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Are Investors Fleeing Third Wave Just As Long-Term Strategy Gains Traction?

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Third Wave Technologies stockholders have been slowly turning their back on the company after it said that fourth-quarter revenues fell by 16.5 percent atop nearly tripled losses.

But are the shareholders, who have caused Third Wave's stock to shed nearly one-third of its market capitalization in 11 trading days, retreating just as the company's long-term growth strategy starts to gain traction?

The Feb. 23 earnings report showed revenue for the three months ended Dec. 31, 2004, fall to $8.1 million from $9.7 million year over year, and net loss for the quarter grow to $4.7 million from $1.6 million.

The posting prompted first Cairns & Company, and later Piper Jaffray, to downgrade the Madison, Wisc.-based company from "Above Average" to "Average," and from "Outperform" to "Market Perform," respectively.

Since Third Wave released its fourth-quarter earnings, the company's stock declined 28.9 percent, or $2.09, to $5.13 in early-morning trading Wednesday. The shares haven't been this low since Sept. 2, when the stock closed at $5.12, meaning that it took Third Wave shareholders 11 days to erase six months of stock growth.

But to hear company officials tell it, there is no cause for concern. "Third Wave met or exceeded all of our expectations for 2004," said Jim Herrmann, Third Wave vice president of finance, during a Feb. 23 conference call with investors.

Where the company and Wall Street differ is Third Wave's continuing efforts to re-brand itself as a clinical molecular diagnostics player from a molecular-tool vendor, several company officials said.

"Our [worldwide] clinical molecular diagnostic revenue grew by 59 percent in 2004 to $14.9 million," Herrmann told investors. "More importantly, US clinical revenue grew by 84 percent for the year," he said.

Indeed, of the company's $8.1 million in fourth-quarter 2004 revenue, more than half, or $4.7 million, was derived from clinical molecular diagnostics, Third Wave said in documents filed with the SEC. That business segment grew nearly 90 percent compared to the fourth quarter of 2003, the company added.

Third Wave's goal is to "build a clinical molecular diagnostics product company with revenue of $100 million and 80-percent gross margin within three to four years," John Puisis, Third Wave CEO, said in the conference call.

But Where to Now?

At least some of Third Wave's future growth seems to be tied to the expiration of PCR patents. "The single most important event of 2005 is our coupling of the Invader chemistry with PCR," said Puisis. The Invader-Plus product, based on the company's platform and PCR, will be rolled out sometime this year.

But despite the product description, Third Wave's real strategy hinges on holding onto chunks of the US clinical molecular diagnostics market and capturing more of it. Along with its cystic fibrosis, Factor V leiden, and hepatitis C virus diagnostics, the company intends to roll out additional ASRs along with Invader upgrades.

The first Invader upgrade — a microfluidic cystic fibrosis diagnostic card developed using 3M technology — has already enjoyed a little time with "about eight" Third Wave customers, Puisis said during the conference call. So far, the results "seem very nice," although the company will take its time rolling out the card, with "a nice target of 40 to 60 accounts that will placed this year," said Puisis.

The company will also roll out a human papilloma virus ASR "to select customers" this year, Puisis said. The HPV diagnostic will be followed by herpes, Varicella-Zoster, Epstein-Barr virus, and cytomegalovirus tests, according to documents filed with the SEC.

In a window on the future beyond 2005, the company's pipeline will contain diagnostics for hepatitis C viral load, HIV viral load, hepatitis B viral load, chlamydia, gonnorhea, and group B strep, as well as "chromosomal analysis and oncology products," said Puisis.

The microfluidic Invader card seems to have a couple of spots in the pipeline as well, hinted Puisis. "In terms of what's next, it could be one of two things, or maybe both — a pharmacogenetics-type P450 set of tests and perhaps an oncology application."

But How About Those Investors?

By all appearances, Third Wave will carry on its course, giving less attention to research revenues, and more to clinical diagnostics, hoping shareholders and analysts will agree with that course in the longer term.

In the conference call, Steven Hamill, the Piper Jaffray analyst who downgraded Third Wave's stock, questioned Puisis about the source of $10 million to $15 million in research product revenues the company projected to generate in 2005.

"We've got a number of things within that number," responded Puisis. "On the lower end of that, closer to $10 million, 60 percent would be continuing projects, and on the higher end, near $15 million, it would be mostly the newer projects driving."

The largest new project is a 100,000-patient, 50-disease, publicly and privately funded drug-response discovery study involving "several organizations" from the International HapMap Project, said Puisis. The multi-year study is set to begin in "late spring or early summer" this year, he added.

But despite this study, research revenue as planned will continue to fall. "Can this get you back to the kind of research revenues you had back in 2004?" asked Hamill.

Not likely, said Puisis. "What we anticipate is not focusing on the dollars," but on IP, business relationships, and penetrating further into Japanese markets, he added.

The company projected 2005 clinical diagnostic revenues of $23 million to $26 million — at least a 54-percent increase over 2004 receipts — and research product revenues of $10 million to $15 million, according to documents filed with the SEC. So, clinical diagnostic product revenues may account for about 60 percent to 72 percent of all product revenues while research product revenues fall.

Clinical diagnostic product revenues accounted for only 32 percent of the company's $46.4 million in total 2004 revenues, and 58 percent of total fourth-quarter revenues of $8.1 million.

— CW

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