In the past few weeks, OSI Systems Inc. has released a few new products – but they’re not the Hawthorne company’s notorious airport body scanners or the massive cargo screeners that are becoming OSI’s bread and butter.
One new entry, called Arkon, is an operating-room workstation and monitoring system for anesthesiologists; the other, called Qube, is a portable patient-monitoring system for use in hospital emergency rooms.
Made by OSI unit Spacelabs Healthcare, they are the most recent additions to the company’s expanding medical device offerings. They also are a rebuff to some investors who have called on the company to spin off the unit and focus on its growing and higher-profile security business.
“Spacelabs is not a stepchild to us,” said company founder and Chief Executive Deepak Chopra. “It’s a great segment for us, but everybody just wants to know about body scanners.”
So why is OSI so hooked to its medical unit? In part, Chopra said, because the devices carry higher margins compared with OSI’s scanner business. In fact, the company is doubling down on the medical device unit by trying to break into new market segments.
Analysts who follow the company agreed that Spacelabs is positioned for growth and that the medical device business is doing well. Still, they said, it’s nearly certain that Spacelabs and a smaller optoelectronics unit will continue to shrink as a portion of OSI’s overall business, which likely will lead to even more calls for a Spacelabs spinoff.
“That comes up frequently: Does it make sense for OSI to divest those businesses?” said Jeff Martin, co-director of research at Roth Capital Partners in Newport Beach. “The security segment is obviously growing faster. The other segments aren’t going to keep up.”
OSI’s Spacelabs unit, based in Issaquah, Wash., was acquired from General Electric Co. of Fairfield, Conn., in 2004. The unit makes patient-monitoring, cardiology and anesthesiology equipment. It manufactures products at plants in Issaquah, England, China and India.
In the fiscal year ended July 1, Spacelabs had global sales of $215 million, one-third of OSI’s total revenue. That’s well below OSI’s $295 million in security sales, but Chopra said the gross margin on medical devices is greater than 50 percent. That’s higher than the margin for security, though he would not say by how much, and the company does not break it out in the earnings reports.
Spacelabs plans to release several more medical devices over the next year, but of the unit’s new products, the Arkon represents the biggest growth opportunity. OSI has sold anesthesiology equipment in Europe, the Middle East and Asia for years, but the Arkon is the company’s first entry into the $400 million U.S. market for anesthesiology devices.
The company hopes to take a few customers away from big players such as GE and Koninklijke Philips Electronics N.V. of Amsterdam, the Netherlands.
“Obviously, we’re not saying we’re going to become a dominant player, but we will capture a good chunk of the market,” Chopra said. “We have no presence in the U.S. market, so a small chunk would be great.”
The Arkon combines patient monitors, a ventilator, paperwork storage compartments and a work table on a portable cart. The system, built by a team of former GE engineers, is designed to make anesthesiologists more comfortable during lengthy surgeries.
Tim Quillin, an analyst at Stephens Inc. in Little Rock, Ark., said the Arkon looks like a credible product that could win the company new business and new revenue.
“To be able to add in a product that can really (contribute) to current sales is an exciting prospect for them,” he said.
OSI has also introduced or updated other medical devices over the past year. Last year, it released a new version of its Xprezzon patient monitor equipped with software that allows doctors to check on patients from mobile devices.
“You can be on the golf course, dial in with your iPad and look at the (vital signs) of Mr. Jones lying in his bed,” Chopra said.
Then this month, the Food and Drug Administration approved the Qube, a smaller and portable version of the Xprezzon that can be used to monitor patients as they are moved around a hospital.
Over the next year, Chopra said he plans to announce more new products than during any other year in Spacelabs’ history.
Medical devices have been part of OSI since Chopra founded the company in 1988. Back then, its main products were components for CT scanners and devices that measured the oxygen content of blood. Only a few years later did the company start making components for bomb detectors.
Still, it’s not likely that sales of OSI’s medical devices will be able to match the company’s security revenue, which could grow by more than 50 percent in the next few years. Since 2005, medical devices have slipped from representing 51 percent of OSI’s revenue to 30 percent in the first half of the current fiscal year. Security, meanwhile, has grown from 32 percent in 2005 to 46 percent.
That growth was driven partly by orders for OSI’s Rapiscan Secure 1000 full-body scanners – ones that can give security officers a detailed, clothes-free glimpse at a body and that caused a stir when they were first widely used two years ago.
But the security trend is likely to continue. In the past year, OSI has announced contracts in Mexico and Puerto Rico to provide security-scanning services rather than simply sell scanning equipment. In Mexico, the company will check for contraband coming into ports and airports, and moving through security checkpoints; in Puerto Rico, OSI will scan cargo containers moving through the island’s ports.
Those two contracts, expected to bring in a combined $170 million annually starting in the next few years, will likely boost OSI’s security revenue well beyond half of overall revenue.
That, in turn, could drive investors to renew calls for OSI to spin off Spacelabs, despite Chopra’s belief that the company is better off with all three of its business segments. The smallest unit, optoelectronics, makes light- and radiation-sensitive parts that go into OSI’s medical and security devices. They also are sold to other companies.
“There’s a real logic to how this whole model works,” Chopra said. “There’s a cross-pollination of technology. We’ve explained that being a broad-based technology company is much better.”
Still, investors prefer focused, pure-play companies and while Quillin said a breakup doesn’t look like the right move now, it might later on if the medical device business holds OSI back. For now, the stock is trading at an all-time high, above $62 a share.
“All of the businesses are doing real well right now,” he said. “So as long as (managers) are proving they can execute in all three businesses, there won’t be a lot of pressure to split those companies apart. But if there’s any misexecution or any of those businesses go off the track, then they could have a situation.”
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