Good day, ladies and gentlemen, and welcome to the Second Quarter 2020 Illumina Earnings Conference. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] 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 Investors 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 document 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, Jackie. 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. But 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 flex to support customers, how we have stepped up what was already an aggressive innovation engine and how we have supported each other in 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 6 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 continue to be impacted by the pandemic. We are 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 are seeing so far in the third quarter. Finally and most importantly, we believe that the long-term opportunity for sequencing is expanding. While…

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 conversion, and cumulatively to date, roughly a quarter of the new systems have been shipped the 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…

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 and 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 position is strong with the recent preliminary injunction helping protect our intellectual property here in the United States. And 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.

[Operator Instructions] Your first question comes from Tycho Peterson JPMorgan.

Hey, thank you. Francis, I know you don't have guidance out there, but I'm 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 dozen customers and 10 countries. I'm just wondering if you can give us any framework about how you're 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'm just curious if you could catch us up on what percentage of those you think is done in the back half. And then lastly on China it was down 19%, which was a bit of a surprise given the recovery there. Can you may be talk to that and when that could return to growth? Thank you.

Okay. So, let's go through each of those in order, Tycho. So 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 are modeling little COVID related revenue certainty 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 will start to scale in Q3 and into Q4. Examples include what's happening with genomic for example in the UK NHS GEL project where they're looking at 35,000 COVID patients and they are sequencing them to understand what are the drivers of the severity of the infection. There's also projects like CanCOGeN in Canada or GMI. On the Diagnostics side, we have a number of customers that are starting to scale up their diagnostic capabilities and so we have customers like [indiscernible]; for example Ginkgo, Helix, Garden to UCLA, they've all just started to scale up their diagnostic capabilities and 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 3000 educators and students a…

Yes. And 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. So definitely resilience on the clinical side of the market in China, but research heavily impacted by the closures. The Beijing resurgence as well in the closures associated with that didn't help either in the quarter.

Your next question comes from Steve Beuchaw from Wolfe Research.

Hi, good afternoon and thanks for the time here. 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. But what I wonder is, how do you think about, to what extent this is demand destruction versus demand deferral. I mean I'll elaborate on that a little bit. So, the funding in a lot of cases, it's 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. And to what extent are you concerned about the funding itself, given the challenges that universities are facing though I don't know that their -- the entirety of your academic funding set, if you will. And then, the second thing I want 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 the TAM is larger. So I wonder if you could just elaborate on that and 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 the lead indicators, how do you track this perspective that the TAM is actually larger, are their project metrics are 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. So there are two parts to it. The first part is around what do we -- 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, there being deferred, because either people are working at home as part of shelter-in-place initiatives and are unable to do the research that they need to do right now, or they are in the lab, but they're being [indiscernible] to non-sequencing COVID related work. But they're being told in, they're telling us though it is their intend to get back to those research projects and even in cases where there is 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. And so 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 are hearing from our customers in the research community is that there is additional funding coming into the mix as a result of the pandemic. And so 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, that is. And so they are thinking about how to plan those projects right now. In addition,…

Your next question comes from Doug Schenkel from Cowen.

Hey, good afternoon. I want to start with the question on COVID and then ask a higher-level question on the capital equipment outlook. So starting on COVID. Yes, while there's little to debate that your efforts to help develop COVID solutions broadly should be commended and widely appreciated. I think it's fair to say there is 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 perceived by Ginkgo, but we've also read about places like the Broad Institute, which have a ton of sequencer setting there are really sophisticated maybe the most sophisticated in the world and yet while they're doing the most COVID testing volume in Massachusetts, we 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 is doing and for market sizing purposes, is it fair to conclude that the revenue per test opportunity for that approach is likely somewhere between $1 to $3 per test. The second thing I want to talk about 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, but instruments -- year-over-year you did better than I think a lot of us expected in the quarter, but as you look ahead, what do you think it's going to happen, like how are you thinking about the second half. Are you thinking that labs, even if they get back and pick up activity are going to tend to hold back a little while and capital spending when possible, just given the uncertainty of the environment? Thank you.

Thank you, Doug. So that's work through the parts of the question. So the first part of the question was around the real role of NGS in COVID testing and how, what kind of role will NGS play given that the majority of testing is being done on PCR and has been. So start there and then I'll talk about capital equipment. In terms of COVID, again if I look at [indiscernible], its research, its diagnostics, its screening and surveillance. Research no question -- there are research projects that are coming online that are uniquely suited to NGS compared to PCR. So all the projects that I talked about really, they are new, they are incremental and they need NGS. And so whether it's GMI in Ireland or any one of the projects that I talked about, that will 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 already done on PCR. So, 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 are a few reasons for it. One is, there are areas where -- we're running into capacity constraints right? And so when we talk to labs in certainly you will read that -- even here in the US, the turnaround times associated with the testing in the US right now can be 10 plus days and when you ask the labs why that is, they will tell you there is supply chain constraints that all the PCR testing services are competing for some of the same elements in the supply chain. And so…

Yes. So if I can jump in real quick, Doug, on capital, I mean first of all, really encouraged by the results and the performance that we saw in NextSeq 2000 in Q2. So, 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 you know basically no need for capacity. They are delaying certain purchases and that's to be expected given the uncertainty, I mean they have been facing some pretty significant closures and we saw that also on consumables where they drew down inventories in Q2. So we're seeing delays, but we're not seeing cancellations. They are still interested 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 mean I believe when you look at a lot of data being reported out of hospital, the improvement has been sharper through the quarter and the outlook I think is better. So I'm just wondering why you think you're not seeing a faster improvement for clinical NGS number one. Number two, just on pricing, do you expect, could you may be elaborate a bit on this to just really open up maybe the lower end of the market you offering $600 price down to the smaller labs and do you think that could galvanize maybe NovaSeq upgrade cycle as things get a little better with funding. And then, 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. So, 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 is taking 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, but any color in terms of the screening opportunity and what you're seeing from customers. Thank you.

Sure. Thank you, Dan. So let's start with the clinical market. Sort of the dynamics there and why not faster. And really the clinical market is story of two markets, right? So if you look at what's happening in NIPT, NIPT has actually been fairly resilient. So if we look at, for example, in the Americas, we actually saw quarter-on-quarter growth in the NIPT market. So from Q1 to Q2, even though overall revenues for went down you did see growth in NIPT. So on one part of the clinical market, that's been fairly resilient to 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 in NIPT and 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 they aren't going in. And that's a human tragedy and it's showing up for us to 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 into get screened and will want to get tested so they can get matched for the appropriate therapy. So in the oncology market, there is 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. So that's the dynamics 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…

Your next question comes from Puneet Souda from SV8 Leerink.

Yes, hi, Francis. Thanks. Thanks for taking the question. So I know this has been covered a little bit, but I just want to get to a core question here. I mean, 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 blend into some of the markets whole-genome sequencing being one of them and drove that market expansion. So I'm just starting to understand as you look at the next couple of years, do you see COVID research, COVID testing, and COVID surveillance and surveillance I completely agree that you absolutely need sequencing to chase some of these, so to speak, but do you think that these markets can truly drive that elasticity of demand for Illumina and that to a $20 per test. I mean, you obviously see TCR antigen other solutions point of care reaching these markets over the next year or so. So I'm just trying to get your view about how do you see elasticity of demand playing out here for Illumina. Thank you.

Yes. Thank you, Puneet. So. I think that different parts of the COVID market are -- need different price points and sort of 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. So let me be more specific. If we look at the diagnostic part of the market, there you do need price points were labs are able to offer a test at $75 to $100, which is where reimbursement is and have a viable business. And so there something like COVIDSeq where the cost to them Illumina reagents is $20 or SwabSeq where it is in the single-digit dollars is exactly the right fit. And so that's the price point that unlocks -- that opens up that market for NGS. Now that market was never an NGS market. So this is all incremental to NGS. That was a PCR market. And so all of this is new dollars now that are available to NGS and to open up that market, you need a test at the $75 to $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 pulling, 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, and so 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 of 10s of thousands there $600 price point makes sense and sort of activates that market and so 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. And so, that's how we are thinking about the different markets and having different offerings with different price points to activate those markets.

Your next question comes from Derik De Bruin from Bank of America.

Hi, good afternoon. So, a question on your comments about inventories being drawn down in the third quarter I guess or are in the second quarter, I guess. Where are they? And do you expect additional drawdowns in the third quarter or it could be some potential for some catch-up spending has come back? And 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, just the ACS [ph], these are the 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 biomedical research centers. So, I'm just sort of wondering what you're hearing about potential personnel cutbacks and things in the academic markets. And this sort of goes into another question about, are you expecting any sort of pick up or budget flush in the fourth quarter. Thanks.

Yes. So 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 referred 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. And as we talk to our customers. I mean, obviously, driven by a couple of things, first of all the uncertainty, the fact that there is still closures the fact that there is 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. And so, 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 do we -- what are we seeing in terms of number of months of inventory with customers and what do we expect the dynamic -- how we expect the dynamics to play out over the next few quarters, that's hard to project, Derik in terms of whether we see starting back up, whether we see 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 few quarters. Then as we said on the prepared remarks, we are expecting activity levels to improve modestly for both clinical and research in Q3. But in terms of predicting inventory and predicting customer behavior in terms of how they're going to stock or destock, that's really difficult to answer at this stage, it's easier to just explain the Q2 dynamic as we did.

Yes. And then 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 certainty sort of prolong a little bit how long the project takes as people are sheltered in place and they have longer to actually use the money. So 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. So for example, I talked about the proposal to increase NIH funding next year by $5.5 million, including an increase of just over $650 million to NHGRI sets the proposal-- for NCRI. That's the proposal. But we're also seeing money come into COVID related research, surveillance from -- for example philanthropies. When we did the donation to the 10 countries in Africa for the African CDC, we were working with one of the largest philanthropies here in the US as well as one out of Asia to try and help deploy this global surveillance network. We are also seeing people who aren't usually funders of genomics work. So, for example sort of interesting cooperation between the expansion of the relationship between Microsoft and Adaptive for example around understanding the immune response to COVID. And so overall, we are still seeing interest in government funding, academic funding, and philanthropy funding associated with that COVID genomic research.

And our last question comes from Jack Meehan from Nephron Research.

Thank you. Just had a couple of additional follow-ups. I think first on the NGS consumables. How long -- I'm not sure what your level of visibility is here, but how long do you think it will 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? Then just a follow-up on the clinical side as you roll out COVIDSeq from 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.

Maybe I'll talk very quickly about the sort of research ramp that you talked about Jack and thank you for the question. Francis can talk about COVIDSeq and the NextSeq turnaround. Again, this is all assumption based at this stage and it all depends on many factors around what we see with regards to the virus and the potential shelter in place restrictions and as we saw in Q2, we were going in the right direction and then things went in the wrong direction I'm preferring to the US here in terms of the response to the virus. But 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 the base space 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. But 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, but that's in response to your question on Research.

Yes. And then, Jack, in terms of your question on the turnaround time in NextSeq, obviously it depends on the workflow at our customers' sites that are implementing COVIDSeq and NextSeq in-house [ph]. The intent of course is to be able to have a test that allows the 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.