OSI Systems [OSIS] took a $2.7 million charge in its fiscal second quarter related to a decision by the Transportation Security Administration (TSA) to discontinue development funding for Automated Target Recognition (ATR) software for the company’s body scanners., a move that also resulted in the company de-booking $5 million from its backlog.
Despite the impact to its financial results, the company somewhat downplayed the fact that it appears to be out of the TSA’s market for the body scanners, which are called Advanced Imaging Technology (AIT), at least for now.
The decision by the TSA enables the company to quit spending research and development funds on the ATR software, for which “we saw a limited future beyond the TSA,” Deepak Chopra, chairman and CEO of OSI Systems, says on the company’s second quarter earnings call. On the other hand, Chopra notes that the company has sold “numerous” AIT system to non-aviation customers and expects to continue to sell them “where image accuracy supersedes privacy concerns.”
Last fall TSA decided it would warehouse some of the Secure 1000 AIT systems that it had purchased from OSI Systems’ Rapiscan division because of continued difficulties in developing the ATR software for the machines. TSA said then it would replace the Rapiscan system with AIT machines from its other supplier, L-3 Communications [LLL], which had already deployed ATR software to its systems.
TSA initially last May decided it would redeploy the Rapiscan AIT systems to smaller airports because the systems have a lower passenger throughput than L-3’s machines. But due to the continued difficulties by Rapiscan in developing their ATR software, TSA later decided to warehouse the AIT systems.
TSA and Rapiscan will work together to redeploy the Secure 1000 systems either to other government agencies that already use the body imagers or to other agencies that could use the systems to enhance their security efforts.
A TSA spokeswoman tells HSR that the agency currently has 250 of Rapiscan’s AIT units, 174 of which are operational at checkpoints around the country and 76 that are house in the TSA Logistics Center in Texas. By June 1, all of the company’s AIT units at aviation security checkpoints in the U.S. will be removed by Rapiscan at the company’s expense.
L-3’s systems have been working with an ATR capability for more than a year. Once a person is scanned by the machine, if the ATR software detects an anomaly hidden beneath a person’s clothing, it highlights the area of concern on a generic body image for possible further screening by a Transportation Security Officer.
By June 2013 all AIT machines used at airport passenger security checkpoints must be equipped with the ATR capability under a congressional mandate. TSA last September awarded contracts to three companies to provide a second-generation of AIT machines that would have a smaller footprint than the current systems that are deployed and have the ATR capability. The contracts went to L-3, American Science and Engineering [ASEI] and the Smiths Detection division of Britain’s Smiths Group.
OSI Systems also says that the Department of Homeland Security continues to investigate whether Rapiscan manipulated operational tests of its AIT systems so improve the chances that its ATR software would meet TSA’s requirements. TSA last November sent Rapiscan a “show cause” letter related to its concerns about the testing although an agency official testified before Congress at the time that there were not indications of malfeasance.
Chopra says the company believes it has clarified all of the questions raised in the show cause letter.
Progress on New Baggage Screener
Chopra also says that OSI Systems expects to begin taking orders in the first half of 2013, which coincides with the second half of the company’s fiscal year, for its new Real Time Tomography (RTT) checked baggage inspection system that received certification in Europe last year. That certification allows airports that adhere to the European Civil Aviation Conference standards to acquire the RTT system for screening checked bags.
The international pipeline for systems like the RTT is growing and is currently valued in the “multiple hundreds of millions” of dollars, Chopra says.
The RTT system is Rapiscan’s first checked baggage screening product so the company would have to win market share in Europe and elsewhere gain customers for the product. But Chopra says that in Europe many of the existing checked baggage systems are in need of replacement and adds that the company is already working with multiple airports for potential sales.
Moreover, says Chopra, the RTT’s selling point is that it has “the best price to performance” ratio versus other checked baggage screening systems and expected lower life-cycle ownership costs.
The TSA is evaluating the RTT system for certification in the U.S. to screen checked bags and Chopra says the company is more confident than ever that that agency will certify the system this year.
The RTT system is different that existing explosives detection systems (EDS) in that it has no moving gantry that spins around the bags as they progress down the screening tunnel. The lack of moving parts is expected to save big on operations and maintenance costs of the systems.
The EDS market is currently dominated by Safran Group’s Morpho Detection, Inc., business, L-3, and to a lesser extent Science Applications International Corp. [SAI].
Turnkey Services in Mexico and Puerto Rico
OSI Systems says that it continues to generate more revenues from its two turnkey screening services contracts, one in Puerto Rico and the other in Mexico, which is the larger of the two deals. In Mexico, where the initial scanning locations were certified as fully operational, revenues are expected to further expand in the second half of the fiscal year.
Chopra expects the scanning services to be fully operational at all locations in Mexico during the company’s 2014 fiscal year, which begins July 1. Currently in Puerto Rico the scanning services are running at 85 percent of the projected run rate and the company has to install screening equipment at one more location.
The turnkey services projects, which involve Rapiscan supplying the screening equipment and the personnel to do the screening on a fee-per-scan basis, are important long-term, stable revenue drivers for OSI Systems but also offer the company higher profit margins.
Beyond Puerto Rico and Mexico there continues to be interest from potential customers in turnkey scanning services projects, Chopra says. However, he says this business takes time to capture, which why the company has accelerated its deployment in Mexico in order to use it as a showcase to other possible customers.