pipeline Expands: Global supply chain shifts and new capacity in Mexico are fueling broad-based Opto growth.
- RF and Golden Dome Visibility: Expansion into missile defense and international naval contracts sets up multi-year upside.
Performance Analysis
OSI Systems posted 11% revenue growth in Q2 2026, with both the Security and Optoelectronics divisions delivering double-digit gains. Security, which represents nearly three-quarters of company sales, was up 15% year-over-year, propelled by service revenue growth and rising RF (radio frequency) business contributions. Optoelectronics and Manufacturing, about one-fourth of total revenue, climbed 12% on the back of diversified demand across medical diagnostics, semiconductors, and industrial clients.
Gross margin fell to 33%, pressured by a less favorable product sales mix and the ongoing transition away from high-volume, high-margin Mexico security contracts. However, the margin drag is expected to subside after Q3, with management pointing to service revenue trajectory and new manufacturing efficiencies as drivers of future expansion. Operating cash flow was robust at $62 million, and Days Sales Outstanding (DSO) improved sequentially, setting up the business for potential outsized free cash flow conversion as Mexico receivables normalize.
- Security Service Revenue Acceleration: Service revenues outpaced product growth and now represent a larger profit lever.
- Opto Demand Diversification: Growth is broad-based, with OEMs shifting supply chains from China to Mexico and Southeast Asia.
- Margin Headwinds Nearing Inflection: Q3 faces the toughest Mexico compare, but margin expansion is anticipated in Q4 and beyond.
The company’s balance sheet was further strengthened by a $575 million convertible note raise, which reduced interest expense and enabled a 547,000 share buyback at $267 per share. Management’s disciplined cost control is reflected in SG&A and R&D as a percentage of sales declining for the eighth straight year.
Executive Commentary
"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."
A.J. Mira, President and CEO
"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 eight years, and this trend is anticipated to continue for fiscal 26th, underscoring our ability to drive operating efficiencies while still funding growth initiatives."
Alan Edrick, Executive Vice President and CFO
Strategic Positioning
1. Security Division: Service-Led Margin Evolution
The security division is rapidly evolving toward a service-led model, where recurring service contracts provide higher margins and resilience against product cycle swings. Service revenue growth outpaces hardware, and upcoming international projects—including a $20 million radiological threat detection network—underscore OSIS’s positioning as a critical infrastructure provider.
2. RF Expansion: Golden Dome and Naval Wins
RF business, focused on advanced communications and surveillance, is scaling up with a new Texas facility to support the Golden Dome missile defense initiative and a $30 million international naval contract. The SHIELD IDIQ contract (ceiling value $151 billion over 10 years) opens a multi-year, high-potential pipeline, though timing of order flow remains subject to government procurement cycles.
3. Optoelectronics: Supply Chain Realignment Tailwind
Optoelectronics is benefiting from global OEMs diversifying away from China, with OSIS expanding capacity in Mexico and leveraging operations in Southeast Asia and India. The division’s strong book-to-bill ratio and expanding opportunity set position it as a growth engine as customers seek low-cost, de-risked supply chains.
4. Healthcare: Turnaround in Progress
The healthcare division remains a laggard, with soft sales and negligible margins, but management is intensifying sales and product development efforts. A recovery is expected to be gradual, dependent on both execution and broader market normalization.
Key Considerations
This quarter’s results highlight OSIS’s pivot toward higher-margin, recurring revenue streams and its ability to execute through supply chain and macro disruptions. The company is balancing near-term growth headwinds from Mexico contract roll-off with longer-term opportunities in security services, RF, and global manufacturing.
Key Considerations:
- Service Mix as a Margin Lever: Service revenues are structurally higher margin and are expected to drive operating leverage into FY27.
- RF Pipeline Visibility: Participation in Golden Dome and SHIELD IDIQ establishes OSIS as a strategic defense supplier, with potential for step-function growth.
- Opto Manufacturing Scale-Up: New facilities in Mexico and Asia position Opto to capture OEM supply chain shifts and margin improvement.
- Capital Allocation Discipline: Convertible note raise, revolver paydown, and share buybacks reflect a flexible, shareholder-oriented approach.
- Healthcare Execution Risk: The division’s recovery remains a wildcard, with management betting on new products and market stabilization.
Risks
Timing risk remains high around large government contract conversions, especially in security and RF, with Q3 facing a pronounced headwind from Mexico contract roll-off. Delays in U.S. government funding or shutdowns could further push order timing. Healthcare turnaround is uncertain, and competitive intensity in security and manufacturing could pressure margins if execution falters or macro conditions shift.
Forward Outlook
For Q3 2026, OSIS expects:
- Revenue growth to be muted due to a $50 million year-over-year Mexico contract headwind.
- Operating margins to remain under pressure before rebounding in Q4.
For full-year 2026, management raised non-GAAP EPS guidance to $10.30–$10.55, reflecting 10–13% growth, while maintaining revenue guidance.
Management highlighted:
- Q4 will see significantly stronger growth and margin expansion as Mexico compare eases.
- Service revenue and Opto momentum should drive sequential improvement into FY27.
Takeaways
OSI Systems is executing on a multi-pronged strategy to drive sustainable, margin-accretive growth, even as near-term revenue faces contract timing headwinds.
- Security and Opto are clear growth engines, with service and RF offering outsized margin and pipeline upside.
- Capital discipline and cash generation provide flexibility, with buybacks and M&A optionality as cash flow accelerates.
- Investors should watch Q4 margin inflection, Golden Dome order flow, and Healthcare division progress as key signals for FY27 trajectory.
Conclusion
OSI Systems is leveraging its service and RF strengths to offset near-term contract headwinds, with Opto and capital allocation discipline providing additional upside. Margin expansion and free cash flow acceleration are set to define the company’s narrative as it transitions into the next fiscal year.
Industry Read-Through
OSI’s results reinforce three themes for the security and industrial technology sector: First, the shift toward service-driven models is structurally raising margins and smoothing revenue volatility. Second, supply chain realignment away from China is creating durable growth opportunities for contract manufacturers with global reach. Third, government procurement cycles and large multi-year defense contracts introduce both upside and timing risk, a dynamic likely to persist across the sector. Companies with operational agility and capital flexibility will be best positioned to capture these trends.