ZELTIQ Aesthetics (ZLTQ) Mark J. Foley on Q2 2016 Results - Earnings Call Transcript

| About: ZELTIQ Aesthetics, (ZLTQ)

ZELTIQ Aesthetics, Inc. (NASDAQ:ZLTQ)

Q2 2016 Earnings Call

August 08, 2016 4:30 pm ET

Executives

Nick Laudico - Senior Vice President, The Ruth Group

Mark J. Foley - Chairman, President and Chief Executive Officer

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Analysts

Richard S. Newitter - Leerink Partners LLC

Margaret M. Kaczor - William Blair & Co. LLC

Jon Block - Stifel, Nicolaus & Co., Inc.

Matt O'Brien - Piper Jaffray & Co. (Broker)

Kyle Rose - Canaccord Genuity, Inc.

Anthony V. Vendetti - Maxim Group LLC

Zack R. Ajzenman - Griffin Securities, Inc.

Operator

Good day, ladies and gentlemen, and welcome to the ZELTIQ Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, today's conference is being recorded.

I would now like to turn the call over to Mr. Nick Laudico from The Ruth Group. Sir, you may begin.

Nick Laudico - Senior Vice President, The Ruth Group

Thanks, operator. Welcome to ZELTIQ's second quarter 2016 earnings conference call. ZELTIQ's senior management on the call today will be Mark Foley, President and Chief Executive Officer; and Taylor Harris, Senior Vice President and Chief Financial Officer.

Our discussion today, including the Q&A session, will include forward-looking statements reflecting management's current forecast of certain aspects of the company's future business, including its guidance for 2016. Forward-looking statements are denoted by words such as will, would, could, believe, should, expect, outlook, estimate, plan, goal, anticipate, project, potential, forecast and similar expressions that look toward future events or performance. Forward-looking statements are based on current information that is, by its nature, dynamic and subject to rapid and even abrupt changes.

Our forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied in our statements. Such risks and uncertainties are discussed in today's press release and can also be found under the caption Risk Factors in the company's filings with the Securities and Exchange Commission, including the latest report on Form 10-Q for the quarter ended March 31, 2016, filed with the Securities and Exchange Commission on May 11, 2016.

During today's call, we will refer to financial measures not calculated according to Generally Accepted Accounting Principles. Please refer to today's press release available on our website at www.ZELTIQ.com for an explanation of our reasons for using such non-GAAP measures, as well as tables reconciling these measures to our GAAP results.

This conference call is the property of ZELTIQ Aesthetics and any recording or rebroadcast of this conference call is expressly prohibited without the written consent of ZELTIQ Aesthetics. After management's prepared remarks, there will be a question-and-answer session.

With that, I'd like to turn the call over to Mark.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thanks, Nick. Good afternoon, everyone, and thank you for joining today's conference call to discuss our second quarter 2016 results. On today's call, I'll provide you with an update on our performance, the factors contributing to our ongoing success and will discuss future growth drivers. I'll then turn the call over to our CFO, Taylor Harris, who will provide a more detailed second quarter financial overview and update to our 2016 guidance.

Q2 was an outstanding quarter for us, as we delivered the largest revenue quarter in the company's history and benefited from several new growth initiatives. Our market leadership position in the non-invasive fat reduction market continues to be driven by our differentiated and proven technology, which selectively and reproducibly eliminates unwanted fat.

As previously communicated, we estimate the market opportunity at $4 billion and have increasing conviction in our view of that opportunity. Not only does our cold-based technology and the associated clinical outcomes stand apart from other competing technologies, but our investment in training, education, practice partnership and the CoolSculpting brand have provided us with a significant commercialization advantage.

Several data points from recent market research continue to validate the significant size of the non-invasive fat reduction market and the fact that it is very early in its evolution.

Let me share some of those data points with you. The North American account opportunity is now estimated to be approximately 25,000 accounts up from our prior estimate of 18,000 accounts. This expansion is being driven by the combination of more dermatologists expanding into aesthetic and by a meaningful growth in the non-core segment, which resonates with our experience in the field and aligns with the cultural shift we are seeing, whereby an increasing number of patients are seeking aesthetic treatments.

Through Q2, CoolSculpting was present 2,546 of those accounts or approximately 10% of the estimated accounts, which leaves us with a healthy opportunity to drive sustainable new account addition over time. Through our recent direct-to-consumer efforts, aided CoolSculpting brand awareness in the U.S. grew an impressive 81% in just six months and now stands at 29%.

Furthermore, our CoolConnect and market research data continues to show an increase in new practice patients, as they represent a majority and growing portion of CoolSculpting procedures. Recent market research performed by the American Society of Dermatologic Surgery showed that 60% of consumers are considering an aesthetic treatment up from 30% in 2013, and that one half of them are considering a body sculpting treatment. This correlates with our own market research, which shows that excess fat is the number one aesthetic concern among consumers, and that there are over 30 million Americans interested in getting a CoolSculpting procedure.

Additionally, this research also indicates that approximately 60% of these 30 million Americans have a household income of over $75,000. Furthermore, we've seen a significant increase in people actively searching for CoolSculpting due to our DTC efforts. Through the end of Q2, we had over 4 million web visits to CoolSculpting.com and we estimate that there were an additional 3 million searches for CoolSculpting that went directly to one of our practice partner website.

When compared to the estimated 150,000 consumers that received CoolSculpting in North America last year, we believe that the patient opportunity is largely untapped. With our average account treating approximately two patients per week and generating $240,000 in CoolSculpting practice revenue, we believe that there is a lot of capacity in our current accounts to capture and treat more existing practice patients along with the new patients we are directing to them.

In the second quarter, this high and growing consumer interest in CoolSculpting drove strong coverage by both online and traditional media, such as, W magazine, Extra, Keeping Up with the Kardashians, Access Hollywood, Refinery29, as well as mentioned (6:54) in Dr. Anthony Youn's book The Age Fix, where he called CoolSculpting the gold standard for non-invasive fat reduction.

In addition, thousands of customers engaged with us during Twitter parties, featuring Dr. Nassif at our first Facebook live video. In light of these additional data points and the growing momentum in our business, we have never felt better about the opportunity in front of us.

Let me now turn to a review of our Q2 performance. In Q2, we delivered 39% year-over-year revenue growth, driven by strong North America system placements, record North America utilization and robust adoption of our new CoolAdvantage applicator. Excluding the 80 system shipment to Ideal Image in Q2 2015, North America systems were up 37% in Q2 2016. Q2 consumable revenue was up 54% globally and 67% in North America on a year-over-year basis.

The significant growth in North America consumable revenue was driven by our best ever quarter of North America sell-in utilization of 1.84 revenue cycles per account per day, which represented a 26% year-over-year increase in account utilization. This is our second consecutive quarter of 26% year-over-year growth in North America account utilization.

At the core of this significant utilization growth is our national direct-to-consumer campaign, which was in its second full quarter of implementation, and which complements our other proprietary sales and marketing programs. Based on the success of these programs and the progress we're making with our new product introduction, we are increasing our full-year 2016 revenue guidance to a range of $340 million to $350 million, representing year-over-year growth of 33% to 37%.

Let me touch on some of the key growth drivers that are contributing to our increased revenue guidance. While only in its second quarter of launch, our national direct-to-consumer campaign is driving both increased awareness and conversion into CoolSculpting treatment. Furthermore, we believe that our DTC investment is helping drive an increase in system placements as evidenced by our results.

We recently took the opportunity to perform an in-depth analysis of our DTC campaigns to-date. For our Phase I pilot, which began in April 2015 in four markets, our analysis was quite encouraging in that we reached breakeven on the investment within the first 12 months and continue to benefit from an ongoing return or tail from this initial investment. Of note, the elevated utilization in our Phase I pilot accounts persists, even as our DTC campaign drives broad-based account growth.

Lastly, in our Phase I pilot markets, we saw a meaningful drop-off in web traffic, once we stopped advertising. However, higher utilization in these markets persisted, suggesting that the patient conversion cycle can take some time, but that the generation of CoolSculpting awareness has a prolonged impact. Our results in the Phase II pilot were consistent with our Phase I results.

As for the national campaign, we've obviously seen a strong lift in utilization in the first half of the year, and if we see a similar tail benefit compared to the pilot experience, we anticipate reaching breakeven within 12 months with additional contributions beyond this initial payback period. At the same time, this campaign has helped drive a significant increase in brand awareness, which should make future conversion efforts more productive.

While we are still early in our DTC experience, we remain very encouraged and will continue to evaluate the ongoing ROI with the goal of optimizing our sales and marketing spend over time. Because of the success of the DTC program and the positive impact that it's having on our business, we expect to continue DTC spend in the back half of the year.

However, consistent with our prior comments, we plan to spend in a more selective fashion in the second half of the year, as we are interested in tracking the tail and don't want to compete for advertising dollars during the Summer Olympics, the fall election cycle or the holidays when advertising rates are much higher.

We continue to have conviction that this is the right strategy for the business, and that it will allow us to fully capitalize on the significant opportunity. Even with our ongoing DTC spend, we expect to deliver an adjusted EBITDA margin in the mid-teens in the second half of the year, which provides insight into the potential leverage in our business.

In addition to our DTC efforts, we continue to actively support our tried-and-true marketing programs, such as co-op advertising, full events, CoolSculpting University and Treatment to Transformation, which form the foundation of our success in the market. As we move forward, we will continue to evaluate the optimal balance of these different investments and will prioritize the spend that is driving the greatest benefit.

Let me now talk about our North American account base. In the quarter, we sold an impressive 283 systems into 165 accounts, with 42% of our systems going into accounts with one or more CoolSculpting systems. When excluding the 80 system shipment to Ideal Image in Q2 of last year, we're very pleased with our year-over-year account and system growth. While it's difficult to quantify the DTC impact on our system sales, we believe that heightened CoolSculpting brand awareness has driven increased physician interest due to growing patient inquiries. At the core, physicians don't want to miss out on the income potential, new patient generation, and certainly don't want their existing patients going elsewhere.

With greater than 50% of CoolSculpting patients being new to their practice, physicians have a keen appreciation for the lifetime value of a new patient. Unlike other niche markets where a subset of the market adopts the technology, we believe that most aesthetic practices will at some point purchase a non-invasive fat reduction product, as it is proving to be a leading gateway procedure into aesthetics for new patients.

Due to CoolSculpting's proven clinical performance, value proposition and ability to generate new patients, it is not uncommon for us to place systems into accounts that had previously purchased a competing technology. In Q2, we estimate that approximately 30% of our new accounts previously purchased a competing technology. We will continue to monitor this market trend with interest going forward.

Moving to our international business, I was very pleased with our Q2 performance where we delivered $15.5 million of revenue, up 19% year-over-year, which was ahead of our expectations, and while CoolAdvantage applicators made an important contribution to quarterly revenue, I believe that we are set up well for the back half of the year due to the rollout of new marketing initiatives, new product introductions, the momentum we are starting to see in Asia and certain EMEA markets, and the recent medical clearance we received in China. As a majority of the new international leadership team was hired in late Q1 and Q2 and needed to fill several open sales positions, I am very pleased with the impact that the leadership team is having in such a short period of time.

And, like North America, we are in the very early stages of growing the non-invasive fat reduction market internationally, which helps overcome the economic challenges in some of our international markets. Again, I feel very good about the investments we are making internationally, the progress we are seeing, and our expected performance in the second half of 2016.

From a regulatory perspective, we were very pleased to receive Chinese medical clearance in July. This is a significant milestone for ZELTIQ, as China represents a tremendous opportunity, given its population size and high interest in aesthetic treatments. Our goal is to establish CoolSculpting as the premier non-invasive fat reduction solution in the Chinese aesthetic market.

For the remainder of 2016, we plan to conduct a controlled launch, with the goal of being ready to accelerate penetration in 2017. The China medical market opportunity is represented by over 14,000 aesthetic clinics and hospitals that are buyers of aesthetic capital equipment.

Additionally, we conducted a market research study to determine the patient or consumer market for CoolSculpting in China. Our market research adjusted for age, BMI, and income and revealed that there are 146 million aesthetically-inclined people in China who would consider getting a CoolSculpting procedure. Over time, we believe that China could be an important contributor to our revenue composition.

During the quarter, we started shipping our new CoolAdvantage applicator, which is generating a lot of excitement in the market. In Q2, we shipped over 650 CoolAdvantage applicators that resulted in approximately $6.5 million of revenue. Additionally, accounts continued to adopt CoolMini and CoolSmooth PRO, which contributed to total add-on applicator revenue of $8.4 million in the quarter.

While we successfully shipped CoolAdvantage applicators in late Q2, the increase in CoolAdvantage demand combined with our strong system quarter, led to a growing back order of CoolAdvantage applicators and contributed to a significant increase in our deferred revenue in the quarter. We expect to clear up most of the CoolAdvantage back orders in Q3, and remain on track to launch our second CoolAdvantage applicator, CoolAdvantage Plus, in Q4 of 2016. Physician feedback on CoolAdvantage has been very positive, as the 35 minute treatment time, combined with greater patient comfort, has led to an improved CoolSculpting experience, and in some cases is helping drive an increase in cycles per patient. Also, not lost on the practice is the ability to increase throughput and profitability per hour, since practices are still charging the same amount for treatment.

While there's a lot of focus on CoolAdvantage, our CoolMini applicator is still in its early launch stage, as it was introduced less than one year ago. With its ability to treat the submental area and other smaller pockets of fat, we've seen a steady increase in its use as our accounts become fully trained. Because of the lack of downtime, comfort of treatment, and ability to get a complete result in just one to two office visits, our CoolMini applicator gets rave reviews from patients and practices for submental treatments.

Of note, both our CoolMini and CoolAdvantage applicators have a cycle ASP of $150 compared to our legacy applicators with an ASP $125. Due to the significant reduction in suction force with our CoolMini and CoolAdvantage applicators, we've been exploring ways to enhance the treatment even further.

To that end, our engineering team had a breakthrough and has come up with a new coupling gel that improves the coupling between the tissue and applicator. We call this our new CoolAdhesive gel. The beauty of the gel is that it is a liquid at room temperature, but becomes viscous and enhances the coupling as the gel cools. We plan to execute a controlled rollout of CoolAdhesive later this quarter, starting with our CoolAdvantage applicator.

As Taylor will discuss, we will incur incremental cost related to CoolAdhesive, particularly in the production ramp-up phase, but given the substantial benefits of the technology, we think this is the right move for our customers and for our brand, and we're excited to introduce the technology to our customers in the very near future.

Through our ongoing investments in innovation, we continue to deliver products that enhance results, improve the procedure, and expand the market, all while growing the value of the CoolSculpting system for our physician partners.

In addition to our recently-introduced applicators, we continue to pursue additional indication and continue to progress with our cellulite, acne and other development programs. We remain committed to innovation and are encouraged by our R&D pipeline and its ability to make a meaningful contribution to our long-term growth.

In summary, we are extremely pleased with our progress during the second quarter. The success we've experienced has led to increased confidence in our business and outlook for 2016.

I will now turn the call over to our CFO, Taylor Harris, to review our financial results in detail.

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Thank you, Mark, and good afternoon everyone. Before I begin reviewing our financial results, I would like to remind everyone that our supplemental financial information, which provides further detail and historical backup for your reference, is posted under the Investor Relations section of our website.

Turning to Q2 results, we reported another strong quarter, with revenue of $89.5 million, or 39% year-over-year revenue growth. We experienced strong growth in both systems and consumables during the quarter, at 23% and 54%, respectively. And while North America continued to drive overall performance, it was encouraging to see growth rebound across our international markets. Included in our Q2 result was approximately $6.5 million of revenue associated with CoolAdvantage; the bulk of this contribution came as add-on applicator revenue, but a small portion represented recognition of deferred system revenue. That said, our deferred revenue balance continued to increase, primarily associated with additional systems sold with CoolAdvantage and CoolAdvantage Plus during the quarter.

Turning to key metrics, we added 246 new accounts globally and 165 new accounts in North America in the second quarter, and our global installed base now stands at 5,254 systems spread across approximately 4,200 accounts, assuming a one-to-one system to account ratio internationally.

North America revenue grew 44% year-over-year, accounting for $74 million or approximately 83% of revenue in Q2 2016, up from 80% of revenue in Q2 2015. During the quarter, we placed 283 systems in North America, up 37% when excluding the 80 systems shipped to Ideal Image in 2Q 2015. Contributing to this strong performance was the placement of 119 multi-systems, of which 102 went to existing accounts, while 17 systems were sold to new accounts that purchased more than one system right from the start.

North America sell-in cycle utilization by account per day was 1.84 for Q2 2016 compared to 1.46 for Q2 2015, an increase of 26% year-over-year, driven by our national DTC campaign and our continued efforts to maintain practice focus on CoolSculpting.

International revenue of $15.5 million increased 19% year-over-year and contributed 17% of revenue, down from 20% in Q2 2015.

As Mark discussed, our international business benefited from the successful launch of our CoolAdvantage applicator, as well as the ongoing adoption of CoolMini, with modest year-over-year performance in combined system and consumable revenue. We recognized $8 million of system revenue from 81 system sales in Q2. Cycles shipped internationally were 75,319, up about 2% year-over-year. While consumable revenue was up 9% on a year-over-year basis. On a worldwide basis, system revenue in Q2 of 2016 was $39.5 million, an increase of 23% from the second quarter of 2015.

Add-on applicator revenue was $8.4 million compared to add-on applicator revenue of $2.8 million in Q2 of 2015. The increase in add-on applicator revenue is attributable to the successful launch of our CoolAdvantage applicator, as well as ongoing demand for our CoolMini and CoolSmooth PRO applicators.

During the second quarter, we shipped over 650 CoolAdvantage applicators, and expect that we will ship the majority of the remaining backlog of CoolAdvantage applicators during Q3, while anticipating to begin shipment of CoolAdvantage Plus applicators in Q4.

Consumable revenue in the quarter was $50 million, an increase of 54% compared to $32.4 million in Q2 of 2015. As a percentage of total revenue, consumables represented approximately 56% in the quarter, versus 50% in Q2 of 2015. Total revenue cycles shipped in the quarter were 370,122, a 47% increase year-over-year.

Cash, cash equivalent and long-term investments ended at approximately $52 million in the quarter, representing strong cash generation of over $13 million during Q2. We continue to expect net cash generation in the back half of the year and believe we have sufficient cash to fund our current growth strategy.

The following results, with the exception of adjusted EBITDA are all reported on the GAAP basis. We will continue to reference an adjusted EBITDA margin percentage, which we define as earnings before interest, tax, depreciation, amortization and stock based compensation.

Essentially, we removed non-cash items for this non-GAAP measure. We believe this metric is indicative of our core operating performance, as it facilitates a meaningful comparison of our operating results. A full GAAP to non-GAAP reconciliation can be found in today's earning release and supplemental financial information.

Gross margin was 69.2% in Q2 2016, down from 71.9% in Q2 2015. As expected, the decrease in gross margin was in part due to the lower gross margin profile of our CoolAdvantage applicator. It was also impacted by higher-than-anticipated system sales, a high mix of eight applicator system bundles sold in the quarter compared to predominately five applicator bundles in Q2 2015, and higher-than-expected warranty expense.

System ASPs, however, remained strong and were in fact up on a year-over-year basis in both North America and international. Q2 2016 sales and marketing expense was $50.3 million, or 56% of revenue versus $32.2 million or 50% of revenue in Q2 of 2015.

Most of the percentage increase is attributed to our national DTC campaign, an increase in international head count, and higher commission expense due to revenue outperformance, as well as payout on approximately $10 million of deferred revenue.

R&D expense in the quarter was $6.4 million or 7% of revenue, versus $5.8 million or 9% of revenue in Q2 of 2015. G&A expense was $8.8 million in the quarter or 10% of revenue versus $6.7 million or 10% of revenue in Q2 of 2015.

Our net loss for Q2 of 2016 was $4.9 million compared to a net profit of $1.2 million in Q2 of 2015. On a per share basis, we had a loss of $0.12 per share, compared to a gain of $0.03 per share in Q2 of 2015. The increase in net loss on a year-over-year basis is largely attributable to our investment in national DTC advertising, temporary gross margin pressures, and the fact that we were recognizing an income tax expense, despite a pre-tax law.

As we discussed last quarter, our tax rate in fiscal year 2016 will be abnormal on a quarter-to-quarter basis, given our current profitability position and as we transition into our international manufacturing and tax structure. To date, our effective tax rate has been negative, leaving us with tax expense. And on a full-year basis, we expected to be north of 150%. Adjusted EBITDA for the second quarter was positive $1.9 million or 2.1% of revenue.

I will now turn to a discussion of our 2016 guidance. Due to stronger-than-anticipated utilization and system placement in North America, we are raising our full-year 2016 revenue guidance and our now expecting revenue in the range of $340 million to $350 million, up from $320 million to $325 million previously. As for the mix of our full-year revenue, we're now expecting that consumables will represent approximately 52% of total revenue, largely due to the strength we are seeing in systems and add-on applicators sales, despite a strong increase in utilization due to the DTC program.

As for gross margin, we are reducing our full-year guidance to approximately 68%, based on a few factors. Now we've obviously performed better than that during the first half of the year, but we're expecting a decline in the second half as we ship greater volumes of CoolAdvantage, CoolAdvantage Plus and the new CoolAdhesive gelpad, and as we bring our Ireland manufacturing facility online.

I would also remind investors that we are currently in a trough period with respect to margins on our systems, given the fact that we have been shipping all legacy applicators in addition to the promise of CoolAdvantage and CoolAdvantage Plus with new system sales. After we have fully launched both CoolAdvantage and CoolAdvantage Plus, however, we will eliminate four applicators from the system bundle and should return to a more traditional margin profile on systems.

With the introduction of our CoolAdhesive gelpad, we will also face some transitory increases in consumable costs, until we fully ramp production in Ireland and automate the manufacturing process, at which time costs should return to normal.

It's important to note that we are not experiencing any ASP erosion, and in fact we recently raised our list price on systems in North America. Over time, we expect our gross margin to improve as our cost of goods comes down, our mix shifts to more consumable and as we benefit from ASP increases associated with North America systems and cycles associated with our recently-introduced applicators.

Operating expenses as a percentage of full year revenue are now expected to be between 66% and 67%, down from previous guidance of 69% to 70%, as we anticipate leverage of our fixed expense base at higher revenue levels. The combination of stock-based compensation, depreciation and amortization is expected to be in the range of 6% to 7% of revenue, and we continue to expect adjusted EBITDA to be in the range of 7% to 9%.

The implication for the back half of the year is a step up in adjusted EBITDA margin to the mid-teen, despite the fact that we will experience some transient gross margin pressure and continue to invest in DTC, all of which should provide a clear and a positive indication of the inherent leverage potential of our business model.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thanks, Taylor. In closing, we are very pleased with the ongoing momentum we are experiencing in the marketplace. Our DTC program has proven to increase brand awareness and utilization, and we see early signs that we can achieve a positive ROI on this investment with the goal of gaining efficiency over time. We continue to launch innovative new products that expand the large, untapped non-invasive fat reduction market, and give physicians and patients a way to reduce fat in a growing number of areas.

Also, we are encouraged by the ongoing strength of our new system placements, which further reinforces our preferred and market leadership position, while also validating the size of the market and market opportunity. Internationally, we were very pleased with our Q2 performance and remain on track to deliver solid growth in the second half of the year.

Turning to profitability; we plan to deliver an adjusted EBITDA margin in the mid-teens in the back half of the year, despite interim gross margin headwinds as well as our plan for ongoing DTC investment. We believe this will serve as a strong indicator of our ability to deliver favorable translation, even as we continue to invest in the business for future growth.

In terms of overall approach, we continue to have a solid growth bias, given the significant size of our end market, favorable return we are seeing on our DTC investment and the near-term opportunity to extend and solidify our leadership position, while at the same time, we are committed to being analytical, data-driven, and focused on ROI as it relates to our investments.

We remain confident in our ability to achieve our previously-communicated long-term financial targets of a five-year revenue CAGR of at least 20% through 2019 and 25% to 30% adjusted EBITDA margin at scale.

I would now like to open the call for questions.

Question-and-Answer Session

Operator

And our first question comes from the line of Richard Newitter with Leerink. Your line is now open.

Richard S. Newitter - Leerink Partners LLC

Hi, thanks for taking the questions and nice performance this quarter guys.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thanks, Rich.

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Thanks, Rich.

Richard S. Newitter - Leerink Partners LLC

So, I just wanted to start off on the guidance. I appreciate some of the color you gave Taylor at the end there, but you now also have the China approval in the medical market. I am just curious between that, if you could parse that out, if any contribution is anticipated to the guidance raise, and what the core underlying kind of utilization assumptions are for the year – the core North America placements and then what if any incremental CoolAdvantage revenue. Can you just parse out each of the pieces of the increase to that guidance range?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Sure. Rich, I'll take a stab at that. So just to make sure I've got the list right, you're looking for China, as well as CoolAdvantage as well as utilization and we may provide a little more color in addition to that. So, China, we're not to give a specific contribution in the medical channel. I will say, we are expecting a bigger second half of the year in terms of absolute dollars as well as percent growth in international than we had in the first half of the year. As you recall, last quarter, despite the fact that we had a year-over-year decline in the first quarter in international revenues, we guided that we on a full year basis we are expecting growth internationally, albeit not at the same levels we had seen historically, that's really still the fundamental assumption in our guidance.

China was part of that when we gave guidance back in Q1 and we're pleased with the medical approval, what we will say – and that came probably a little ahead of our expectations, which is great, but as we had talked about previously, there are some gating items in China as we ramp into the medical market. One is the (36:01) in public hospitals. And the second is just our desire to build the market in a judicious way really starting with some of the key opinion leaders.

As you look at CoolAdvantage, so we are again anticipating a bigger second half of the year than we had in the first half of the year. If you look at our total add-on applicator revenue, we're assuming somewhere in the $20 million to $25 million range in the second half of the year. So that would represent potentially a doubling of what we saw in the first half of the year. The vast majority of that is the CoolAdvantage and CoolAdvantage Plus product line. And I would say, underpinning that we're assuming that we get to close to approximately 50% penetration of our North American accounts (36:52)

And then lastly, Rich, I think you mentioned kind of what else changed, what about utilization. Utilization, we are still expecting growth on a year-over-year basis in the second half of the year, not at the level that we saw in North America in the first half of the year. We had a 26% year-over-year increase in both Q1 and Q2, which was really remarkable. We're not assuming that same level of growth, but we are still assuming a utilization pick up, and that's part of a tail return that we expect on DTC, as Mark discussed. Really I'd say the biggest change in our guidance from last quarter to this quarter is the strength that we're seeing on the systems front in North America. So, whereas historically we've guided to relatively flat year-over-year performance in systems, we are now assuming a pickup year-over-year in the back half of the year. So, hopefully that maps it out for you.

Richard S. Newitter - Leerink Partners LLC

Yeah. That was extremely helpful. And then if I could just get one more quick one in on the margin side. So Mark, I think you said, you're going to be exiting in the back half, you feel confident at mid-teens EBITDA margin, despite some of the kind of the puts and takes in lower sales and marketing and lower gross margins, how should we be thinking about the go-forward basis? Once the new product areas that are creating noise on the gross margin line start to anniversary, can you give us any color when that might be? When are we back to normalized margins? And do we assume that you're going to kind of pick up a spend on DTC as we move into 2017? And how should we be thinking about more of a run rate? Is it mid-teens, something slightly below, but a higher revenue base, how should we be thinking about the balance of that growth and spending as you normalize some of these transient margin issues on the gross margin line?

Mark J. Foley - Chairman, President and Chief Executive Officer

Yeah, Rich, so good question. Let me try and parse those. The first one on the gross margin side, I think we've flagged kind of the key contributors that was a bit of a mix issue due to the stronger system sales. It had to do with the applicator composition, where we decided to ship all of the legacy applicators to new account or new system purchases, meaning that they'll get the CoolAdvantage applicators when those fully roll out.

So I think, by the time that we have both CoolAdvantage and CoolAdvantage Plus completely rolled out, new system sales will go from a eight applicator bundle to a four applicator bundle. So we'll get that pick up once that happens, and as we've guided, we expect to start rolling out our CoolAdvantage Plus applicators in Q4. So, once we have enough capacity to support new system sales, we'll get that benefit pretty early on.

As it relates to the actual CoolAdhesive gel, we're really excited about that, with Ireland coming online, and the process to make that new gelpad, there will be sort of a transition until we can fully run at full absorption in Ireland, and that's not going to happen until sometime later in 2017 when that's fully running.

So once that happens, the cost of our consumables manufacturing will start to come online. So those are a lot more deterministic on that side of it. In terms of the mix, I think that one is a little harder to predict, I mean, I think that it wasn't just the CoolAdvantage applicators or the new applicators that contributed to it, but it was really strong system performance. And the good news is that today's system is tomorrow's consumable. So we think, from a long-term standpoint, we are actually really encouraged by this trend. And we'll start to see that benefit as our mix shifts to heavier consumables. And so that's going to happen at the rate that it happens, and that's sort of on the cost of goods side of it.

In terms of the sales and marketing side of it, we continue to feel good about the long-term guidance that we put out there, of the 25% to 30%. I got to tell you, though, that the deeper we get into this market, the more conviction we have about the opportunity.

And if you look at how we size the market, with roughly 30 million consumers in North America that we think are good candidates for the technology and the fact that over 50% of the patients coming in for CoolSculpting treatment are new to the practice, that would say that there is probably a much bigger opportunity to capture consumers that are outside of the aesthetic channel.

And therefore, the only way that we are going to get people outside of the aesthetic channel to come into the aesthetic channel is by building awareness. So, as it relates to sort of what investment we're going to make on the sales and marketing line, I think that we're still working our way through that, and we'll be able to give a little more clarity about that when we get into our full 2017 guidance.

But we're very mindful of needing to demonstrate that this translates over time, and we will continue to share data that we think is relevant to give you sort of a map on how we get there. But right now, based on the return we are seeing, we think that this has been a really good investment for us.

The only other thing I'd comment on, we've got a history of front end loading our sales and marketing expenses, at least our field heads at the beginning of the year. At this point, I don't know that there's anything that would say that that's not likely to happen again in 2017, but we do want to work through that.

I will say though that, if you look at our capital reps, we haven't added capital reps for the last three years. So, as our North American sales organization continues to grow, the number of new adds as a percentage of the total field organization continues to decline as a percent, but in the absence of anything different, we like having our field team on board at the beginning of the year for our Global Sales Meeting.

Richard S. Newitter - Leerink Partners LLC

Thanks a lot.

Operator

Thank you. And our next question comes from the line of Margaret Kaczor with William Blair. Your line is now open.

Margaret M. Kaczor - William Blair & Co. LLC

Good afternoon, guys.

Mark J. Foley - Chairman, President and Chief Executive Officer

Hey, Margaret.

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Hey, Margaret.

Margaret M. Kaczor - William Blair & Co. LLC

So first question for me is, you guys had another strong quarter of placements, and I'm wondering if we're at this point where the advertising and consumables demand is driving those system placements. And maybe as a follow-up to that, why shouldn't we expect the placements to really be a leading indicator of demand as we go into 2017 and even beyond that?

Mark J. Foley - Chairman, President and Chief Executive Officer

Well, again, Margaret, I think that – we're asking ourselves the same question. I think we really were anticipating that the DTC advertising was largely going to benefit our cycle utilization. But as you pointed out, with the strength in system sales, there is no doubt that it's also having an effect there. And what we're hearing from some of these accounts is that there are an increasing number of consumers that are either asking about CoolSculpting when they're in the practice or calling the physician to see if they offer it. So I do think that that's driving.

I think as we look at sort of decreasing our DTC spend in the back half of the year, to look at the tail and not to compete with some of the other higher-cost advertising periods. I think the question is, what impact does that have on a go-forward basis. We have a much better insight into what the tail is on consumer utilization. We haven't really had an opportunity to evaluate the tail on system purchases, but I think it's a fair question. I just think we need a little bit more time to evaluate that and see what sort of impact that that might have.

Margaret M. Kaczor - William Blair & Co. LLC

Okay so, as we look at utilization growth, obviously, that was quite good as well. And you talked about the two pilot programs that, that utilization growth was sustainable. But can you talk anything about what you've seen through August at this point? Have you seen any sequential decline in utilization growth versus that first half? And really, what should we expect for spending in 2017?

Mark J. Foley - Chairman, President and Chief Executive Officer

Yes, so in terms of August, I think it's a little premature to comment. As you know, we do get CoolConnect data. We do continue to track that. We would expect a similar tail performance in our national campaign, just like we saw with our pilot. So, we are hopeful that we will continue to see a good return on the DTC dollars that we spent in the first half of the year. And again, we do plan to spend on some DTC in the back half of the year as well.

In terms of what we're going to spend in 2017, I think we're going to hold on that until we actually get into our 2017 guidance. But based on the return thus far, I think it's fair to say that there will be DTC dollars that we spend in 2017. So I think we'll hit that when we get there.

Margaret M. Kaczor - William Blair & Co. LLC

Okay. And then maybe last one for me, we did see international come back this quarter. Do you see – did we see any placements in China? And really, how should we think about that controlled launch in China? A year ago you guys had that bulk 40-system purchase in Q1 of 2015, so are there medical chains to sell into and just help us better frame that. Thank you.

Mark J. Foley - Chairman, President and Chief Executive Officer

Sure. So as a reminder, we sold last year into the spa market in China. At the beginning of the year, we said we expected to place about 100 systems into the Chinese market. We called out when we first shipped some systems into that market and then didn't really sort of provide ongoing guidance in terms of placements in China. So now, with the medical clearance, we're really focused on the medical market. And as Taylor said, our goal really in the back half of 2016 is to start to seed (46:22) the market and start to get physicians to be able to capitalize on the tender process. So I don't know that we'll see the same level of bolus orders into the medical market at least in the back half of the year. But we would expect more meaningful pickup in 2017, and so we're looking forward to capitalizing on that. Next question.

Operator

Thank you. Our next question comes from the line of Jon Block with Stifel. Your line is now open.

Jon Block - Stifel, Nicolaus & Co., Inc.

Great, guys. Thanks and good afternoon. Just trying to figure out where I want to burr my questions. Maybe the first one, a little bit different of Rich's approach, so I get a raise of $20 million to 2016 revenues. I get about, based on your percentages, $17 million or $18 million is capital, $2 million to $3 million is consumables. So when I look out at the gross margins, coming out about 250 bps from the prior guide, is about half of that, Taylor, roughly, is about half of that due to the mix just being heavier on capital/add-on applicator? And then maybe the balance 100 bps from that adhesive gel that you guys called out?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Yes, Jon, I think that's pretty close. The one other factor would be warranty, but I'd put that third on the list.

Jon Block - Stifel, Nicolaus & Co., Inc.

Okay, perfect. And then, maybe one or two more if I can slip them in. So I'll stick with you, Taylor. So still working through some numbers and you got to make some assumptions, but it looks like you're starting to get a real lift in the realized ASP. So as we see CoolAdvantage and even CoolMini that carry the $150 price tag, that realized ASP is going to tick higher. So as we look out, let's go out one or two to three years. I'm not asking for specific guidance, but maybe can you frame for us the opportunity where that has not been a lever for this company so far. But when you look out a couple years, based on the uptake that you're seeing in CoolAdvantage, how maybe that ASP, let's stick with North America, might progress?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Sure. Well, the – in terms of what we've seen in the first half of the year, let me just remind you that in Q1, we deferred a portion of system revenue due to CoolAdvantage, CoolAdvantage Plus, which we haven't delivered yet. And so then in Q2, the vast majority of our system sales, we also deferred revenue on for CoolAdvantage and CoolAdvantage Plus. We shipped a few systems that included it. So in the back half of the year, you're going to get a pickup. It's going to flow through system revenue and appear to be an uptick in ASP, but it's going to be driven by the fact that we're going to be shipping CoolAdvantage and CoolAdvantage Plus to those accounts who purchased the product in the first half of the year and to whom we're delivering those applicators in the back half of the year.

So I think what you're going to need to do for 2016 is blend out that ASP through the course of the year just because it's really a timing issue. Now, what I'll say over time, we mentioned on the call that we're taking a price increase in North America. Our list price, we're going to be taking up closer to where some of the competitors have been having their list price of the product. And the reason for that is we're obviously the market leader, and we think we have the most compelling technology, and we're investing the most in the field. And so we really – as we looked at it, especially given as you pointed out, Jon, the introduction of some of these new technologies, we just see no reason for us to be at a disadvantage on system pricing.

So we won't talk about specific numbers of where pricing could go, but I think it's important to note we're taking up lists to approximately where the competitors are, and then we'll see how much of that sticks, but we would assume that we could migrate up our ASP on systems over time.

The one other factor that I'll add into the mix is we do sell second systems to accounts at a lower price than the first system. And so in any given quarter or year, our mix of those placements will have an impact on pricing.

Mark J. Foley - Chairman, President and Chief Executive Officer

And, Jon, let me add. I think you were also asking about the consumable mix with that particular question?

Jon Block - Stifel, Nicolaus & Co., Inc.

Yeah, yeah. Exactly.

Mark J. Foley - Chairman, President and Chief Executive Officer

And so if you think about the consumable mix, once our CoolAdvantage applicators are fully released, look at, for example, new system sales in Q1 of 2017, we'll have four applicators, we'll have the two CoolAdvantage; the CoolAdvantage, which will replace three suction-based applicators, the legacy applicators; and CoolAdvantage Plus, which will replace the CoolMax. We'll then have CoolMini and we'll have CoolSmooth PRO. So all of those applicators except for CoolSmooth will now have the higher cycle ASP. So, all the new systems going forward will benefit from that. And then, in terms of the mix of our existing account base in terms of how they choose to use it, it will really depend on kind of the adoption of the new applicators.

We've talked about sort of this 50% adoption of our existing account base of our CoolAdvantage applicators. We think that's reasonable. Our guess too would be that that's going to be a little bit more biased towards our busier accounts just because I think they're probably more apt to step up and invest in newer technology. So certainly, as we go forward, we expect an increasing contribution to come from the new applicators and, therefore, the higher cycle ASP.

Jon Block - Stifel, Nicolaus & Co., Inc.

Got it. And just one quick follow-up to that, Mark. Do you feel any need to standardize on the colder temperatures, if that's the right word? In other words, our feedback has been that the user experience on CoolAdvantage, it's just so much better than the legacy, right? It's quicker, it's a better tissue draw, it's less bruising. So, just your thoughts. Are you going to just let the market dictate the speed at which that shakes out or anything that you guys can do to accelerate it to sort of get a uniform consumer experience? Thanks, guys.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thanks. It's a great question, Jon. Our history has been more to try and be as customer-friendly as possible and really let them make that choice. So, we've seen an increasing number of accounts that are buying more than one system because they've concluded that being able to do two cycles at the same time on a patient is a better patient experience, but that doesn't mean that those with single system accounts can't deliver a great experience as well.

So I think our feeling right now is kind of like an iPhone upgrade. Let those accounts that want to make that change. I think for them not only is it about the patient experience, but they can increase the throughput and increase the dollars per hour in a room. We've heard reports in some cases that consumers are signing up for more cycles because of the shorter time. So I think, at this point, we're going to let it be more market-driven and kind of let our customers decide. But I think your question is a fair one.

Jon Block - Stifel, Nicolaus & Co., Inc.

Thanks for your time guys.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thanks.

Operator

And our next question comes from the line of Matt O'Brien with Piper Jaffray. Your line is now open.

Matt O'Brien - Piper Jaffray & Co. (Broker)

Good afternoon, guys. Thanks for taking the question. Just hoping to start on Q2. You beat our number on the top line by quite a bit, but gross margins were a little bit softer and so the marketing spend was a little bit higher than we were expecting. Can you just tell us, very specifically, why there wasn't more leverage in Q2, given the top-line strength?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Sure. So Matt, we don't guide on a quarterly basis. So I will say that our result in terms of the profit to revenue ratios were fairly well in line with what we were expecting. Now the one thing that I would say that may throw things off a little bit in terms of modeling, and it's tough for us as well, our royalty expense we actually recognize on gross revenue. So in gross margin, we did have some royalty expense on revenues that were deferred out of Q2. So no revenue in Q2 but we get the royalty expense in Q2. Our commissions are similar in that we are paying commissions on some of that deferred revenues that's going to show up in the back half of the year. So that was a combined, I think, about $1.5 million impact on expenses that weren't really associated with revenues in the quarter. Other than that, it wasn't really out of line with what we were expecting.

Matt O'Brien - Piper Jaffray & Co. (Broker)

That is fair enough. And then to follow-up on Rich and Jon's question a little bit on gross margin, there's 250 basis point reduction from a variety of sources, but as we think about moving through the course of the year and then into 2017, can we get back to and above the first half of the year as far as gross margins go as we get into 2017 and 2018 – or I'm sorry, 2017. And I guess what I'm asking is, is that going to be a pressure point on the model for 2017 above what you may have been expecting?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

So, Matt, as we've looked through it, we don't think that anything that we've experienced so far this year affects our view of the longer-term gross margin profile in our business, which we've scoped out historically as being in the mid-70% range. As Mark indicated, one of the bigger factors that's putting pressure on us here in 2016, which is the number of applicators that we're shipping out for a system bundle that should resolve itself in 2017. So I say that just to give you some confidence that we think we will be headed back in the right direction beginning in 2017 but without pointing to a specific number for 2017, and we'll get to that at a later date.

Matt O'Brien - Piper Jaffray & Co. (Broker)

Okay. Last one, if I could just sneak one more in. On the systems side, it was another phenomenal quarter, up 37% US ex Ideal, and that's your toughest comp of the year. And I know DTC is helpful here, but can you give us a little more sense for what's really driving the growth? Be it core or non-core, where you're seeing a lot of the uptake. Is it the applicators? Really kind of the new, shorter applicators turning the market on to coming around to ZELTIQ or is there something more beyond that? Because I guess what I'm asking is, even with the increase in revenue you're expecting for the back half of the year, and the increase in the pricing, it would seem like the set up with easier comps in the back half for system sales is quite favorable.

Mark J. Foley - Chairman, President and Chief Executive Officer

Yes, Matt. This is Mark. I think as we outlined before, the deeper we get into this market the more we're convinced that if you're in aesthetic practice, you have to think about offering non-invasive fat reduction. It's just becoming a cornerstone procedure. It's driving new patients in, and I think we're seeing a sort of a classic adoption curve, where you had sort of the early adopters and then a lot of people that sat on the sidelines to try and see is this a market worth getting into or not. And if so, making sure that they're getting in with the technology that's got proven clinical performance and sustainability and that's going to have high patient satisfaction. And I think we're starting to see that evolution.

There's no doubt that the direct-to-consumer campaign helped to maybe accelerate some of these purchases because I think as people saw more consumers coming in asking about it, I think that gave them a little bit more comfort to go ahead and make a buy now. I think the other thing is just with new competitive entrants, there's more people now that are considering it. So I actually think that the competitive dynamic right now is helping and is bringing us, frankly, into more discussions than what we might have been in, in the past.

And if you look at sort of the total number of accounts that we're going to open in a given calendar year in North America compared to what we're sizing to be the account opportunity in North America, it's just – there is a lot of opportunity. In terms of the mix, it tends to be pretty consistent. We certainly see the non-core market grow a little bit more just because of how that overall market is growing and the interest there. But we continue to be pleased with our placements into the dermatology and plastic surgery channel as well. So maybe a little bit more non-core but, overall, good growth across the board.

Matt O'Brien - Piper Jaffray & Co. (Broker)

Very helpful. Thank you.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thanks.

Operator

Thank you. And our next question comes from the line of Kyle Rose with Canaccord. Your line is now open.

Kyle Rose - Canaccord Genuity, Inc.

Great. Thank you very much for taking the questions. I've been hopping between a few calls so I apologize if I ask anything that has been repeated previously. But first question, I kind of wanted to follow on the previous question there is, earlier at the end of 2015 and early in 2016, you talked about really pushing into the facial aesthetics market. Obviously, CoolMini really helped there. Just wanted to see if you could characterize what the push into facial aesthetics has impacted as far as capital sales year-to-date and how we should think about that opportunity or is that specifically being a driver moving forward?

Mark J. Foley - Chairman, President and Chief Executive Officer

Hey Kyle, that's a great question. As you know we manufactured the CoolMini standalone system with the idea that some of these facial plastic physicians would only want to buy the facial device and that with the approval to treat the submental area and launch of CoolMini that, that was going to be a specific or niche. I think what we're finding is that certainly the facial plastic market is opening up a whole new group for us. We've still yet to sell the CoolMini standalone. Everybody that I think has made that buy decision to bring in CoolMini decides that if I'm going to make that kind of investment, I might as well treat all body areas because I think there's a number of their peers that have the CoolSculpting system. And when they call them, they say, hey, this is – it's been great, it's bringing in new patients, and they're able to treat other different areas. So, it's hard to sort of segment that out. We have certainly been successful in selling into the facial plastic market, but I think we're just seeing overall strength across a number of different groups, and it's not sort of limited to the facial plastic group.

Kyle Rose - Canaccord Genuity, Inc.

Okay. Great. And then just one other question. From a sales and marketing standpoint, it sounds like DTC is going to continue I guess indefinitely in the near-term. How do you think about the trade-offs or the spend between some of the co-op initiatives in the individual doctor-specific spend versus the broader DTC campaigns? I mean does the DTC end up cannibalizing some of that? And should we think about there being a little more leverage from that perspective? Or should we think about both of those continuing for the foreseeable future?

Mark J. Foley - Chairman, President and Chief Executive Officer

Yes, great question. And that's one that we're sort of wrestling with internally. As we came in 2016, because of the strength in the business, we didn't think we were at a stage where we needed to start trying to make trade-offs. We had good early data from our two Phase I and Phase II pilots. And DTC was a new incremental investment that we were making. And so at that point in time, we didn't want to start dialing back other things and confound the impact.

There's no doubt that DTC has had a great effect. And as we look at our co-op program, there's two benefits to the co-op program. One is, it binds us more closely with our practice partners, where we're really working with them together, so it's an ability to maintain focus and attention at the practice level. And then there's no doubt there's some brand efforts, but I think what we're going to increasingly look at, is there a way where we can strip out and create more efficiency while still being a really good partner.

And my guess is that there are going to be opportunities for efficiencies, and those are the kinds of things that are going to assist with our translation over time. I think there's going to be a great way to get the return on our brand investment that we're looking for, while still continuing to be a good partner. And I think that, as we move into 2017, we're spending a lot of time looking at, how do we get some efficiencies there, again, while still being a good partner. So I wouldn't expect that those are going to continue to grow at the same level together, but we'll figure out kind of how to balance those.

Kyle Rose - Canaccord Genuity, Inc.

Great. And then one final question, you've got the new applicator launching in the Q4, just historically, you've kind of committed to launching one new applicator or one new indication on an annual basis. Just, when we think about 2017 and the set up there, obviously, we've got the longer-term initiatives of acne and cellulite, but do we think that's going to continue in 2017, or is that something that we're going to need to wait for some of those bigger indications in some of the out years? And then thank you.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thanks Kyle. No, I mean I think we're still committed to that at least one meaningful new product introduction a year. We've talked about an arm indication that we're working on. And so we continue to move forward with that. We'll get into some more details, some granularity, when we give our 2017 guidance, but I think you should expect, again, at least one meaningful new product introduction in 2017. And to-date, that's been our longer-term strategy as well.

Kyle Rose - Canaccord Genuity, Inc.

Great. Thank you very much.

Operator

Thank you. And our next question comes from the line of Anthony Vendetti with Maxim Group. Your line is now open.

Anthony V. Vendetti - Maxim Group LLC

Thanks. Just a question on the CoolAdhesive, or the new Cool gelpad. So I know that was part of the margin issue, but if the costs associated with that are going to continue, my question is, is that going to be a consumable piece or is that going to be given as part of the CoolAdvantage applicator?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Yeah. So, Anthony, this is Taylor. That's going to – that affects our consumables margin. So when we ship out cycle cards, we ship out the appropriate amount of other consumables that you need in order to perform those cycles. And so the CoolAdhesive gelpad would be one of those. We're in a position where we're going to have a cost position on CoolAdhesive that is well above our cost position on the current gelpad. So that's driving the unfavorability here in the back half of 2016, and it will continue into 2017 until we can automate and improve some of those processes and bring that cost position down to a more normalized level.

Anthony V. Vendetti - Maxim Group LLC

Okay, so $150 for the Z card is inclusive of that? There's nothing else you're going to be able to charge above that, or not contemplating at this time? It's just that...

Taylor C. Harris - Chief Financial Officer & Senior Vice President

That's right. Currently, we don't charge additionally for these ancillary consumables.

Anthony V. Vendetti - Maxim Group LLC

Right. And then on the CoolMini, I know Mark commented that there were not any standalone CoolMini sales because of the desire to have the full system. You mentioned, Taylor, that the add-on applicators were $8.4 million. We already know $6.5 million was CoolAdvantage. So $1.9 million, what's left is CoolMini, CoolSmooth, right? So can we assume that most of that's CoolMini? And if so, is CoolMini still growing on a sequential basis, in terms of sales from first quarter?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Let me just correct one item, which is that, so we had $6.5 million of CoolAdvantage revenue in total. The vast majority of that was in the form of add-on applicator revenue. I think it was, though, probably in the $5.5 million range, so the balance would be CoolMini and CoolSmooth.

I'd say that CoolMini is – I wouldn't say that we're increasing on a sequential basis. I think we've had relatively steady performance in the first half of the year. And just to give you an indication of that, we're now up to the mid-60%s in terms of percentage adoption within the North American account base. And that's above the target that we had set earlier, so we feel good about that. There's probably some room to go, but you definitely shouldn't assume a perpetual stream of those add-on applicator sales.

Mark J. Foley - Chairman, President and Chief Executive Officer

But I will say, Anthony, in terms of the actual utilization of CoolMini itself, again, we had the sort of bolus shipment in Q4, which got us to that 50% norm number right out of the gate and then we went up to 60% last quarter. But getting that sort of on, training these accounts, getting them up and running with it, is still an ongoing process. So in terms of the percentage of our overall cycles, we do think that the CoolMini utilization is continuing to grow, even in those accounts that purchased the product previously.

Anthony V. Vendetti - Maxim Group LLC

Okay, yes. That was helpful. That was my next question. So the utilization continues to grow for it. But at some point, you're going to reach a saturation in terms of add-on CoolMini applicators?

Mark J. Foley - Chairman, President and Chief Executive Officer

Correct.

Anthony V. Vendetti - Maxim Group LLC

Okay, great. And just on...

Mark J. Foley - Chairman, President and Chief Executive Officer

Because all new accounts get the CoolMini now. So it's just a matter of kind of what sort of level of penetration with our existing accounts do we get to.

Anthony V. Vendetti - Maxim Group LLC

So, Mark, you mentioned ASPs are continuing to go up as you add on the new applicators. I guess the question is, with the competition that's out there, is the expectation that that is at some point going to flatten or be under some pressure? Or you're not seeing that at all? And then if you can just talk about what you are seeing in the marketplace in general?

Mark J. Foley - Chairman, President and Chief Executive Officer

Yes, I mean, again, we had very good ASPs. As a matter of fact, they're up on a year-over-year basis. And as Taylor mentioned, we're taking up our list price. Historically, if we look at other competitive entrants in the market, we pretty typically do see price concession coming in a couple of quarters after they've launched, in an attempt to drive deeper penetration and we have yet to see that activity negatively impact our ASPs. And I think it has to do with the fact that we put a lot behind our brand. We invest a lot. We commit to training. We do co-op advertising, so we feel really good about the value that we're giving to our accounts when they make that investment. And so it's hard to say, we're just – we're not seeing ASP pressure. We haven't seen ASP pressure in the past when competing technologies have discounted more significantly or bundled. And again, I think it gets to the point where the market right now is so large and so early that this is much more of a market creation stage than it is necessarily a cannibalization stage. So – and I think we've got a ways to go there.

Anthony V. Vendetti - Maxim Group LLC

Okay. Great. Thanks guys.

Mark J. Foley - Chairman, President and Chief Executive Officer

You're welcome. Operator, let's take one more question.

Operator

Certainly, and our last question today comes from the line of Zack Ajzenman with Griffin Securities. Your line is now open.

Zack R. Ajzenman - Griffin Securities, Inc.

Good afternoon. Thanks for squeezing me in. Two questions. The first one on warrantees last quarter. You guys highlighted kind of the catch up warranty provision as the characterization there. So I'm just kind of curious, is this kind of the new norm when thinking about warranty expenses going forward and how should we think about, on a normalized basis, warranty expense as a percentage of revenues?

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Sure. So part of this is standard warranty, in other words the cost that we provision for just as part of shipping out any new product. We are, though, having increased extended warranty costs, just as we have more products out in the field and more customers purchasing extended warranty contracts. So, I do think especially with that extended warranty piece that where we're at right now reflects some of the significant growth in number of systems in the field. And it is reasonable to think about that as an ongoing cost of revenue. Now we will have an opportunity at some point in the future to revisit the pricing, the terms on extended warranty, contracts, but we haven't done that yet. And so we're a little over 1% of sales each quarter that goes to warranty expense. I think that's a reasonable level to assume, at least here for sort of the next few quarters.

Zack R. Ajzenman - Griffin Securities, Inc.

Got you. And then moving over to China, the controlled launch here, are those systems, do they include the new applicators? And can you just give us an idea of the economics for consumable sales in China?

Mark J. Foley - Chairman, President and Chief Executive Officer

It's a great question. So this approval will not include the new applicators. So this approval relates to a much earlier submission where with the legacy applicators, so that's what we're going to be starting with there. And we've already begun the process of filing on our new applicators. In terms of the capital consumable mix, it will be similar to what is in our other markets where there will be a capital component and a consumable component. We do have a distribution partner in China, so we will be selling at a lower ASP into that market so that the distributor can make their margin, but there's no sort of other change in terms of how we think about the capital consumable split in that market.

Zack R. Ajzenman - Griffin Securities, Inc.

Got it. Thanks guys.

Mark J. Foley - Chairman, President and Chief Executive Officer

Thank you.

Taylor C. Harris - Chief Financial Officer & Senior Vice President

Thank you.

Operator

Thank you. And that does conclude today's question-and-answer session. I would now like to turn the call back to Mr. Mark Foley, CEO and President for closing remarks.

Mark J. Foley - Chairman, President and Chief Executive Officer

Great. Thank you everyone for joining our Q2 earnings call. And we look forward to speaking with you again on our – report on our Q3 results. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!