Memorandum

LabStyle Innovations Investor Update – Smartphone BGM soft launches in UK, New Zealand, and Italy; ~5,000 app downloads – April 25, 2014

Executive Highlights

  • LabStyle Innovations has initiated a soft launch of its Dario smartphone glucose meter in the UK, New Zealand, and Italy. Additional launches are planned for Germany, the Netherlands, Canada, France, and Spain.
  • No timing update was given on Dario’s pending FDA 510(k) application with the FDA, though management does not expect too many surprises. A US launch is expected in 4Q14.

LabStyle Innovations’ CEO Mr. Erez Raphael led an investor update call last Thursday, sharing updates on the company’s all-in-one BGM system (Dario) that integrates a small meter (plugs into iPhone and Android headphone jack), a lancing device, a 25-strip cartridge, and a mobile app. For background on the Dario platform, please see item #29 in our 2014 JP Morgan Healthcare Conference/Biotech Showcase full report or our coverage of the device’s CE Mark in September.

Below, we have outlined the top five highlights from the investor update call:

1. An update on the soft launch and reimbursement status of the Dario system in the UK, Italy, and New Zealand, along with plans for future expansion (Germany, the Netherlands, Canada, France, and Spain).

2. Status of the pending 510(k) application with the FDA (filed in December 2013) – no timing update, but management does not expect surprises. A US launch is expected in 4Q14.

3. Significant management optimism regarding the Dario app, which has been downloaded almost 5,000 times with less than $3,000 spent on marketing.  

4. An expectation that 2Q14 will represent the first quarter of revenue. Investor concerns over significant dilution following a $4 million private placement in February.

5. A partnership with FatSecret (a food app) and news that Dr. William Polonsky (Behavioral Diabetes Institute, San Diego, CA) has joined LabStyle’s Scientific/Medical Advisory Board.

Our report concludes with the call’s Q&A.

Top Five Highlights

1. Management highlighted that a soft launch of the Dario BGM system began three weeks ago in the UK, Italy, and the Netherlands. No launch metrics were shared, though LabStyle has limited its manufacturing to 3,000 devices at the moment. There is no reimbursement at this time, though management expects it will come in Italy by the end of April, followed by the UK within the next two months. Significant uptake in these countries is not expected until reimbursement is obtained. Mr. Raphael remarked that New Zealand has an out-of-pocket payment system, meaning reimbursement won’t be required to get a sense of how the device will compete in the market. In these early days, LabStyle has seen “very positive excitement” from distributors and users.

  • LabStyle plans to increase the sales volume of Dario in the soft-launch markets, and will move to Germany, the Netherlands, Canada, France, and Spain for the next wave of the launch. The company has contemplated launching the standalone Dario app in other countries, including the US, but is waiting to make the final decision for a “couple of” weeks until early feedback comes in.
  • Management highlighted three reasons that the soft launch is particularly important, all revolving around the company’s execution abilities: (i) to demonstrate that the company’s supply chain is functioning; (ii) to prove there is validation for the product; and (iii) to demonstrate that the marketing and distribution channels are working. Mr. Raphael highlighted that the soft launch’s focus is not on the volume consumed.

2. Regarding the pending FDA 510(k) application for the Dario system (submitted to the FDA in December), management shared no timing updates. According to the company’s January 2014 fact sheet, a US launch is expected in 4Q14. Mr. Raphael acknowledged that it is difficult to predict what the FDA will do, though the Dario system does seem to have a predicate device. Thus far, communication with the FDA has implied that the company would not experience too many surprises, “if at all.”

  • We are interested to see how the FDA views this product, since it does not function as a standalone meter like Sanofi’s iBGStar or LifeScan’s OneTouch VerioSync (i.e., the Dario meter derives its power from the phone’s headphone jack, and thus requires the phone to function). This is not unprecedented in diabetes – the iHealth BG3 Smart Gluco-Monitoring System does not function as a standalone meter either, since it relies on the smart device for power. iHealth has commercialized the BG5 Smart Gluco-Monitoring system (standalone Bluetooth-enabled meter), but not the BG3 version. The FDA has historically been strong on meters giving insulin recommendations (e.g., Abbott’s FreeStyle Insulinx can only log insulin in the US version), and indeed, LabStyle’s 510(k) submission does not include the insulin calculator part of the Dario app.

3. As of the investor update, the Dario app had been downloaded almost 5,000 times, with the company investing less than $3,000 in marketing. The company’s “waiting list” reportedly includes around 16,000 people across the globe. Notably, the app has been top ranked in the app store of all of the soft-launch countries. Regarding a more concentrated marketing effort, management plans to wait until the Android version of the app is ready to market (in June or before) – this will ensure that the company can supply the expected demand for the device.

  • LabStyle is using the free app as a gateway to the Dario BGM system. Management expects 20% of people that download the free app to convert to the Dario device when it becomes available. Each download costs the company ~$2, and each user is expected to bring in ~$10. Combined with the cost of the device, the company estimates that the ROI on the product is under one month for both the investment of the device and the user.
  • LabStyle’s longer-term goal is to make the Dario app the “new standard for diabetes management.” The app will include a data log for blood glucose, food intake, data sharing tools, pattern recognition, and insulin recommendations (outside the US). The Dario app will also connect users, enabling virtual rewards and online competitions.

4. Mr. Raphael commented that 2Q14 will be the first quarter of revenue. By the end of the first quarter, LabStyle had delivered products to distributors, and distributors had sold these products on to users. In 2Q14, the company expects to see non-GAAP revenues, but it will likely take another quarter or two before revenues are seen in accordance with GAAP.

  • A series of investor questions sharply rebuked management’s recent February fundraising, calling it a “death spiral bomb.” LabStyle announced a $4.2 million private placement on February 13 at a price of $1.88 per unit (one common share + 0.75 common share purchase warrants to buy stock at $2.35 within five years). The company’s current stock price is $1.41, down from $2.77 this time last year and a 52-week high of $3.10. The market cap is now at $31.9 million, down from a 52-week high of $58.9 million.
  • At Biotech Showcase, CEO Mr. Erez Raphael remarked that revenue from strips is expected to be the majority of sales in the next two years; however, Mr. Raphael expects revenue from the software/data side will be more lucrative in the long term. LabStyle’s proprietary strips cost $0.10 each to make, well under the average price in Western countries of $0.40 per strip (according to Mr. Raphael). Reimbursement in Europe is expected on a country-by-country basis.
  • A future goal is to recognize revenue from the software platform through licensing (payers, healthcare professionals) and data monetization. This is a unique business model that has not been traditionally used in BGM. The current plan is to give the app away for free. Management noted in Q&A that patients with type 1 diabetes collect “between 40 and 50 data points per day,” and LabStyle plans to monetize this data for research and studies. We find 40-50 data points to be highly optimistic, but look forward to learning more as the company gains more commercial experience.

5. In April, LabStyle made two announcements: a partnership with food app FatSecret on April 9 and April 2 news that Dr. William Polonsky (Behavioral Diabetes Institute, San Diego, CA) had joined LabStyle Innovation’s Scientific/Medical Advisory Board.

  • On April 9, LabStyle Innovations announced a new partnership with the food app FatSecret. The FatSecret platform provides nutritional information (such as carbohydrate and fat content) as well as forums for sharing weight loss and dieting tips. With this partnership, LabStyle claims that Dario will be the only diabetes management app with a “regionally localized food database.” Users in the UK, Italy, and New Zealand (the three countries where the device has been soft-launched) will have immediate access to FatSecret. We certainly commend LabStyle for taking a holistic approach to managing diabetes, though we’d also note that manually logging anything tends to be burdensome for patients, and engagement generally wanes over time. Still, some users will undoubtedly appreciate the convenience of an integrated food/BGM app.
  • On April 2, LabStyle announced that the well-regarded behavioral psychologist Dr. William Polonsky joined the company’s Scientific/Medical Advisory Board. Dr. Polonsky is a leader in diabetes psychology, education, and support, and LabStyle should benefit greatly from his guidance – we imagine he will be particularly helpful as the company evaluates how to design its app to engage, motivate, and support patients over time.

Questions and Answers

Q: When will the Android app be available?

A: The Android app should be ready for market by beginning of June or before. Additionally, by the beginning of July, the new version of our device is going to combine the two separate IOS and Android device into one.

Q: Once the Android app is available, will you begin a more full-scale marketing effort in order to add additional users to the app and boost sales of the device?

A: That was our original thought; however, we have already performed so well in the app store. We were top app in medical device in New Zealand; until a week ago we were top ranked in UK and Australia, and for the last three weeks, we’ve held our ranking between one and four. We are getting a lot of virality, and we think that we’re getting a lot of friction faster than what we thought. We might go into other markets earlier than anticipated; once we have the Android app out, we’re take it to market. Our original thought was to wait for the Android, but all in all everything went faster than anticipated.

Q: Can you tell us a little bit about the opportunity to monetize the app once it gets in hands of users. It’s a little bit of chicken and egg scenario. How do you monetize the app if you don’t have users, and how do you get users if there isn’t enough marketing or advertising to encourage the downloading of the app. How will a significant number of app users drive device downloads and opportunities to monetize the app?

A: There are two ways for monetization or revenue streams that are not disposable: the first is revenue from remote services. Some countries that have a remote approach for diabetes or other chronic disease over a mobile platform. We have a platform for diabetes and also other chronic diseases. We believe that we can generate revenue from our value services for diabetes, both type 1 and type 2 diabetes. Through the platform in Western countries, patients with diabetes will be able to get support from advisors in real time. Additionally, there is also monetization of data, as you mentioned. The current plan we have is to not to charge for app at all. Our distributors were not comfortable giving away the app for free, but that is a powerful differentiator from other companies that don’t have a device but are charging a service for its use. Providing our app for free puts us in a position to convert users to the device, which is why we’re keeping our device free. However, we will monetize data, just not the app. Once we are moving forward and gathering data, we will begin that process. For patients with type 1 diabetes, they are collecting between 40 and 50 data points per day, and we believe we will be able to monetize this data for research, and studies done in diabetes. So we are really going to try to leverage this data and provide many different services.

Q: Could we get a sense of the magnitude of the distribution order that you sign with a country? Particularly in larger countries like the UK and Germany.

A: We are putting all of our efforts in to ensure that we have a huge commitment from our distributers. We are protecting ourselves by providing committed course in terms of quarters forward for the next three years. When we are planning our financial plan forward, we consider commitment from the distributors. I must say our ability to get the app and going out really fast hurts us. The distributors stand behind the commitment. The main concern medical device companies have is depending on a distributor; in our situation, the dependency is mitigated by our approaching customers directly through the app and mobile digital marketing. That is also where we feel more comfortable.

Q: Do you expect to recognize any revenue from 1Q14, since the soft launch began in 1Q14?

A: By the end of the first quarter, we will have delivered products to distributors and distributors will have sold these products on to users. You could say we will have generated sales, but US GAAP requires other considerations like our ability to predict warrantee, previsions, etc. You will certainly see non-GAAP revenues, but you will likely have to wait a quarter or two before you start to see revenue in accordance with GAAP.

Q: Will Q2 be recognized in the same way? Will there be product shipped but just not recognized in the same way?

A: It is too early to say, but we may have an indication of traction and warrantee estimations. We will be able to give guidance as to level of sales, even if they are non-US GAAP sales

Q: The company has talked in the past about a waiting list of potential users; could you comment on the size of waiting list and its composition? Is it made up of people from the soft-launch countries, or is it global? You have also mentioned that you would like to be able to identify patients with type 1 diabetes easily; would you be able to do this through a waiting list or any other means?

A: All in all on waiting list we have around 16,000 for all countries together. We have seen about 5,000 downloads for the app and, as we believe that the app is going to remain as one of the highest ranking apps in the app store for the next several weeks, we’ll be able to collect more users from the app; all in all, we think that users who have downloaded the app will be more likely to convert to our device. The rate is going to be higher for those who have tasted how sweet the Dario product is, through the app. We are going to focus our efforts on converting app users.

Q: Rather than giving the values in dollars, could you give us a range for the soft launch in terms of units? Is it over 1,000, between 1,000-3,000, between 3,000-5,000?

A: We have limited our overall manufacturing to 3,000 at the moment. We need to see how things move forward. Our soft launch is not about volume but about the value for the user and the ability to stand in front of our product and provide accurate numbers about our ability to convert users. The cost acquisition for users is important for small companies, and we provide friction with not too big an investment. We want to show customers all of the different things that we are doing.

Q: You never talk about your home country of Israel. Is it approved there, and would it be the easiest place to get significant traction?

A: The only problem is that we’re speaking Hebrew. Technologically-wise, our device is multiregional and multilingual and can be scaled pretty fast. It is not too complicated, but it comes down to the technical aspect of translating the meter into Hebrew. Right now we are focused on the countries that we have a soft launch in; we would probably make the effort in Israel. There is excitement in the country for the device, and at the end of the day I think we have to deliver on that demand. I think this is just a matter of focus on and not about regulation or technology. We had thought that Israel is too small, but maybe that’s not the right way of thinking; we need to play in our neighborhood.

Q: In a year from now, what do you expect your gross margins to be?

A: We would prefer at this stage, as an emerging company, to not yet provide these numbers. We want to move forward safely. We want to be in the position where what we put on the table will provide confidence for investors in management. We do not want to provide this guidance at this stage in company.

Q: Based upon the last financing – a death spiral bomb that you’ve done to dilute shareholders here – what kind of commitment can this company now make to shareholders to assure that management will not continually dilute them at such a disgusting rate. How do you build faith in the management of the company?

A: We believe that when the company is moving forward, in order to build on the fundamentals, we need to think about the company finances. It was a final private placement, and looking forward and thinking about future of the company, we do think that going into a public offering into a major exchange is a better way of financing than a private statement. The situation that the company experienced in the last two to three months wouldn’t have worked through a public offering. In the future, we know how to make right decisions.

Q: The last valuation that you raised at is less than what you raised before; why should shareholders believe that you are making more progress and not less?

A: The updates and calls that we are providing, and will continue to provide going forward, should provide the confidence needed to go forward. You cannot run a company on short-term fluctuations on share price. However, that is crucial for the shareholders, and we understand that. On the other hand, we are talking about a company that has tremendous technology and upside potential, but that will take time. We will not have 100,000 downloads in a month and we will not have a million devices sold by 3Q14. We hope that investors will stay along, and we look forward to bringing in new investors. We would like to believe that every round would be an up round, but we don’t control the markets. We control funds and allocations of funds to provide fundamental data to shareholders.

Q: Should shareholders expect another death-bomb spiral to dilute them even more because there is no floor yet? How should we believe there won’t be another death-bomb spiral for financing?

A: The company continues to look at the best opportunities in which to best fund opportunities. We are not going to generate significant revenue that will cover all of our expenses for some time. It is clear to all shareholders the nature of growth companies. We will deliver value into company so that in the future we can provide financing in best interest of all of our shareholders.

Q: If you do have another round of investing, isn’t it 90% of the last 10 days of the stock price?

A: The financing that is completed in February has a one-time reset that takes place 20 days after S1, in respect to that financing, becomes effective. Pricing is set at 90% of the ten lowest trading days of that 20-day period.

Q: To improve value, you would want to market products with a press release to get the stock price up from $1.36.

A: This is obviously what we want to see. Given the timing we have from a company standpoint, the fact that we are doing a soft launch and generating revenue, we will hopefully get partnerships and push forward platform traction of the fundamentals. Hopefully this will mean good investor relations, and we believe it will translate to stock prices – however, we cannot control this. That is what we would like to see and what we’re driving for.

Q: I would love some more discussion on selling the Dario device in Apple [retail] Stores.

A: I see this act as mainly something on the marketing front. We did a lot of investigation about selling medical devices in non-medical stores. We think it can provide a lot of good, but it is not the sort of activity that creates volume. We wouldn’t put efforts into getting on the shelf of the Apple Store, but it is something that would be great to have and we would do that if it was possible, of course. The device, including the package, is very sexy, and we do think we should have a picture of the device in the Apple Store.

--by Adam Brown, Hannah Martin, and Kelly Close