Osi Systems Inc Q2 FY2025 Earnings Call

Hello, everyone, and welcome to the OSI Systems Inc. Second Quarter 2025 Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. Now it's my pleasure to turn the call over to the Executive Vice President and Chief Financial Officer of OSI, Alan Edrick. Please proceed.

Thank you. 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 new President and CEO. Earlier today, we issued a press release announcing our fiscal 2025 second quarter financial results. Before we discuss these results, however, 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 refer both to 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 release. I will begin with a high-level summary of our financial performance for the second quarter of fiscal 2025 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 updated outlook for fiscal year 2025. Our second quarter financial results were excellent with record Q2 revenues and operating income at the Security division and solid performance by the Opto division. We are excited by the momentum across our business and are confident that we are well-positioned for the second half of the fiscal year. So let's start with a high-level summary of our fiscal '25 Q2 results. First, revenues increased 12% year-over-year to a Q2 record of $420 million with growth in each of the three divisions highlighted by the 16% year-over-year revenue increase in our Security division. Second, the strong revenue growth led to record Q2 non-GAAP adjusted earnings per share of $2.42. Third, bookings were significant. And with a book-to-bill ratio of 1.2 in the quarter, we finished the quarter with a record backlog of more than $1.8 billion. Our strong backlog and robust pipeline of opportunities provide good visibility going forward. And fourth, we generated operating cash flow of $53 million in Q2, a $76 million jump over the same quarter in the last fiscal year. This performance was driven by strong profits and an improvement in working capital metrics. As you may know, we had mentioned in our previous call that our strong operating cash flow dynamics was expected to return in 2025. Before diving more deeply into our financial results and discussing our updated outlook for the full fiscal year I will turn the call over to Ajay.

Thank you, Alan, and thank you everyone for joining us today. I'm pleased to join this call as CEO for the first time after assuming the role on January 1st. It is gratifying to report another record-breaking second quarter for fiscal 2025 where we achieved revenues of $420 million, representing a 12% growth year-over-year and strong earnings. The quarterly performance was driven primarily by excellent execution in Security and solid results from the Optoelectronics and Manufacturing division. Our continued healthy backlog as Alan pointed out and expanding opportunity pipeline provides us confidence for robust growth in the second half and fiscal year and positions us well for the future. Let me discuss each division's performance starting with Security. The Security division delivered Q2 revenues of $290 million, representing a 16% growth over Q2 in the prior year. Bookings were also excellent, as we achieved a book-to-bill ratio of approximately 1.2 for the quarter. During Q2, we continued to deliver on programs and numerous locations, including airports, ports, borders and critical infrastructure. In addition, our turnkey projects are performing well in Albania, Puerto Rico, Guatemala and Uruguay, which commenced earlier last quarter. During the quarter, we received significant orders for both aviation and cargo products and announced a few of these wins shortly after the quarter ended. First, we announced a $27 million award to provide checkpoint and whole baggage inspection products for an international airport. The products to be provided include, RTT 110, explosive detection systems for screening whole baggage, Orion 920 CT checkpoint screening systems, which are integrated with our Rapiscan trade return systems. In addition, we will supply our trace and other screening systems for air cargo. This award is the latest in a string of major international airport awards received in the past few quarters, which indicates promising growth for our aviation security product revenues going forward. Second, we announced an $81 million order from an international customer for Eagle M60 mobile high-energy cargo and vehicle inspection systems for border security applications. Third, we announced a $32 million award from an international customer for M60s, including service and support for port and border security applications. Expanding our installed base among aviation and border security customers not only broadens our hardware installed base, but also significantly boosts our potential for future recurring service revenues. Our aviation contracts open up avenues for additional revenue to follow-up training, hardware maintenance, spare parts and upgrades to our automated threat detection algorithms. Similarly, some of our border and cargo security clients, aside from seeking these types of services mentioned also utilize a proprietary search scan, multisite integration platform. This platform allows us to increase future revenues through new user licenses and software upgrades. Our inspection systems have a typical life cycle of 7 to 10 years, thereby creating a predictable stream of ongoing recurring service revenues. Lastly, we announced a $23 million order to support deploying and integrating long-range radio frequency critical communication systems. As part of the award, we expect to provide essential hardware and technical services to enhance the US government's strategic RF communication capabilities in a critical region. This is an excellent win for us in our recently acquired RF Solutions business. Furthermore, we are optimistic that we can enhance this business in the marketplace by utilizing our global reach across regions and offering solutions to customers with critical security communication and surveillance requirements. Our security pipeline includes a wide range of opportunities, both internationally and domestically. Moreover, domestic growth would accelerate driven by the new administration's national security policies. With both major political parties supporting enhanced border security, we are well-positioned to play a key role. Our nonintrusive inspection technologies are ideally suited to bolster security at airports, ports, borders and other critical infrastructure points. Overall, while product revenue growth has been robust, we expect service revenue as a percentage of overall security revenues to increase and these historically have a higher margin. Moving on to Optoelectronics. Optoelectronics delivered another impressive quarter on modest top line growth, achieving a quarterly record with $101 million in revenues. This record was in part driven by our flex circuit operation which serves consumer and medical technology customers and was a major contributor to Q2 growth. Based on Opto's recent trends and our dialogues with key OEMs, we believe that the phase where many customers were adjusting inventory levels and tempering demand forecasts is now mostly in the past. During the quarter, we announced an $11 million order to provide critical electronics subassemblies for a long-standing healthcare OEM customer. We also announced an order for $6 million from a different healthcare OEM to provide optical sensors for its patient care devices. These orders exemplify the kind of repeat business we consistently secure from established customers, accounting for approximately 80% of this division's total revenue. We are actively working with clients looking to diversify away from China by relocating component or value-added manufacturing to our international facilities. Given our current demand visibility, we anticipate the Opto division will deliver robust performance in the second half of the fiscal year. And finally, let's discuss the Healthcare division where Q2 revenues grew 7% year-over-year with improving profitability although less than we typically see. It was nice to see a return to growth in healthcare indicative of a pickup in order activity from hospitals and solid execution of our sales strategy built around clinical workflow and predictive analytics solutions. During the quarter, we announced a $6 million order from a U.S.-based hospital system to provide patient monitoring solutions and related supplies. We expect to provide a range of patient monitoring solutions and accessories to support this customer and others. While we continue to invest in developing new products including our next-generation platform, we are intently focused on driving growth and improving the overall operating performance of our Security division. On a personal note, I'm honored and excited to begin the President and CEO role at OSI. The company has a critical mission to support the global community's safety, security, and well-being. Having been part of this company's journey, I have seen the potential in all of our operational divisions and the talented individuals who have been key to our success. I look forward to continuing OSI's growth. Overall, we are pleased with OSI's first half look and look forward to an even stronger performance in the second half. 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 the fiscal 2025 second quarter. As previously mentioned, our Q2 revenues were up 12% compared with revenues in the second quarter of the prior fiscal year. This increase was primarily driven by our largest division, Security. The 16% year-over-year increase in Q2 Security division revenues was fueled by growth in aviation checkpoint product sales including strong growth in trace detection system sales. Q2 revenues included continued shipments from the $200 million-plus cargo contract and also from our two contracts with the Mexican government. In addition, the business we acquired in fiscal Q1 is gaining momentum and contributed to the Security division revenues nicely. Third-party Opto sales were solid delivering a 4% year-over-year increase, driven by growth from our Flex business as well as others. The rightsizing of inventory levels as Ajay mentioned with our Opto customers is largely complete and we anticipate an acceleration of the revenue growth rate in the Opto division as early as Q3. And the Healthcare division returned to growth, reporting a 7% increase in year-over-year sales in Q2. The fiscal 2025 Q2 gross margin of 35.1% was solid. Our gross margin in Q2 last year of 37.9% was the strongest in any quarter of fiscal 2024 due to a very favorable product mix in Security. Our gross margin will generally fluctuate from period to period based on revenue mix and volume, impacts of changes in supply chain cost, inflation and effects of inflation among other factors. Moving on to operating expenses. Q2 SG&A expenses were $71 million or 16.8% of sales compared to $72 million or 19.2% of sales in Q2 of the prior year. The 240 basis point improvement resulted from leveraging our fixed cost structure and maintaining strong discipline in managing such costs. We work diligently across each of our divisions to improve efficiency and manage our SG&A cost structure. Research and development expenses in Q2 of fiscal 2025 were $18 million or 4.3% of revenues compared to $16 million or 4.4% of revenues in the same prior year quarter. We continue to dedicate considerable resources to R&D, particularly in our Security and Healthcare divisions as we remain focused on innovative product development, which we view as vital to the long-term successes of our businesses. We recorded a $0.2 million restructuring and other charges in Q2 of fiscal 2025 compared to $1 million in the same quarter of the prior year. Moving to interest and taxes. Net interest and other expenses in Q2 fiscal 2025 increased to $8.6 million from $6.5 million in Q2 fiscal 2024, primarily due to a higher amount of borrowings associated with the investment in working capital for the sales growth and acquisition completed in Q1 and stock buyback, partially offset by the favorable impact of the convertible notes issued during Q1, which were partially used to repay higher cost borrowings. Our reported effective tax rate under GAAP was 23.3% in Q2 of fiscal 2025 compared to 20.2% in Q2 of last year. However, excluding the impact of discrete tax benefits, our normalized effective tax rate, which is the rate reflected in our calculation of non-GAAP adjusted EPS was 24.0% in Q2 fiscal 2025 compared to 25.8% in Q2 of 2024. I'll now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our adjusted operating margin in the second quarter of fiscal 2025 was a solid 15.0%, up sequentially from 10.3% in Q1. This quarter faced a tough comparison as Q2 in fiscal 2024 was 15.5%, which was the strongest adjusted operating margin quarter of FY 2024. The Q2 adjusted operating margin in the Security division was 19.9%. Although down year-over-year due to this tough comparison, this represented the second strongest adjusted operating margin in the Security division's history. Due to a ramp-up of newer Opto operations, the Opto division's adjusted operating margin was 12.8% in the second quarter of fiscal 2025 compared to 13.4% in last year's Q2. We anticipate nice adjusted operating margin expansion in Opto in the second half of fiscal 2025. The Healthcare division's adjusted operating margin while wider than we would like, still increased 300 basis points year-over-year. Moving to cash flow. Q2 marked a return to significant cash flow with cash provided by operations of $53 million. CapEx in the 2025 second fiscal quarter was $5.5 million while depreciation and amortization expense in fiscal Q2 was $10.6 million. We saw a nice improvement in DSO in Q2 and solid collections led to a 16% reduction in DSO from Q1. As we mentioned last quarter our receivables and DSO are both above typical levels mainly because of the timing of billings and collections for our significant international security cargo contracts. For these contracts, billing is triggered by the achievement of significant project milestones, which are highly influenced by the customer's timeline and sign-off. So under GAAP we recorded an unbilled receivable for revenue earned and then bill and collect cash subsequent to the achievement of the relevant milestone. Note, while unbilled receivables are elevated relative to the historical levels and represent a significant source of future cash flow, the balance decreased by 19% at the end of Q2 versus the end of Q1. We continue to anticipate operating cash flow could be significant in the second half of fiscal 2025. Our balance sheet is solid with net leverage of approximately 2.1 as calculated under our credit agreement. Aside from $7.5 million of annual required principal payments under our bank term loan, the bulk of our bank debt matures in fiscal 2027. We estimate over 70% of our debt was fixed versus floating at the end of Q2 of fiscal 2025. And finally, turning to guidance. We are increasing our fiscal 2025 revenues and non-GAAP diluted EPS guidance. For the full fiscal year, we anticipate revenues in the range of $1.685 billion to $1.710 billion, increasing our guidance on year-over-year revenue growth to a range of 9.5% to 11.1%. We are also increasing FY 2025 non-GAAP adjusted earnings per diluted share guidance to a range of $9.10 to $9.40 per share, representing 11.9% to 15.6% growth. This fiscal 2025 non-GAAP diluted EPS guidance excludes potential impairment, restructuring and other charges, amortization of acquired intangible assets and their associated tax effects as well as discrete tax and other non-recurring items. We currently believe this guidance reflects reasonable estimates. The actual impact on the company's financial results and timing changes on the expected conversion of backlog to revenues and new bookings is difficult to predict and can 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. We continue to remain focused on the growth of our businesses. We believe our efforts will enable OSI to continue providing innovative products and solutions. We'd like to take this opportunity to thank the global OSI team for its continued dedication in supporting our customers and partners. And at this time, we'd like to open the call to questions.

Thank you. It comes from the line of Josh Nichols with B. Riley. Please proceed.

Yes. Thanks for taking my question. Ajay, congratulations on the new role. Things are off to a great start. Looking, you touched on it briefly, I think, but while it's early days, the new administration clearly has an increased focus on border security. Any context you could provide around the potential increase in opportunity versus what you're currently doing on the US border front and how that could change if there's some increased allocations to budgets for some of these three-letter agencies that are going to be doing a lot of the border security if there's an anticipated ramp-up over the next few years, presumably?

Josh, this is Ajay. Thank you. So, great question. It's been not even three days, but I think, as you know, that border security really is, by and large, an issue. And there's been a lot of movement both in the House and in the Senate trying to reconcile the bills, which are substantially higher than what they were previously in terms of total funding. So we think with the new emphasis with the new administration, it's positive. We believe that the technology that we provide and not just the technology, but some of the software like CertScan, which we're able to really go in and look to see if drugs, and the wrong people are coming in, is really a plus for us. We are the dominant player with CBP, and we feel very good as we go forward. And I think that we'll see more and more over the next three to six months, but all indications from our end are positive.

Thanks for the context. And then just a little bit deeper, I mean, on the recent acquisition, the RF Solutions business seems to be doing pretty well. I noticed the company secured, I think, a $23 million award already. Could you talk a little bit about some of the opportunities that you see layering this into OSI Systems, given that you have a much larger global sales infrastructure and the opportunity to kind of expand the revenue base relative to what it was currently doing before you acquired the business?

I think you kind of answered your question over there because, yes, one of the advantages that this company has now is, it's got OSI's financial muscle as well as the different areas that we are in all over the world. So we definitely are going to help them. We are integrating them, working very closely. I mean just keep in mind they're in the defense sector, but also their over-the-horizon radar is really crucial for border security and drug interdiction. Keep in mind that these radars provide broad range-based surveillance systems that enable tracking of aircraft, drones, surface ships and designated zones around the U.S. border. And we feel that's an opportunity as we go forward, besides obviously their traditional opportunities in defense. So we are talking to the customers. And we have had a very positive response. Also, I think from an OSI perspective, we have a customer base which is very similar to theirs, but it's got us deeper into those customers. And more and more we have more to discuss with them. So we're not just discussing, scanning, but we're discussing how we protect the overall border, for example.

Sounds good. Thank you.

Thank you. One moment for our next question please. It comes from the line of Mariana Perez Mora from Bank of America. Please proceed.

Hello everyone and thank you for taking my question. So the first one is going to be around Mexico and I appreciate the details you gave in the prepared remarks. But could you please describe how much of a contribution Mexico was to the quarter? And how should we think about that going forward at least in the second half of the year? I see that book-to-bill was really strong in the quarter. And you also had a really strong start to the year with orders. So is that enough to offset any slowdown in terms of recognition of the Sabina contracts? Or how should we think about that transition? Thank you.

Hi Mariana, this is Alan. Good question. The Mexico contract was a significant contributor to us in the first half of the year. In the second half of the year, it's anticipated to continue to be a significant contributor, but at a lighter amount than we saw in the second half of fiscal 2024, with a very robust backlog and the strong opportunity pipeline we're effectively replacing the strong Mexico revenues that we had in Q3 and Q4, a portion thereof with non-Mexico contracts. We feel extremely confident about that. So really a robust opportunity set. Mexico is important to us. But as we have said, we shipped a significant amount last year, shipping a significant amount this year, but we are really well positioned for the future because we have such a strong backlog of non-Mexico business and such a strong opportunity set as well.

Thank you. As we consider this transition, especially since the initial stages of this contract focused mainly on products, how should we view the balance between products and services for the second quarter and likely over the next 12 months?

So this is Ajay. I think that if you look at the product that's getting shipped, we always say that one of the things the products that we ship leads us to recurring service revenue. So we feel really into 2026 and really 2027 and beyond that we're going to see some very good recurring revenue from certain risks. All these products have to be serviced in Mexico for example. So that revenue will continue. And as I mentioned earlier that service revenue has very good margins. So we're fully expecting that.

And maybe to supplement that, this is Alan. We've had significant product revenue growth over the last few years. And as those products are now beginning to roll off of warranty and create service revenue, as Ajay described, we expect to see real strong service revenue growth at the higher contribution margins beginning as early as now this sort of Q3. So it's a nice position to be in with a strong installed base that we put out there moving to this more recurring revenue at higher margin is a nice position to be in.

Thank you. And one more from my end. I'm just curious like part of this radio frequency critical communications award that you got. How much of that is incremental to the portfolio you acquired? And how much is more like a recompete of what the existing portfolio was?

We see opportunities for incremental business, but this particular situation is new as we move forward. Our goal is not only to capture this incremental business but also to achieve growth. With the support of OSI, we aim to expand beyond just the defense sector into areas like border security where we see potential for new business. We are committed to maintaining our existing business while also exploring new opportunities.

Perfect. Thank you so much for the color.

Thank you. One moment for our next question, please. It comes from Larry Solow with CJS Securities. Please proceed.

Thank you, Ajay. I welcome you and congratulate you on your new role. My first question for you is regarding the expanding opportunity pipeline you've mentioned. You've shared insights about your end markets and verticals, but I'm curious if any of those verticals stand out with greater potential for expansion moving forward. We've discussed ports and borders extensively, and it seems like the new administration may not bring significant changes, despite what the headlines suggest. Does the new administration create more opportunities for expansion, or where are you observing notable growth potential?

Thank you, Larry. Growth is happening across all areas. While we discuss border security, which is currently in the news, we anticipate growth there as many projects are just beginning. As Alan mentioned, this isn't solely about the initial products; it's also about how we can integrate them with our CertScan software to generate recurring and service revenues. Aviation presents substantial opportunities, especially internationally. We've revealed some orders, and we see potential in check baggage and checkpoint systems. With the recent changes at TSA, we are poised for opportunities, particularly since our RTT product is highly advanced and many of their systems are over 20 years old. These are likely to be replaced in the next few years. We are also involved in their tray systems, which present significant prospects, both in the U.S. and abroad. Additionally, with the move away from manufacturing in China, our extensive international facilities position us well. We collaborate with many defense companies in both security and Opto sectors, allowing us to leverage these opportunities and engage with customers as a uniquely positioned company. In the medical sector, we are investing heavily in next-generation products and expanding our offerings just as we are in security. Overall, we are optimistic about growth opportunities that extend beyond just ports and borders, as that is just one important aspect of our potential.

Right. And on the ports and borders in particular it feels like you've announced several larger-sized deals. Most of them were actually international. I'm just curious do you feel like you got a bigger opportunity now? While obviously international is a bigger geographical region, but is the US to me seems like maybe it's lower on your proportion of what's driving ports and borders today. Is that a fair statement?

You know, I think that the US is just as important if not the most important to us. As you look at it we've driven a lot internationally, but we have these IDIQs with CBP for example. And I think there are going to be new IDIQs coming in. We have worked very closely with CBP and other organizations where we develop new products they're coming out. We have the largest share of the market in the US. And we feel as the next-generation products come out which we've developed very closely talking to our customers. So it's not just something we're coming out with and integrating the hardware with the software where it makes it easier for people to look for contraband, et cetera. And keep in mind a lot of people just look at security as an expense. But at the end of the day when we introduce these products and I'm not going to go into some specifics for competitive reasons, but it really facilitates the trade coming through the borders. And in the end it's really cheaper overall for the consumer. So a lot going on but the US is important. I think there's a good opportunity for the next several years.

I have a question about the margin security. You mentioned that the gross margin was down year-over-year due to the mix. However, when looking at it sequentially, it appears that your services revenue was fairly stable while your margin increased by 550 basis points. Is this primarily driven by SG&A leverage from the higher revenue? Would you say this is the main factor?

Yes, Larry, it really is. The economies of scale as we leverage our fixed cost structure. So that is really kind of what drove it on a sequential basis for OSI Systems overall. You're exactly right.

Got you. Finally, regarding the Opto division's 4% growth in the quarter, it's a welcome return to growth in the first half. You mentioned several qualitative aspects, including onshoring, and I know you have a new facility in Mexico. What is the main driver behind the expected margin expansion in the second half of the year? Is it simply due to operating leverage, or could you provide more details on that? Thanks.

Good question, Larry. This is Alan. So I'd say really what's going to drive the accelerated growth in Opto as we expect in the second half of the year is a few-fold. One is kind of the rightsizing the inventory levels is largely behind us. So we're now seeing customers return to their normal ordering patterns. And in fact our book-to-bill in Opto in our second quarter was north of one as well. So we expect that to drive accelerated growth. You mentioned the new operation that we have in Mexico. That is gaining momentum also which will certainly help. The mix of business is expected to be favorable for us in the second half which should also drive some margin expansion. So all-in-all we expect to see some nice top line growth coupled with operating margin expansion in the second half for the Opto division.

Great. Thanks, Alan. I appreciate it.

Thank you. Our next question comes from the line of Christopher Glynn with Oppenheimer. Please go ahead.

Yes. Thanks. Curious I just want to dive into the aviation sector a little bit and welcome Ajay. Good to hear you on the call. Curious would you call the global replacement upgrade cycle in aviation in its early days? I know the US is sort of lagging internationally, but maybe kind of an innings rating for the international and the total global on that? And are you seeing improving win rates in aviation versus historical?

Thank you, Chris. It's an interesting question because aviation is a large market. Within aviation, there are various checkpoints, including checkpoint CT systems for baggage, people screening, and trace products. The US has been focused on checkpoint CT, and I believe they will consider improvements in trace, where we are a significant player and a leader. RTT for checked baggage also presents a substantial opportunity for us. We expect that TSA will start looking to upgrade or replace some products in a few years, around three years from now. This reflects where the market is heading, and we believe we are well-positioned to engage. Internationally, we are securing many orders in this large market, involved in checkpoint, checked baggage, and trace sectors. We have bundled our products, and customers are familiar with us. The market varies; in some regions, it's just beginning, while in others, it's more established. As we approach the end of one cycle, another begins, reflecting an ongoing process. Much like owning a car, this equipment typically lasts seven to ten years, although in aviation, it may vary slightly depending on technology. This business is continuous, and as we move forward, there is recurring service revenue. Thus, it's not a straightforward matter of beginning and middle; it's an ongoing business, which is the best way to frame it.

That's really helpful for understanding that. You mentioned the bulk of the debt coming due in fiscal 2027 or calendar 2027. What are you anticipating for pricing or timing as you address that? How far ahead are you interested in tackling this?

Hey, Chris, this is Alan. So yeah, the credit facility, which is sort of our natural five-year credit facility, matures in December of 2026, which is our fiscal 2027. Throughout the course of calendar 2025, we'll be working with our banks as we've done numerous times in the past to likely amend and extend the credit facility. As you may know, even though we're not an investment-grade company due to our size, we have investment-grade pricing as it comes to the credit facility. So quite favorable for us.

Great. Thanks. That's all I got.

Thank you. Our next question comes from the line of Matt Akers with Wells Fargo. Please proceed.

Hey, good morning, guys. Thanks for the question and congrats, Ajay, on the new role. I wanted to ask about cash. Good to see positive cash flow in the quarter, some of that working capital reversing. I know, Alan, you mentioned the back half continue to see pretty good cash flow. Just curious, should we see that as still kind of lumpy around maybe some of these milestones on some of the big international products? Or are we to the point now where that's kind of a steadier free cash flow here going forward?

Yeah, Matt, good question. This is Alan. It will never be sort of a steady pace of cash flow in the likes of our business. We'll always have some quarters that are much stronger and some quarters that are a little bit lighter. We have an opportunity to continue to sort of outperform on a cash flow basis with a strong free cash flow to net income conversion rate given that we have some money sort of tied up in working capital. So as the receivables begin to normalize, as does the inventory, there's opportunity for significant free cash flow generation. And we expect to see that in our second half and as we move into fiscal 2024 and forward. So we think we'll continue to have a good free cash flow conversion rate, but it's never going to be perfectly smooth due to kind of the nature of our business and some of the international contracts that we have.

Yeah. Got it. Okay. And then I wanted to ask about tariffs, given that that's been kind of a topic with the new administration. Just curious how you think about any risk associated with either prices due to tariffs or customers? You guys have a lot of international business Mexico for example just how you're kind of thinking about the risk around that.

Yes. It's a question that is on a lot of people's minds obviously. I think, it's a little too early to tell what's going to happen. But I will say from an OSI perspective, we're well situated because we have manufacturing facilities in the US. We have manufacturing facilities in Europe and Asia. And we have the flexibility to turn things around and really work closely with our customers on what their needs are, and if they need to address any tariff situation. So I think at this point, it's a wait-and-see attitude, but I think it's much more of a challenge for companies that are manufacturing only outside the US and importing into the US. For us, like I said, it's much more flexible and we have the ability to really switch manufacturing to different locations. So we'll watch it just like everybody else is watching it.

Yeah. Great. Thank you. And then if I could squeeze one last one in. I guess, maybe any way to think about the seasonality between Q3 and Q4? I think Alan as you mentioned Q2 last year margins kind of unusually strong. Just anything to think about it as we go into the back half?

Yeah, Matt, good question. We would see the back half weighted a bit more to Q4 as we typically do. Q4 tends to be our strongest quarter at the end of the fiscal year. As a result we would see our revenue stronger there. And from a margin mix perspective, we would expect to see the operating margins stronger in Q4 than in Q3.

Great. Got it. Thank you.

Thank you once again. We have a follow-up question from Mariana Perez with Bank of America. Please go ahead.

Thank you. Hello, again. So I have a follow-up to Matt's question. When we think about balance sheet and free cash flow how should we think about receivables going forward and especially the unbilled receivables balance?

All right, Mariana, it's Alan. So we would expect that our DSO is going to improve going forward. Of course, we expect to grow the top line. So in absolute dollars receivables could grow from time to time, but we'd expect to see our DSO down. With respect to unbilled receivables, we are really pleased to see a 19% decrease in our unbilled receivables from the end of Q1 to Q2, which is what we are anticipating. I believe as we get to the end of the fiscal year in June, we'll see those unbilled receivables significantly down from where they are today. And as we move the unbilled receivables to billed receivables and therefore cash collection that's what should drive sort of this outsized free cash flow for us as well. So a real nice position to be in for us.

Thank you. And one more on the contribution from the acquisition. Have you measured how much was it per share?

Not per share. We did roughly $17 million of revenues in the quarter. So it performed quite nicely for us.

Thank you so much.

Thank you. One moment for our next question, please. It comes from the line of Jeff Martin with ROTH Capital Partners. Please proceed.

Thanks. Hi, Alan and Ajay, somehow I get mixed up in the queue, currently. I wanted to dive into the surveillance business that you acquired in September a little more. In terms of the product portfolio, are there things you can do to enhance that offering? Is it where it should be? Do you need to invest significantly in R&D and other complementary products that are either in your existing security product portfolio or that you might look to acquire in the future to enhance that?

So Jeff, I think, I went into it a little bit but just to reemphasize why this made sense was number one, the customer base that they have in the US with DoD and obviously internationally is really something that we're very familiar with and we're able to go and talk to those customers and really expand our offering. You go and look at some of the products that they have, I mentioned the over-the-horizon radar. Obviously, what everybody looks at over-the-horizon radar is for drones and missiles, like what's going on in Ukraine, everybody was looking at ballistic missiles coming through. And that's where satellites would pick up. But cruise missiles and drones are causing just as much damage. So, there's a big opportunity for traditional over-the-horizon radar to be there. Having said that, it really applies very closely like I mentioned, to what we do is more security, because these radars can be used for ships, vehicles, drones coming across the border, carrying all kinds of drugs and anything else, and the capabilities of drones from a payload is going to get bigger and bigger. So I think that's going to become a definitely more and more of a threat. And then traditionally out there in other defense areas, like their ULF, which is ultra-low frequency, which is really for communication for submarines when they're underwater that's the only form of communication that they really have. And there are opportunities in space and others. But really, the key opportunity for us is providing them with the capabilities from a financial standpoint, from a reach standpoint and really working much closer with some of the larger companies, defense contractors out there. As far as your question on R&D, they spend money on R&D, but a lot of that R&D is funded by their customers. So we think it's a very good fit and the opportunities are definitely there and we'll keep you informed over the next several quarters, but we feel good about it.

That's helpful. Appreciate that. So, the security and the Opto have been covered pretty extensively. So, all throughout the health care division question, out there. I know you've been working on next-generation patient monitoring systems for several years now. Are you at a point where you can kind of give a timeline on what the rollout of that new platform looks like? And you also have mentioned in the past that you're evaluating the leasing model within the industry, which could be a differentiator. And just maybe, if you can give an update if that's gained much traction or if that's more pending the launch of the new patient monitoring platform.

We are investing significant resources in the new platform with our R&D team. I can't provide a specific timeline due to competitive reasons, but we anticipate advancements in 2026 and beyond. We are encouraged by the progress we are making. Additionally, we are looking at other offerings beyond the next-generation platform, such as remote monitoring and predictive analysis, which all complement each other. Our goal is to enhance our technology and sales capabilities for future growth. As we begin to launch these products, we will share more details.

Great. And then last question for me on the turnkey side, you mentioned existing customers are happy. Things are going well there. Are you seeing much opportunity to expand the customer base within the turnkey solutions offering?

The short answer is, yes, we're working on several opportunities. Like, you know, these are not opportunities that happen in a couple of months. In some cases, you have to work with the international governments, you have to basically go through and educate them on the whole process. So it takes quite a while to get through it, but we are actively working on several opportunities right now.

Excellent. Thank you.

Thank you so much. And I do not see any further questions in the queue. Back to you guys.

Well, thank you. Once again, thank you for participating in our conference call, and we look forward to speaking with you at our next earnings call.

And thank you everyone for participating in today's program. You may now disconnect.