Good day, ladies and gentlemen, and welcome to the Second Quarter 2020 Illumina Earnings Conference. At this time, all participants are in listen only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one on your telephone. As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Ms. Jacquie Ross, Illumina Investor Relations.
Good afternoon, everyone, and thanks for joining us for our 2020 second quarter results. During the call today, we will review the financial results released after the close of the market and offer commentary on our commercial activity, after which we will host a question-and-answer session. If you've not had a chance to review the earnings release, it can be found in the investor relations section of our website at illumina.com.
Participating for Illumina today will be Francis deSouza, President and Chief Executive Officer, and Sam Samad, Chief Financial Officer. Francis will share an update on our business, and Sam will review our financial results. Similar to last quarter, we are hosting our call from a number of different locations, so please bear with us if there are any technical challenges or pauses.
This call is being recorded, and the audio portion will be archived in the investor section of our website. It is our intent that all forward-looking statements regarding our financial results and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties.
Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based upon current available information, and Illumina assumes no obligation to update these statements. To better understand the risks and uncertainties that could cause actual results to differ, we refer you to the documents that Illumina files with the Securities and Exchange Commission, including Illumina's most recent Forms 10-Q and 10-K. With that, I'll turn the call over to Francis.
Thank you, Jacquie. Good afternoon, everyone, and thank you for joining us today. As expected, the second quarter was tough in the context of our original 2020 plan. Nonetheless, a quarter of strong execution in the current environment that further strengthens our foundation for future expansion.
I've been proud to see how our employees have pivoted and flexed to support customers, how we have stepped up what was already an aggressive innovation engine, and how we have supported each other and our communities through this pandemic. As we navigate the near-term disruption, we remain focused on the long-term opportunity for Illumina and for sequencing, which, if anything, is larger today than it was six months ago.
To summarize our second quarter experience and outlook, our second quarter revenue of $633 million was down 25% from a year ago as our customers around the world continued to be impacted by the pandemic. We're seeing indicators of gradual recovery and, barring an unexpected development in the course of the pandemic, the second quarter should represent the revenue floor for the year.
Further, we expect sequential revenue growth in the third and fourth quarters. Second, despite lower patient visits, our clinical business remains more resilient than research, which continues to be more impacted by ongoing shelter-in-place restrictions.
Third, infectious disease is emerging as an additional long-term focus area for genomics. Illumina has responded quickly with three workflows, including software tools and COVIDSeq, our diagnostic test for COVID-19, which went from concept to authorization in less than 60 days.
Given the timing, these contributed very modestly to revenue in the second quarter, and we're encouraged by the interest we're seeing so far in the third quarter. Finally, most importantly, we believe that the long-term opportunity for sequencing is expanding.
While COVID-19 has had a negative short-term impact on our customers' ability to operate, this shared experience is broadening awareness and appreciation of the value of genomic insights. Studies, including GEL's 35,000-patient study in the U.K., could ultimately accelerate the adoption of genomic tests into routine clinical use for infectious disease and surveillance.
Looking to the second half of 2020 specifically, sequencing consumables, which make up most of our revenue, remain correlated with shelter-in-place activities, and recovery, therefore, depends on how quickly our customers get back into their labs. That said, we're encouraged by the momentum in the business as we move into the second half of the year.
Sequencing consumable run rates are improving, and some of our clinical customers are at or above their run rates from the fourth quarter of last year. Sequencing system placements increased sequentially, including higher NovaSeq shipments. Additionally, NextSeq 2000 shipments beat our second quarter expectations.
Population genomics initiatives are continuing to move forward. All of Us, for example, has received the necessary IDE from the FDA and will start sequencing and genotyping later this quarter. Beyond research, COVID-19 related sequencing for both diagnosis and screening is at the earliest stage of adoption and could scale more meaningfully in the second half of the year.
Sequencing continues to play a critical role in understanding the SARS-CoV-2 virus, the transmission dynamics of the pandemic, the development of effective treatment and vaccines, and the interactions between host and virus with respect to transmission and virulence.
In addition, we're seeing growing interest in leveraging sequencing to help address the need for increased diagnostic and screening testing capacity. To contribute to testing capacity, Illumina urgently developed COVIDSeq, the first NGS-based diagnostic for COVID-19. We received Emergency Use Authorization from the FDA on June 7th, and shipped to a few early access customers towards the end of the second quarter.
PathGroup, for example, intends to launch towards the end of this quarter and scale through the end of 2020. COVIDSeq runs on our NovaSeq, and in addition to a diagnostic yes or no, provides a full viral sequence for most positive samples.
This information can be critical to understanding community transmission patterns in order to better control regional outbreaks. We continue to extend the utility of COVIDSeq with a series of amendments that will add saliva, improve automation, and de-risk supply chain.
In the immediate term, we have submitted an amendment to the current authorization for our existing COVIDSeq test that simplifies the workflow with an additional RNA extraction method to de-risk the supply chain and extend the test beyond our NovaSeq by adding NextSeq.
This will enable lower throughput labs to offer COVID-19 diagnostic testing locally, which could supplement current PCR test providers who are experiencing turnaround times of up to 10 business days.
Looking forward, and with Illumina's COVIDSeq supply scaling up, we are in discussion with dozens of customers in more than 10 countries, with a number of these actively evaluating COVIDSeq.
For example, the Institute of Genomics and Integrative Biology in New Delhi just completed their first clinical validation of COVIDSeq and reported sensitivity of more than 98%, and an increase in diagnostic yield of between 8% and 10% compared to PCR.
The team is interested in COVIDSeq as a means to increase available frontline testing while also gaining access to the viral genome data that can be used to monitor transmission of the virus. In addition to COVIDSeq, we're pleased that Ginkgo and Helix were among the seven recipients of funding from the NIH's Rapid Acceleration of Diagnostics initiative.
This underscores the potential for sequencing-based diagnostic tests to scale and diversify testing beyond PCR, which we believe will be increasingly important as we head into the fall flu season. Moving to screening, it remains to be seen how widely screening programs are adopted, but it is clear that a number of programs will scale in the third quarter.
Testing for America last week announced a partnership with the historically Black colleges and universities to develop return-to-campus initiatives for the academic institutions within the Thurgood Marshall College Fund and the United Negro College Fund family. Delaware State University, for example, started its pilot screening program a few weeks ago, with plans to test up to 3,000 students and educators a week.
Back to the quarter, and starting with regional results, all regions were impacted by prolonged closures or reduced operations at research labs, and also in some cases by temporary reallocation of resources to PCR testing for COVID-19.
China revenue of $79 million was down $5 million sequentially, consistent with our expectation for a relatively modest decline. COVID-19 headwinds were driven by the research market, with extended closures among some universities and research institutes that we expect to continue into the third quarter.
Clinical, however, has shown some resilience through the pandemic, with growth both sequentially and year-over-year, driven by reproductive health. Oncology testing is still below pre-COVID-19 levels, but improving. EMEA revenue of $168 million was largely in line with our expectations and reflected significant sequential declines in both research and clinical sequencing consumables.
Research headwinds were driven by lab closures, while some other customers redirected resources to non-sequencing-based COVID-19 diagnostic testing. As expected, the Americas region saw the largest sequential dollar impact from COVID-19 and was down $142 million from last quarter to $335 million.
Compared to April, more academic and government labs are resuming operations, but most are still operating well below pre-COVID-19 levels. Clinical continues to be more resilient, with some customers reporting lower clinical samples associated with shelter in place restrictions.
Finally, the Asia Pacific region reported revenue of $51 million, compared to $57 million in the second quarter of 2019 as research labs reduced activity. Moving to the customer view, we continue to track sequencing run rates as an indicator of general activity, but remind you that this is not directly correlated to revenue.
It's clear that while customers navigate this pandemic, many are maintaining a lower level of sequencing consumable inventory than before. As a result, shipments, and therefore revenue, are lagging the recovery we're seeing in run rates. That said, in clinical, we shared that the run volume at the end of April was about 80% of the run rate in the fourth quarter of last year. Clinical run rates for the second quarter of this year averaged 84% of the Q4 2019 run rate.
The trend is one of modest recovery, but with significant variation from week to week. Within clinical, reproductive health continues to be the most resilient, followed by oncology. Moving to research, second quarter run rate improved from about 55% at the end of April to about 65% of the Q4 2019 run rate, clearly remains significantly impacted by the pandemic.
Weekly run rates among research customers are more variable than clinical. While commercial disruption has been unavoidable, the broader Illumina team continues to execute against our strategic priorities, with new product releases and acquisitions that are intended to further enhance our customers' application portfolio and ease of use, and expand our market opportunity.
Early feedback on NextSeq 2000 has been very positive, with customers reporting that the sequencers outperform expectations with the excellent data quality they've come to expect from Illumina.
Despite the shift to the virtual world, our team has done a terrific job of installing new systems and getting customers up and running, which speaks to the strength of our support organization as well as the underlying engineering and product design. Additionally, customers are showing continued interest in the P3 flow cell, which remains on track for a fourth quarter launch.
As noted earlier, we obtained the first emergency use authorization for a sequencing-based COVID-19 diagnostic test in early June, highlighting our versatile R&D and regulatory capabilities.
In early July, we launched the TruSight Software Suite for genetic disease that enables labs to accelerate time to potentially transformative genomic insights from weeks to hours. The TruSight Software Suite helps customers quickly sort through millions of variants to identify hard-to-find genomic conditions.
We believe that this TruSight Software Suite could, over time, become part of a new standard of care for newborns suspected of a genetic condition, and there is already broad and growing reimbursement offered for genetic disease testing. As the opportunity for clinical sequencing grows, we continue to identify and address bottlenecks to adoption, and this has resulted in innovation across the entire sequencing workflow.
Most recently, we announced our new DNA PCR-Free Prep, which reduces library prep time by as much as 75%. This accelerates time to result and improves lab efficiencies, which are both even more important in the context of clinical samples. At the other end of the workflow, we continue to find ways to help our customers store, manage, and analyze the vast amounts of data generated by our sequencers.
With that in mind, we closed two technology acquisitions in June and July that, combined with our existing software solutions, improve the efficiency and scalability of processing and sharing data. BlueBee offers software solutions that enhance users' ability to extract insights from genomic data stored in Illumina's analytics platform, and Enancio brings proprietary lossless genomic data compression software that reduces storage footprint fivefold and will be integrated directly into the DRAGEN workflow.
Outside of the sequencing workflow, but important nonetheless, we received positive feedback on our new sustainable reagent packaging, which will divert almost 250,000 cubic feet of foam packaging from landfills each year. Finally, I'm pleased to announce some enhanced features and new pricing for our NovaSeq reagent kits. The new reagent kits deliver longer shelf life and extra cycles, extending our performance lead in the high throughput market.
Additionally, the new kit offers more accessible pricing for any NovaSeq user, bringing the $600 genome into reach for all our customers. These changes represent Illumina's ongoing commitment to sequencing innovation to enable deeper sequencing, adoption of more data-intensive applications like whole genome sequencing, single cell, and liquid biopsy, and larger cohorts to increase the statistical power of studies. With that, I'll hand it over to Sam to discuss the financials in more detail.
Thanks, Francis. As discussed, second quarter revenue declined 25% year-over-year to $633 million as the pandemic impacted our research customers in particular. Total sequencing system revenue of $88 million was slightly ahead of our expectations, with stronger than expected NextSeq 2000 shipments. Shipments for NovaSeq, NextSeq 2000, MiSeq, and MiniSeq all increased sequentially.
We continue to see NextSeq 2000 adoption across a broad range of clinical and research applications, including oncology testing, single cell, molecular pathology, and infectious disease, including COVID-19 research.
For the second quarter, most of the NextSeq 2000 shipments were legacy NextSeq conversions, and cumulatively to date, roughly a quarter of the new systems have been shipped to new to Illumina customers. Sequencing consumable revenue was $387 million, with many customers still operating below pre-COVID levels.
Of interest, clinical sequencing consumable revenue represented close to 50% of total sequencing consumables, given the greater pandemic impact we're seeing among research customers. Sequencing service and other revenue was $91 million, down sequentially due to lower licensing revenue, and down year-over-year due to lower sequencing service revenue. Overall, sequencing revenue was $566 million and represented 89% of total revenue.
Total array revenue was $67 million, down 39% from the same quarter last year, and down 32% from the first quarter of 2020, in part due to our lower expectations of the DTC market and its normal seasonality, in addition to COVID-19 related headwinds.
Moving through the P&L, as always, I will highlight non-GAAP results that include stock-based compensation. I encourage you to review the GAAP reconciliation of these non-GAAP measures, which can be found in today's release and the supplementary data available on our website.
Please note that all subsequent references to net income and earnings per share refer to the results attributable to Illumina shareholders. Non-GAAP gross margin of 68.6% was lower, as expected, on a both year-over-year and sequential basis due to lower revenue, which generated less fixed cost leverage and higher freight costs associated with the pandemic.
Non-GAAP operating expenses of $334 million were down $5 million from the first quarter of 2020, and $26 million lower than the second quarter of 2019. This was lower than expected due to an adjustment to stock-based compensation expense to account for updated EPS projections. Non-GAAP operating margin was 15.8%, down from 33.6% last quarter. The non-GAAP tax rate of 18.5% was up from last quarter and prior year due to a higher income mix in jurisdictions with a higher tax rate.
For the second quarter of 2020, GAAP net income was $47 million, or $0.32 per diluted share, and non-GAAP net income was $92 million, or $0.62 per diluted share. On a per share basis, our GAAP results include $0.61 for two discrete tax expense items.
The first of these relates to a valuation allowance established against the deferred tax asset for California R&D tax credits, and the second reflects finalization of the Altera court case, which determined share-based compensation must be included in intercompany cost-sharing payments.
This is partially offset by $0.38 on a per share basis from other income, which includes $69 million in unrealized gains from equity investments. Additionally, in the second quarter, cash flow from operations was $240 million, capital expenditures were $38 million and free cash flow was $202 million.
DSO of 55 days compared to 50 days last quarter, in part due to less favorable revenue linearity and lower revenue. We repurchased $143 million of common stock. We therefore ended the quarter with approximately $3.3 billion in cash equivalents, and short-term investments. Our weighted average diluted share count for the quarter was approximately 148 million.
We have $420 million available for share repurchases under our current plan. Additionally, our 2021 notes became convertible from July 1st through September 30th, 2020. As a reminder, the dilutive effect of the convertible notes has been included in our diluted average share count since the second quarter of 2018.
We continue to believe that the uncertainties around the severity and duration of the COVID-19 pandemic and the impact that has on our research customers in particular, makes it challenging to provide quarterly or full year outlooks at this time.
Directionally, we can share that we expect sequencing run volumes for our clinical customers to modestly improve from the 84% reported in the second quarter. For research and applied, we remain cautious and expect run volumes to improve modestly over the 65% reported in the second quarter.
We expect sequencing instrument revenue to grow modestly on a sequential basis, and we expect array revenue to be flat to slightly up. In terms of regional performance, we expect sequential growth in every region in the third quarter.
While some regions are recovering more quickly than others, there will certainly be headwinds across all regions. When compared to the third quarter of 2019, we expect revenue in all regions to be lower, with the exception of APJ, which is expected to be about flat.
For the third quarter of 2020, we expect non-GAAP EPS to be modestly higher compared to the second quarter of 2020, reflecting a gradual improvement in revenue, a sequential decline in non-GAAP gross margin, in part driven by the adjustment to stock-based compensation in the second quarter and increased field service activity as labs reopen, and an increase in non-GAAP operating expenses, primarily driven by the adjustment to performance-based compensation in the second quarter.
While we expect operating expenses to grow sequentially in the third quarter, we remain thoughtful and deliberate about where we invest. This means continuing to invest in R&D projects and utilizing our balance sheet to pursue growth opportunities.
As a genomic technology leader, we believe we have an obligation to invest in innovation regardless of short-term revenue headwinds. At the same time, we'll balance this in other areas by pausing or delaying certain capital expenditures and limiting other discretionary spend. With that, I'll hand the call back over to Francis.
Thank you, Sam. While the near-term disruption is challenging as we continue to navigate the pandemic, we remain as bullish as ever on the opportunity ahead for Illumina. The long-term opportunity for sequencing is expanding as the need for more infectious disease research and surveillance capabilities comes into focus. Innovation remains our North Star.
We will continue to partner with our customers as well as innovate internally to ensure that sequencing-based applications are contributing to global efforts to combat this pandemic, and whatever combination of research, diagnostics, screening, and surveillance applications is the most impactful.
Our competitive positioning is strong, with the recent preliminary injunction helping protect our intellectual property here in the United States. Looking beyond the pandemic, we remain unwavering in our commitment to innovation and to investing appropriately to progress our technology pipeline and continue to deliver gold standard sequencing products to market. My thanks to our customers and to our employees who are demonstrating resilience and flexibility as we work through this pandemic together. With that, we can start the Q&A.
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound or hash key. In order to allow everyone time for questions, we ask that you please limit yourselves to one question each. Please stand by while we compile the Q&A roster. Your first question comes from Tycho Peterson from JP Morgan.
Hey, thank you. Francis, I know you don't have guidance out there, but I am wondering if you can help us put some numbers around a couple of things. On the COVID testing opportunity, you talked about that scaling more meaningfully in the back half of the year and the 12 customers in 10 countries.
I am just wondering if you can give us any framework about how you are thinking about the scale up there and the magnitude of that opportunity. Similarly on PopSeq, at the beginning of the year, you talked about 280,000 genomes.
Obviously, there have been delays, but I am just curious if you could catch us up on what % of those you think get done in the back half. Lastly on China, it was down 19%, which was a bit of a surprise given the recovery there. Can you maybe talk to that and when that could return to growth? Thank you.
Okay, let's go through each of those in order, Tycho. First, let's talk about COVID and how we expect that to scale in the second half. As we said in the prepared remarks, we saw very little COVID-related revenue in Q2, and we expect that to start to build into the back half of the year.
In our base modeling, we're modeling little COVID-related revenue, certainly in Q3, but there are a number of areas where our customers are looking to use sequencing that we expect to start to contribute revenue in Q3 and then ramping in Q4. Those areas are research, diagnostics, screening, and surveillance. On the research side, there are a number of projects that got kicked off in Q2 that'll start to scale in Q3 and into Q4.
Examples include what's happening with genomics, for example, in the U.K. National Health Service Genomics England project, where they're looking at 35,000 COVID-19 patients, and they're sequencing them to understand what are the drivers of the severity of the infection. It's also projects like CanCOGeN in Canada or GMI.
On the diagnostic side, we have a number of customers that are starting to scale up their diagnostic capabilities. We have customers like PathGroup, for example, Ginkgo, Helix, Guardant, UCLA. They've all just started to scale up their diagnostic capabilities.
We expect them to begin to scale in Q3 and then ramp up in Q4. We also have some customers that are looking at rolling out a screening-based offering as part of back-to-school or back-to-work initiatives.
One example includes what's happening at Delaware State University, as I mentioned in the remarks, where they are working with one of our customers to screen about 3,000 educators and students a week as part of getting people safely back into school. It remains to be seen how those initiatives scale up over Q3 and Q4, and there's quite a range of outcomes there, as you can imagine, where you can imagine getting it fairly big if it really gets adopted as a way to get people back safely to school.
There are a number of surveillance initiatives that are starting that are looking at helping track the epidemiology of the pandemic and also looking to put together infrastructure that will last beyond this pandemic. For example, there's work happening around the CDCs, for example, in terms of setting up a surveillance infrastructure.
Those are the four buckets. There's research, there's diagnostics, screening, and surveillance. Again, very little in terms of revenue so far, but starting to ramp in Q3 and heading towards the end of the year. That was the first question. The second question, Tycho, was around PopGen. Let's talk about some of the big initiatives.
In terms of All of Us, we didn't see any sequencing revenue associated with All of Us in Q2, but there was progress there where they received the IDE from the FDA and are looking to start ramping up in Q3 and then more meaningfully ramp up in Q4. The U.K. NHS has put on pause the project that it had, and is really now focused on the Genomics England-related project that I just talked about.
The UK Biobank was sequencing in Q2, but significantly down in terms of run rate from where it was in Q1. We expect that to continue to ramp over the course of the year. In terms of China, which I think was the last part of your question, it was down.
What we're seeing in China is a real headwind in the research market, where although you're seeing China sort of work its way back to normal, there is still a phenomenon where a lot of the academic labs are either closed or operating at lower capacity or being repurposed for COVID-related testing. The research market in China continues to be down. Having said that, we're seeing more resilience in China from the clinical market. We saw both strength in the NIPT side of the business and in oncology relative to the research market.
Yeah, I would just add, Tycho, on the clinical side in China as well, we're seeing growth actually sequentially and year-over-year. We saw that in Q2. Definitely resilience on the clinical side of the market in China, but research heavily impacted by the closures. The Beijing resurgence as well, and the closures associated with that didn't help either in the quarter.
Your next question comes from Stephen Beuchaw from Wolfe Research.
Hi, good afternoon, and thanks for the time here.
Thank you.
There are two things I wanted to touch on. One is academic, and two is sort of lead indicators, I guess I'd call it. In academic, I think we all have a pretty good understanding as to why it's a challenging environment, right? It has nothing to do with Illumina, it's just the way the world is right now.
What I wonder is how do you think about to what extent this is demand destruction versus demand deferral? Maybe I'll elaborate on that a little bit. The funding in a lot of cases is there, but it's hard for people to get into the lab. Does that mean that these projects are simply being deferred into some point out in the future?
To what extent are you concerned about the funding itself, given the challenges that universities are facing, though I don't know that they're the entirety of your academic funding set, if you will. The second thing I wanted to talk about or ask about is, Francis, early on in your prepared remarks, you made a comment that suggested that at some point out in the future, as a function of everything that's going on right now, you think that the TAM is larger.
I wonder if you could just elaborate on that. I'm sure you've already touched on a lot of the points, but how do you track that? What is it you're seeing day to day or is it mostly intuition? Are there leading indicators? How do you track this perspective that the TAM is actually larger?
Are there project metrics or quoting activity that you're looking at that give you a view as to what is likely to emerge in terms of sequencing activity, some number of weeks or months or quarters out into the future, that you would be willing to talk to us about a little bit? Thank you.
Sure, Steve, thank you for the question. There are two parts to it. The first part is around what do we expect will happen in the academic markets around research dollars and whether we expect the projects to be deferred or canceled and how are we thinking about it. The feedback we're getting from our customers, Steve, is that the projects are being deferred, that they aren't being canceled.
They're being deferred because either people are working at home as part of shelter-in-place initiatives, are unable to do the research that they need to do right now, or they are in the lab, but they are being seconded to non-sequencing COVID-related work. What they're being told and they're telling us, though, is that they intend to get back to those research projects.
Even in cases where there's a deadline associated with the funding for those projects, in many cases, the deadlines are being pushed out to allow them to come back and pick up on the work. The clear feedback we're getting from our customers is that those projects are on pause and they expect to pick them back up.
In addition, what we're hearing from our customers in the research community is that there is additional funding coming into the mix as a result of the pandemic. What they are seeing is money being allocated to genomics research associated with the pandemic, whether it's to do with the host response, for example, or understand why some people are impacted more severely by the disease, or a whole host of other things that's driving more dollars into the research market.
They are thinking about how to plan those projects right now. In addition, they're telling us that the early signals around NIH budgets, for example, in the U.S., are very positive, that the early proposals are around an increase of about $5.5 billion to the NIH budget on a base of about $47 billion. A pretty substantial increase as the first proposal.
That includes things like COVID-related work, but it also proposes an increase into the funding of NHGRI, which is directly obviously related to genomics initiatives. The academic research, the signals about the comeback in academic research seem very positive to us right now.
That's part of the reason why we introduced the $600 genome, because we wanted people, as they're thinking about the projects that they'll take on when they come back in, to be able to scope them appropriately and go broader with their emission, because now they can plan larger projects with deeper sequencing or larger cohorts.
There's definitely a lot of thinking about what they do when they come back. So that was the first part of your question. The second part of your question was around, okay, how does this impact the addressable market for Illumina?
What's been the impact of the pandemic? It's becoming clear to us that the overall TAM for Illumina has expanded over the last few months, that if you had talked to us in even January or certainly by December or before, really we'd have talked to you much more about the opportunity and the clinical opportunity in oncology and reproductive health, but not a lot about infectious disease.
Clearly that's really changed over the last few months. What's becoming very clear is that there is a role for genomics in a number of areas in infectious disease. There is an existing role for genomics that's scaling up in research. There was always some genomics-related research in infectious disease. That's really starting to scale up as we look to the coming months and quarters, around some of the things I talked about, right?
Understanding the virus, understanding the interaction of the virus and the host. There's also a real need for genomic testing in diagnostics. That's fairly new, right? If we talked a few months ago, we'd have said, really, that the infectious disease diagnostics market is really a PCR market primarily, and that's changing as we look forward.
There's going to be a sequencing-based diagnostic capability that comes to market because of customers of ours like the PathGroup or Ginkgo or Helix, and that's going to be an important part of the diagnostic testing market going forward, and that's new and that's real. We're also seeing customers explore a much larger opportunity about screening, and we're early in that, and you've heard about what's happening in Delaware State University.
That represents an entirely new opportunity around thinking about how you create safe environments in schools and work, and that's a new part of the market that's becoming accessible to genomics.
Finally, there's a surveillance opportunity. This is something that I think is durable because it's becoming very clear that we need a global pathogen surveillance network that's genomics-based, that we need a much better early warning system to understand if there is a viral outbreak happening.
That could be for things like the coronavirus today, but looking forward, it's needed for things like antimicrobial resistance, for bioterrorist attacks, for example. So there's a need for an early warning system. There's a need for a network system that understands the transmission and virulence of the pathogen as it makes its way through a population, that's able to track the epidemiology of it.
That's also new, right? That's starting to be put into place, and that's something that we will need from now on. That's a whole new part of the market that's being introduced to genomics.
Your next question comes from Doug Schenkel from Cowen.
Hey, good afternoon. I want to start with a question on COVID and then ask a higher-level question on the capital equipment outlook. Starting on COVID, while there's little debate that your efforts to help develop COVID solutions broadly should be commended and widely appreciated, I think it's fair to say there's a ton of debate in both the clinical as well as the investor community about how big a role Illumina next-generation sequencing approaches, such as SwabSeq, can play as a true clinical testing solution, given the associated complexity and logistical challenges.
We've all read about exciting initiatives such as those pursued by Ginkgo, but we've also read about places like the Broad Institute, which have a ton of sequencers sitting there, are really sophisticated, maybe the most sophisticated in the world.
Yet, while they're doing the most COVID-19 testing volume in Massachusetts, they have no plans to use Illumina NGS for clinical sequencing. With that in mind, how many labs do you think are going to try to do what Ginkgo's doing? For market sizing purposes, is it fair to conclude that the revenue per test opportunity for that approach is likely somewhere between $1-$3 per test?
The second thing I want to talk about is capital. It's great to hear that clinical volumes are picking up and that folks are getting back in the lab, and obviously, those are good signs when it comes to the outlook for consumable demand. Instruments, you were down year-over-year. You did better than I think a lot of us expected in the quarter.
As you look ahead, what do you think is going to happen? How are you thinking about the second half? Are you thinking that labs, even as they get back and pick up activity, are going to tend to hold back a little while on capital spending when possible, just given the uncertainty of the environment? Thank you.
Thank you, Doug. Let's work through the parts of the question. The first part of the question was around the real role of NGS in COVID testing and what kind of role will NGS play, given that the majority of testing is being done on PCR and has been. Let me start there, and then I'll talk about capital equipment.
In terms of COVID, again, if I look at the four buckets where we pulled, it's research, it's diagnostics, it's screening, and surveillance. Research, no question, there are research projects that are coming online that are uniquely suited to NGS compared to PCR. All the projects that I talked about, really, they're new, they're incremental, and they need NGS.
Whether it's GMI in Ireland or any one of the projects that I talked about, that'll be on NGS, and those will ramp over the course of the year. In diagnostics, there's no question that the first wave of testing was really done on PCR. As the world needed to scale really quickly up its testing, it absolutely made sense for all of that scale-up in the first wave to happen on PCR.
The reason NGS is being pulled in now, there's a few reasons for it. One is there are areas where we're running into capacity constraints, right? When we talk to labs, and certainly you'll read that even here in the U.S., the turnaround times associated with the testing in the U.S. right now can be 10+ days.
When you ask the labs why that is, they'll tell you there's supply chain constraints, that all the PCR testing services are competing for some of the same elements in the supply chain. Labs are talking to us about needing an orthogonal testing modality that doesn't compete for the same supply chain resources.
That's where NGS comes in, and that's why people are looking at NGS for the second wave, where they expect a pretty significant need for testing. We were talking to one lab, and they said, look, on a given day, they'll turn down 20,000 people for a test just because there's no capacity. There's clearly need for an orthogonal system that doesn't compete for the same supply chain. That's one reason we're being pulled into diagnostic testing.
Another reason we're getting pulled into diagnostic testing is, in some cases, people want more information. They don't just want the diagnostic yes or no. They do want a few things. One, they want to do confirmatory, for example, if somebody is positive on PCR, in some cases, they want to do confirmatory testing.
They want to get more information on the viral genome for epidemiological information, to get transmission data so they can help inform policy decisions. In some cases, they run a certain percentage of the negatives, just to make sure that there isn't a false negative problem happening.
For that reason, too, they're looking to scale up their NGS capacity. Those are some of the reasons we're being pulled into diagnostic testing. Now, you asked about SwabSeq versus COVIDSeq, and frankly, obviously, we support them all.
SwabSeq has been developed to provide a quick diagnostic yes or no answer, right? It's a cheaper test, and it does give you that yes/no answer. There are various flavors of SwabSeq that are being implemented by different customers of ours.
You asked about the economics. You can think about depending on the flavor, it's sort of in the low to mid single digits per test that comes to Illumina. If the customer is using COVIDSeq, you should think about it as a $20 per test, for example, that comes to Illumina. That's sort of the drivers of why NGS is being pulled into the diagnostics section.
To help with that, obviously, we developed COVIDSeq, and sort of launched it at the end of Q2, and we've just filed for the EUA amendment to make the workflow simpler and to enable COVIDSeq to be run on NextSeq, which allows the smaller labs now to do the COVID testing. The next question you had. The other two areas we've been pulled into COVID.
We talked about research, we talked about diagnostics. We're being pulled into screening. Again, the idea here is to screen a healthy population, very large scale. Some of our customers, like we talked about on the call, are looking to use NGS for that high-scale testing. It's early. There are some exciting pilots happening, and we're watching to see how they play out.
For surveillance, that's something you can really only do on NGS. It's not something you can do on PCR, because what you want to do with surveillance is identify a pathogen outbreak as it happens. For there, you actually do need to get the sequence of the pathogen.
Similarly on surveillance, you want to track the transmission of the pathogen, and for that, you again need the genome of the virus more than you can get from a PCR test. Surveillance is a real need that is uniquely suited for NGS. In terms of capital equipment, I'm going to turn it over to Sam.
Yeah, if I can jump in real quick, Doug, on capital. First of all, really encouraged by the results and the performance that we saw in NextSeq 2000 in Q2. It came in better than expected and really, the feedback that we're hearing from customers is great. What we're also hearing from customers is absolutely no outright cancellations of capital equipment or basically no need for capacity.
They are delaying certain purchases, that's to be expected given the uncertainty. They've been facing some pretty significant closures, we saw that also on consumables, where they drew down inventories in Q2. We're seeing delays, we're not seeing cancellations. There's still interest. In terms of our expectations for the second half, we're expecting definitely a sequential increase in terms of the revenue that we expect from instruments and obviously the placements as well.
Your next question comes from Dan Brennan from UBS.
Great. Thank you. Thanks for taking the questions. Quite a couple, which I'll wrap into one. First one would be just on the clinical market. I know the improvement that you're expecting in Q2 is fairly modest. I believe when you look at a lot of the data being reported out of hospitals, the improvement's been sharper through the quarter and the outlook, I think, is better.
I'm just wondering why you think you're not seeing a faster improvement for clinical NGS, number one. Number two, just on the NovaSeq pricing, could you maybe elaborate a bit on this? Does this really open up maybe the lower end of the market? Are you offering the $600 price down to the smaller labs? Do you think that could galvanize maybe a NovaSeq upgrade cycle as things get a little better with funding?
Then on kind of number three, back to COVID, I'm just wondering, on screening, I would think kind of the time is now in terms of as schools are looking to open up in the next couple of weeks. The fact that you're pointing maybe to 4Q is when this could kind of become more real for you.
What is it that kind of has taken more time to get to this point for screening for you guys, and maybe could you elaborate a little bit on your funnel? I know, Francis, you talked about Delaware. You said there's a lot of interest. Any color in terms of the screening opportunity and what you're seeing from customers? Thank you.
Sure. Thank you, Dan. Let's start with the clinical market and sort of the dynamics there and why not faster. Really the clinical market is a story of two markets, right? If you look at what's happening in NIPT has actually been fairly resilient. If we look at, for example, in the Americas, we actually saw quarter-on-quarter growth in the NIPT market.
From Q1 to Q2, even though overall revenues for Illumina went down, you did see growth in NIPT. On one part of the clinical market that's been fairly resilient is the NIPT part, and that's fairly consistent. If you look at oncology, what's happening is, even though the oncology segment is more resilient than the research market, it is less resilient than NIPT.
What's happening, and this is a dynamic that's playing out more broadly, is that people aren't going in to get screened for cancer, and fewer people are being diagnosed with cancer. It's not that they're not getting cancer just as much as they were before, it's just that they aren't going in.
That's a human tragedy, and it's showing up for us, too, where the oncology market is slowed down. Now, the cancer isn't going away, and so at some point, we do expect people will go in to get screened and will want to get tested so they can get matched with the appropriate therapy.
In the oncology market, there's likely to be some catch-up that needs to happen. Now, unfortunately, it won't help everybody, but there will be some catch-up that needs to happen. That's the dynamic playing out in the clinical market.
On the NIPT side, some more resilience, and oncology, some resilience, but certainly not as much as on the NIPT side. In terms of the new NovaSeq pricing, the $600 genome. The intent is, with this release, to make the $600 genome more accessible to all Illumina customers with this kit.
What we think that does is it allows our customers to plan for larger projects as they think about writing grants, and it is primarily targeted at the research market to, whether it is single-cell applications or deeper sequencing or larger cohorts, we wanted them to be aware of the price point as they are planning the projects when they come back into the labs.
I think this will be an incremental positive in terms of the economics for maybe some of the smaller core labs that have not yet upgraded from their HiSeq to NovaSeq. I think this makes the economics even more compelling, and so I think it will be an incremental positive in terms of driving that upgrade cycle. In terms of screening, unfortunately, the screening need isn't going to go away in the next couple of weeks as people go to school.
I was talking to an individual who runs the public health system of one of the largest states in America, and he and I sort of agree that we will need this for at least a year, maybe somewhere between a year to two years. The reality is, even in an optimistic scenario, we're talking about a vaccine towards the end of this year becoming available, and then between it being available and being broadly deployed, there's going to be some time.
In that time, there's going to be a real need to make sure that we have safe schools and safe work environments, and that's where the need for screening is. I think that need for screening is going to be playing out even going into the middle of next year. We've talked about one case being rolled out. We have a number of customers that are working on their screening initiatives, and we'll leave it up to them to be public about what they're doing.
Your next question comes from Puneet Souda from SVB Leerink.
Hi, Francis. Thanks. Thanks for taking the question. I know this has been covered a little bit, but I just want to get to a core question here. Traditionally, we have seen Illumina grow via the elasticity of demand, and that's what's driven you into multiple markets.
We have seen expansion of multiple markets with that elasticity of demand. You were, in fact, the first ones to enter some of the markets, whole genome sequencing being one of them, and drove that market expansion.
I'm just trying to understand, as you look at the next couple of years, do you see COVID research, COVID testing, and COVID surveillance, I completely agree that you absolutely need sequencing to chase some of these strains, so to speak, but do you think that these markets can truly drive that elasticity of demand for Illumina and that, too, at $20 per test?
You obviously see PCR, antigen, other solutions, point of care, reaching these markets over the next year or so. Just trying to get your view about how do you see elasticity of demand playing out here for Illumina. Thank you.
Yeah. Thank you, Puneet. I think that different parts of the COVID market need different price points. What we want to do is make sure that we have the right offering at the right price point to activate the different parts of the market. Let me be more specific. If we look at the diagnostic part of the market.
There, you do need price points where labs are able to offer a test at $75- $100, which is where reimbursement is, and have a viable business. There, something like COVIDseq, where the cost to them, Illumina reagents is $20, or SwabSeq, where it's in the single-digit dollars, is exactly the right fit.
That's the price point that unlocks, that opens up that market for NGS. That market was never an NGS market, so this is all incremental to NGS. That was a PCR market. All of this is new dollars now that are available to NGS. To open up that market, you need a test at the $75-$100 price point, and so to Illumina, that's either sort of low-to-mid single digits or $20 a test, but that's a large test.
Similar with screening, you need that same price point, and you may even, with pooling, be able to get to lower price points in that market, and that's the price point that you need to activate those markets. Screening could be a very large market, and it needs that kind of price point. Now, research and surveillance can sustain a higher price point.
There, the $600 genome, I think, is the right sort of price point, where if you're doing cohorts in the not measured in the millions, but measured in the thousands or tens of thousands, there a $600 price point makes sense and sort of activates that market.
That's how we're thinking about it for the research market. Surveillance, it could be even a little bit higher, because you're not talking about, again, millions of samples. That's how we're thinking about the different markets and having different offerings with different price points to activate those markets.
Your next question comes from Derik DeBruin from Bank of America.
Hi, good afternoon. A question on your comments about inventories being drawn down in the third quarter, I guess. In the second quarter, I guess. Where are they, and do you expect additional drawdowns in the third quarter, or could there be some potential for some catch-up spending as comeback?
I just want to go back on the sort of the academic and government market. I mean, we've had some conversations with people talking about pressures on philanthropy and endowments, and we've seen a number of organizations, such as the ACS and some of these other ones cutting back on their spending.
I know that's a big chunk of money that goes into supporting some of the sequencing centers and the biomedical research centers. I'm just sort of wondering what you're hearing about potential personnel cutbacks and things in the academic markets. This sort of goes into another question about are you expecting any sort of pickup or budget flush in the fourth quarter? Thanks.
Yeah. Let me talk about inventories, Derik, and thank you for the question, and I'll hand over to Francis to talk about the academic dynamics that you refer to. With regards to inventories, I mean, first of all, Q2 really played out as expected for us in a number of ways. I would say on the instrument side was favorable, driven by NextSeq 2000.
On the sequencing consumable side, really where I would say we had lower than expected performance was on the research side and driven by what we think is inventory, what we believe is inventory drawdown in that market. As we talk to our customers, I mean, obviously driven by a couple of things. First of all, the uncertainty, the fact that there's still closures, the fact that there's still uncertainty as they look forward.
The fact that also supply chains have become less uncertain, so they have more visibility to the fact that supply chains are not disrupted, so they can actually get inventories when they need them. They don't need to stock up. When you look at the activity levels that we saw in Q2, it was really where we were expecting activity levels to be, but there was definitely a gap on the research side driven by research customers drawing down inventories.
Your question is around what are we seeing in terms of number of months of inventory with customers, and how we expect the dynamics to play out over the next two quarters. That's hard to project, Derik, in terms of whether we see stocking back up, whether we see a different dynamic in Q3 or Q4. Really, we don't have that visibility.
What we are expecting is that activity levels will be a proxy to how we see sequencing consumables sequentially grow in the next two quarters. As we said on the prepared remarks, we are expecting activity levels to improve modestly for both clinical and research in Q3. In terms of predicting inventory and predicting customer behavior in terms of how they're going to stock or de-stock, that's really difficult to answer at this stage.
It's easier to just explain the Q2 dynamic as we did. In terms of academic and sort of government funding, what we are seeing is, in some cases, researchers are getting more time to spend academic funding, so that could certainly sort of prolong a little bit how long a project takes as people are sheltered in place, and they have longer to actually use the money.
We definitely are seeing that. We are seeing, though, more money come into genomics-related COVID research, not less, and that's coming from some of the usual sources. For example, I talked about the proposal to increase NIH grants, sorry, funding next year by $5.5 billion, including an increase of just over $650 million to NHGRI. That's the proposal. A total for NHGRI. That's the proposal.
We're also seeing money come into COVID-related research or surveillance from, for example, philanthropies. When we did the donation to the 10 countries in Africa for the Africa CDCs, we were working with one of the largest philanthropies here in the U.S., as well as one out of Asia, to try and help deploy this global surveillance network. We're also seeing people who aren't usually funders of genomics work.
For example, sort of an interesting cooperation between the expansion of the relationship between Microsoft and Adaptive, for example, around understanding the immune response to COVID. Overall, we are still seeing interest in government funding, academic funding, philanthropy funding associated with COVID and genomics research.
Our last question comes from Jack Meehan from Nephron Research.
Thank you. Just had a couple of additional follow-ups. First on the NGS consumables. I'm not sure what your level of visibility is here, how long do you think it'll take for research labs to get back to 100%?
We've heard from some customers, they think they can catch up by year-end from some of the closures that took place. Do you think that's realistic or not? Just to follow up on the clinical side, as you roll out COVIDSeq for the NextSeq box, can you give us an update on what the turnaround time will look like for testing and just how that could fit into the needs for COVID-19? Thanks.
Yeah.
Francis, maybe I'll talk very quickly about the sort of research ramp that you talked about, Jack, thank you for the question. Francis can talk about COVIDSeq and the NextSeq turnaround. Again, this is all assumption-based at this stage, it all depends on many factors around what we see with regards to the virus and the potential shelter-in-place restrictions.
As we saw in Q2, we were going in the right direction, things went in the wrong direction, I'm referring to the U.S. here in terms of the response to the virus. In terms of our expectations, Jack, is that, again as we mentioned earlier, is to see an improvement. We were at 65% average in terms of run rates in Q2. That's a proxy.
That's essentially activity levels on the sequencers that are connected to our proactive network and to BaseSpace, and we expect that to improve in Q3 and to improve, also sequentially, modestly albeit, in Q4. To get back to 100%, I can't answer that.
That really is not something that we have visibility to at this stage. I think the way you should be thinking about it is gradual, modest improvement in terms of activity levels as we go forward, and that applies to clinical as well. That's in response to your question on research.
Jack, in terms of your question on the turnaround time in NextSeq, obviously it depends on the workflow at our customer sites that are implementing COVIDSeq and NextSeq and how they turn around. The intent, of course, is to be able to have a test that allows a turnaround in that 24-hour time frame, but it really depends on the customer.
I will now turn the call back over to Jacquie Ross for closing remarks.
Thanks, Mike. As a reminder, a replay of this call will be available as a webcast in the Investors section of our website, as well as the dial-in instructions contained in today's press release. Thank you for joining us today. This concludes our call, and we look forward to our next update following the close of the third fiscal quarter.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.