Maker of Body Scanners May Need Image Control

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The latest development in the controversy over OSI Systems Inc.’s full-body airport security scanners stripped some of the value from the company’s stock.

The Hawthorne company May 20 said that its Rapiscan security unit, which makes the scanners, expects to receive a notice of proposed debarment from the Department of Homeland Security.

The company said the notice, a follow-up to a letter it received from the Transportation Security Administration in November seeking information about the testing of its software, restricts its ability to seek new government contracts. OSI will continue to fulfill its current contracts.

Shares of OSI, which trade on the Nasdaq, fell 15 percent to $54.59 for the week ended May 22, making it one of the biggest losers on the LABJ Stock Index. (See page 60.)

The scanners first became controversial when passengers complained they showed revealing images of their bodies to agents looking for potentially dangerous objects. The company then changed the images to look more like line drawings.

Separately, the government is investigating allegations that Rapiscan falsified test data for its software, which the company has denied.

The Transportation Security Administration in January said it ended its contract with Rapiscan for the $200,000 machines and Rapiscan agreed to remove its 174 scanners from U.S. airports. The company is trying to redeploy the scanners to other government agencies.

OSI said the notice from DHS is the first step in formal proceedings and will allow Rapiscan to communicate directly with Homeland Security officials.

Deepak Chopra, chief executive of OSI, said the company has complied with all obligations to the TSA.

“We look forward to having the opportunity to present our views to DHS and working with the agency to achieve a mutually satisfactory outcome,” he said in a statement.

OSI said there are two possible outcomes besides debarment: The parties could reach an administrative compliance agreement, or DHS could withdraw the notice.

Analysts who cover OSI are not alarmed.

Yair Reiner, an analyst with Oppenheimer & Co. Inc. in New York who follows the company, said a compliance agreement, which would result in a fine, is the most likely outcome. He has a “buy” rating on the stock and a price target of $70.

“Nothing we know suggests a breach serious enough to warrant a debarment,” he wrote in a note to clients. “We believe the DHS will ultimately come to an agreement with OSI and restore its normal vendor relationship.”

Josephine Millward, an analyst at Benchmark Co. LLC in Washington, D.C., wrote in a research report that the risk of debarment is extremely low and that the share sell-off is an overreaction.

The Rapiscan unit also makes metal detectors, baggage scanners and big X-ray machines and accounts for about half of the company’s revenue.

OSI’s other business lines are medical devices – such as heart monitors – and optoelectronics, which are light-sensitive devices for the aerospace, medical and telecommunications industries.