Remember the airport scanners that sparked a firestorm of controversy a year ago because they saw through clothing to show detailed images of a traveler’s body?
The Transportation Security Administration has quietly stopped buying the scanners, which are made by Hawthorne manufacturer OSI Systems Inc., until the software is changed so it doesn’t show such risqué images.
Though the $200,000 body scanners are a small part of OSI’s business, the company is eager to sell hundreds more to the TSA. It has submitted new software to the agency, and is awaiting what it hopes will be approval so the company can resume selling the units.
The company is trying to get the “nude image” hullabaloo behind it – even though it maintains the whole matter was media driven.
“(OSI) will not allow fabricated controversy or unsubstantiated claims to prevent us from working to provide the best security technology possible,” said Pete Kant, executive vice president of Rapiscan Systems, the OSI division that makes the scanners.
The company stands to lose millions of dollars in business if the TSA turns down its software. An OSI rival with software already up to TSA standards recently secured a nearly $45 million contract to provide scanners to the agency.
Even so, analysts who follow OSI are not overly concerned. The company, which makes other scanning devices and has wholly separate lines of nonsecurity business, posted record profits last year without a single scanner order from the TSA. (The scanners that prompted the controversy were purchased earlier.)
It has also launched a security-service venture through which it won’t just sell scanners but will operate its security devices for customers as part of a package of services. It already has won such a contract in Puerto Rico.
“The (airport) scanners are a bit of a sideshow,” said Timothy Quillin, managing director at Stephens Inc. in Little Rock, Ark., who follows the company.
Scanner orders
A little more than half of OSI’s revenue comes from two slower-growing business lines: medical devices, such as heart monitors, and opteoelectronics – light-sensitive devices used in the aerospace, medical and telecommunications industries.
However, its largest single line of business is Rapiscan, which also makes metal detectors, baggage screeners and massive X-ray machines. But by far its best known products are the Rapiscan Secure 1000 body scanners, which were first widely used last year. The backscatter scanners use low-powered X-rays that do not penetrate skin but provide clear body images.
That’s what caused an uproar that hit a peak about a year ago. Airline passengers complained they were forced to allow TSA to look at what amounted to nude images of themselves. If they opted out of that, the passengers were subjected to physical pat-downs by TSA agents. The situation became the subject of late-night jokes and a “Saturday Night Live” skit, for example.
While the military is still purchasing the scanners, the TSA placed its last order for them in October 2009 and will not purchase any more until the machines come equipped with what the agency is calling Automated Target Recognition software. A scanner with that software won’t show the nearly nude images that have raised travelers’ ire. Instead, it would show a generic outline of a person, more like a cartoon image, but it will highlight any suspicious areas agents should check by hand.
TSA officials hope the new software will blunt criticism of the scanners and help passengers get through checkpoints quickly.
“It addresses the privacy questions and enhances privacy,” said TSA spokesman Nico Melendez. “And it’s also effective for security. It makes the process more efficient.”
Currently, there are some 200 Secure 1000 scanners in use at airports across the nation. In an effort to preserve travelers’ privacy, TSA protocol calls for its agents to observe the images in a separate room away from security checkpoints. The checkpoint is only alerted by the agent if something in the image is suspicious. The new software would eliminate the need for the remote agent, speeding up the review process.
The TSA has successfully tested Automated Target Recognition software over the past year on another type of full-body scanners – ones that use high-frequency radio waves called millimeter waves and are made by L-3 Communications Holdings Inc., a New York rival of OSI. In September, the agency placed a $44.8 million order for 300 of the machines.
OSI delivered its version of Automated Target Recognition software to the TSA this summer. Melendez said the agency expects to start testing the software in the coming months, but he could not give a timeline for when it will be completed.
However, he noted that testing for L-3’s software took several months, including lab testing last fall and use at some airports this spring.
Josephine Millward, an analyst at Benchmark Co. LLC in Washington, D.C., who follows OSI’s stock, said she expects testing to wrap up by early next year and for TSA to resume scanner orders soon after.
“If everything goes well, OSI should receive a follow-on order from TSA in March,” Millward said.
Rapiscan’s Kant said that once the software is approved, OSI hopes to provide about half of the roughly 800 scanners the TSA is expected to purchase for U.S. airports. That could amount to $80 million in business – but the orders would likely be stretched out over several years.
Service suite
Still, the lack of TSA orders hasn’t scared investors. Stories about the nearly naked images started popping up in March of last year when OSI’s stock was trading for around $30. The stock closed Nov. 2 at $43.44., bolstered by strong fiscal reports.
The company recently posted strong fiscal first quarter earnings, and in the fiscal year ended June 30 posted record profit of $33.4 million. That was up 42 percent and driven in large part by growing sales of Rapiscan’s other offerings.
But beyond growth in the company’s sales of equipment, analysts say the biggest positive for OSI and Rapiscan is the company’s move into providing security services.
In September, the company won a $98 million contract with the U.S. Army to set up security systems at bases overseas. Early last year, the company signed a 10-year contract with the Port Authority of Puerto Rico to scan all cargo containers coming into the Port of San Juan and other island ports. The Caribbean operations started in April.
In both cases, OSI is providing equipment as well as the workers who either install or operate it. The company said it has more than 100 employees in Puerto Rico.
Still, the strategy comes with some risks, as it’s a different operating model that has required the company to spend money on personnel costs.
“There will be a few dozen people operating the equipment, so that is something of a twist on what they’ve typically done,” Quillin said. “The trick will be staffing it, and staffing it well and staffing it correctly.”
Rapiscan’s estimated revenue from the port operations will be about $20 million annually over the next 10 years, a figure that OSI is looking to boost by winning contracts at other locations.
“When we sell equipment, it has a useful life of seven to 10 years, so we’re not selling a replacement for seven to 10 years,” Kant said. “This broadens our market, and it adds more consistency to our overall revenues.”
