OSI Systems [OSIS] last month scored its second major turnkey screening services contract in two years, a six-year, $400 million contract a tax and customs agency in Mexico that gives the company a stable revenue stream in the coming years, something missing from the security equipment vendors whose business tends to go up and down.
The company says the award value could increase once the program scope has been finalized but the $400 million is the minimum, Deepak Chopra, OSI’s chairman and CEO, says on the company’s second quarter earnings call. That means the contract will provide “substantial recurring revenue and profit streams for OSI over its six year duration,” he says.
OSI will have more clarity on the contract by this spring, Chopra says.
Alan Edrick, the company’s chief financial officer, says the long-term recurring revenues from the new contract will be above those expected from OSI’s backlog at the end of its second quarter. Backlog stood at $377 million at the end of December.
Under the contract with the Servicio de Administracion Tributaria, OSI’s Rapiscan Systems division will provide cargo and vehicle inspection systems, staffing, maintenance support and systems integration to network sites throughout the country, including ports of entry, inland checkpoints and airports, all part of a comprehensive cargo and vehicle screening program.
Chopra calls the award a “landmark even” for the security industry, which typically sells its screening equipment to customers as part of their security infrastructure. Two years ago the company won similar turnkey screening services award with the Puerto Rico Ports Authority.
However, the 10-year award with Puerto Rico, which analysts peg to be worth about $200 million over that time, works on a fee-per-scan model. Still, that contract opened the door for a another way of doing business with customers in the security market and the new win in Mexico validates Rapiscan’s its approach to providing alternative solutions.
The “Mexican contract is material because it validates the company’s strategy of providing turnkey services to expand its addressable market,” Benchmark Capital defense and security analyst Josephine Millward says in note about OSI’s second quarter earnings. “OSI’s security business is expected to grow double-digits in the coming years while its competitors are struggling to grow.”
Millward also points to the stable revenues that both the Mexican and Puerto Rican contracts will provide OSI, helping to smooth out what is “a traditionally lumpy business.” She also believes the profit margins on these contracts will be better than the usual straight forward equipment sales.
Stephens, Inc. security analyst Tim Quillin also lauds OSI’s Mexico contract, calling it a “game changer in terms of its impact on visibility, growth, margins and investor perceptions.”
OSI expects to get to a full-run rate on the Mexico contract before its FY ’13 begins, which is July 1.
OSI says its win in Mexico came against a competitive field, taking more than a year to secure, and benefited from its ongoing work in Puerto Rico. It also says there will be more turnkey screening services opportunities, for which it will be at an advantage give its wins in Puerto Rico and Mexico.
Chopra says that his company is “actively involved” in other potential turnkey screening services opportunities, which he says have a long cycle before award, and that it is not at capacity in terms of being able to pursue these opportunities.
Any purchaser of security screening equipment remains a potential buyer for a screening services solution, Chopra says.
As for operations in Puerto Rico, OSI has two screening sites operational and the third is expected to be ready by the end of its third quarter, which will account for about 85 to 90 percent of the screening, says Ajay Mehra, president or Rapiscan. One smaller screening site will also be set up, he adds.
Edrick says the second quarter revenues from the Puerto Rico work were about 20 percent of what the company expects at its peak quarter from the contract. That was with one screening site. The second site became operational in January.
While the company won’t disclose margins on the contract, and other turnkey services work Rapiscan is pursuing, he says the margin profile is “significantly above” its typical business.
Second Quarter Earnings
OSI posted a strong second quarter with net income up 34 percent to $12.3 million, 61 cents earnings per share (EPS), from $9.2 million (47 cents EPS) driven by record operating profits in its Healthcare Group and a 14 percent increase in operating profits at the Security Group to $8 million.
Losses from an airport security contract in Mexico where OSI took on the role of systems integrator are behind it, Edrick says.
Sales in the quarter grew 11 percent to $188 million from $169.3 million driven by a 16 percent gain at the Security Group to $89 million. Healthcare and the Optoelectronics and Manufacturing Group also increased sales.
Backlog at Rapiscan at the end of December stood at $286 million and bookings in the group were $56 million in the quarter. The Mexican screening services contract is not in the reported backlog.
Given its strong performance in the first half of its fiscal year, OSI raised its earnings and sales guidance for the year. Earnings are expected to be between $2.30 EPS and $2.42, up slightly from the previous outlook of between $2.27 and $2.40 EPS. Sales are now expected to be between $750 million and $770 million, up $10 million from earlier projections.