May 20 (Reuters) - OSI Systems Inc said the U.S. Department of Homeland Security has issued it a "proposed debarment notice" related to privacy concerns over its full-body passenger scanners used in airports, limiting the company's ability to sign new federal government contracts until the issue is resolved.
OSI Systems shares fell as much as 17 percent on the Nasdaq on Monday. They were down about 9 percent at $60.40 in the afternoon.
The U.S. Transportation Security Administration (TSA) cancelled its contract with OSI in January for its scanners using an X-ray technology called backscatter that displays naked images of passengers to security officers.
A TSA spokesman said in January the agency was in the process of removing all backscatter units from airports, replacing them with L-3 Communications Holdings scanners which only creates a generic outline of passengers' bodies.
The agency gave OSI's Rapiscan unit until June 2013 to come up with a software upgrade to prevent the scanner from projecting the naked images but said it was unlikely that the company would meet that deadline.
Rapiscan received a show-cause letter from TSA in November alleging that it did not disclose privacy-related issues in a timely or complete manner.
"Although we have not yet received the actual notice, it would be the first written correspondence from DHS regarding the show cause letter," OSI Systems Chief Executive Deepak Chopra said on Monday.