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PHARMACYCLICS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 8, 2014

You should read the following discussion and analysis of our financial condition and results of operations together with our interim financial statements and the related notes appearing at the beginning of this report. The interim financial statements and this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2013 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Form 10-K filed with the Securities and Exchange Commission on February 26, 2014. The following discussion contains forward-looking statements that involve risks and uncertainties. These statements relate to future events, such as our future clinical and product development, financial performance and regulatory review of our product candidates. Our actual results could differ materially from any future performance suggested in this report as a result of various factors, including those discussed elsewhere in this report, in our Form 10-K for the year ended December 31, 2013 and in our other Securities and Exchange Commission reports and filings. All forward-looking statements are based on information currently available to Pharmacyclics; and we assume no obligation to update such forward-looking statements. Stockholders are cautioned not to place undue reliance on such statements. Company Overview We are a biopharmaceutical company focused on developing and commercializing innovative small-molecule drugs for the treatment of cancer and immune mediated diseases. Our mission and goal is to build a viable biopharmaceutical company that designs, develops and commercializes novel therapies intended to improve quality of life, increase duration of life and resolve serious unmet medical healthcare needs; and to identify and control promising product candidates based on scientific development and administrational expertise, develop our products in a rapid, cost-efficient manner and to pursue commercialization and/or development partners when and where appropriate. IMBRUVICA® (ibrutinib, PCI-32765) first came to market on November 13, 2013, when it was approved by the U.S. Food and Drug Administration (FDA) under accelerated approval as a single agent for the treatment of patients with mantle cell lymphoma (MCL) who have received at least one prior therapy. On February 12, 2014, the U.S. Food and Drug Administration (FDA) approved IMBRUVICA under accelerated approval as a single agent for the treatment of patients with chronic lymphocytic leukemia (CLL) who have received at least one prior therapy, the second indication for IMBRUVICA. The FDA's accelerated approval for these indications was based on overall response rate (ORR) of patients participating in the PCYC-1104 and PCYC-1102 Phase II clinical studies. Improvements in survival or disease-related symptoms was not established in these studies at the time of accelerated approval. Subsequent to June 30, 2014, we received additional FDA approval for IMBRUVICA on July 28, 2014 (please see Note 13 to the condensed consolidated financial statements). Unless otherwise noted, any disclosures in this report with respect to the patient populations for which IMBRUVICA is approved refer to the approved patient populations as of June 30, 2014. IMBRUVICA is the first once-daily, single-agent, oral kinase inhibitor for patients with MCL and patients with CLL who in each case have received one prior therapy and is being jointly developed and commercialized by Pharmacyclics and Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson & Johnson. We market IMBRUVICA and have three product candidates in clinical development and several preclinical molecules in lead optimization. We are committed to high standards of ethics, scientific rigor, and operational efficiency as we move each of these programs to viable commercialization. In December 2011, we entered into a worldwide collaboration and license agreement (the Agreement) with Janssen, for the joint development and commercialization of ibrutinib, a novel, orally active, first-in-class BTK inhibitor which has been and continues to be developed for the treatment of hematological malignancies, including non-Hodgkin lymphoma (NHL), CLL and multiple myeloma (MM). Under the Agreement, we received our first significant revenue in the form of milestone payments during the year ended June 30, 2012. Together with our partner Janssen, Pharmacyclics is commercializing IMBRUVICA in the United States. In 2006, we acquired multiple small molecule drug candidates for the treatment of cancer and other diseases from Celera Genomics, an Applera Corporation business (now Celera Corporation - a subsidiary of Quest Diagnostics Incorporated), including technology and intellectual property relating to drugs that target histone deacetylase (HDAC) enzymes (specific and multiple isoforms), a Factor VIIa inhibitor targeting a tumor signaling pathway involved in angiogenesis, tumor growth and metastases and B-cell associated tyrosine kinase inhibitors potentially useful for the treatment of lymphomas/leukemias, anti-inflammatory and autoimmune diseases. Clinical Development Overview The table below summarizes our programs and clinical product candidates and their stage of development: Product Candidates/Programs Disease Indication Development Status(1) IMBRUVICA BTK Inhibitor B-cell lymphomas: Multiple trials (Phase I, II, III) in • Chronic lymphocytic leukemia treatment naive and in (CLL) relapsed/ • Small lymphocytic lymphoma (SLL) refractory patients • Mantle cell lymphoma (MCL) • Diffuse large B-cell lymphoma (DLBCL) • Follicular lymphoma (FL) • Multiple myeloma (MM) • Waldenstrom's macroglobulinemia (WM) • Marginal zone lymphoma (MZL) • Other BTK 2nd Generation Autoimmune and Non-clinical testing, Inhibitor anti-inflammatory disease Phase I Abexinostat HDAC Relapsed/refractory lymphomas Multiple trials (Phase Inhibitor (PCI-24781) and solid tumors I, II) Factor VIIa Inhibitor Cancer Phase II complete (PCI-27483)



(1) "Phase I" means initial human clinical trials designed to establish the safety, dose tolerance, pharmacokinetics (i.e., absorption, metabolism, excretion) and pharmacodynamics (i.e. biological markers for activity) of a compound.

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"Phase II" means human clinical trials designed to establish safety, optimal dosage and preliminary activity of a compound in a patient population. "Phase III" means human clinical trials designed to establish the safety and efficacy of a compound. These are the most important trials required by the Food and Drug Administration ("FDA") and are done to rigorously establish the clinical benefit and safety profile of a drug in a particular patient population. "Preclinical" means the stage of drug development prior to human clinical trials in which a molecule is optimized for "drug like" properties and evaluated for efficacy, pharmacokinetics, pharmacodynamics and safety. Marketed Product - IMBRUVICA® (ibrutinib) IMBRUVICA is approved by the U.S. Food and Drug Administration as a single agent for the treatment of patients with MCL and patients with CLL who in each case have received at least one prior therapy. The FDA approval for these indications was based on ORR of patients participating in the PCYC-1104 and PCYC-1102 Phase II clinical studies. An improvement in survival or disease-related symptoms was not established in these studies. IMBRUVICA is a new agent that inhibits the function of Bruton's tyrosine kinase (BTK). BTK is a key signaling molecule of the B-cell receptor signaling complex that plays an important role in the survival of malignant B-cells. IMBRUVICA blocks signals that stimulate malignant B-cells to grow and divide uncontrollably. The following information can be found on the prescribing information for IMBRUVICA: The approval in MCL was based on the results of a multi-center, international, single-arm trial of 111 patients with previously treated MCL. Tumor response was assessed according to the revised International Working Group (IWG) for NHL criteria. The efficacy results demonstrated a 65.8% overall response rate (95% Confidence Interval (CI): 56.2, 74.5); 17% of patients achieved a complete response and 49% of patients achieved a partial response. The median duration of response was 17.5 months (95% CI: 15.8, not reached). The approval in CLL was based on the results of a Phase Ib/II, open-label, multi-center, international, single-arm trial of 48 patients with relapsed or refractory CLL who received 420 mg of IMBRUVICA daily. The primary endpoint was safety and a secondary endpoint was ORR, which was assessed by a modified version of the International Working Group on CLL (IWCLL) criteria by an Independent Review Committee. The efficacy results demonstrated a 58.3% ORR (95% confidence interval (CI) (%), 43.2, 72.4), all partial responses. The duration of response (DOR) ranged from 5.6 to 24.2+ months. The median DOR was not reached. IMBRUVICA (ibrutinib) - Recent Clinical Development Updates During the three months ended June 30, 2014, we provided updates on several of our clinical programs in various press releases and filings with the Securities and Exchange Commission. During the three months ended June 30, 2014, we participated in three prominent medical conferences, the 50th Annual Meeting of the American Society of Clinical Oncology (ASCO) in Chicago, IL, the 19th European Hematology Association (EHA) Congress in Milan, Italy and the American Association for Cancer Research (AACR) in San Diego, Ca. During these conferences, IMBRUVICA was presented in a total of 4 oral sessions and 14 posters in 7 histologies (CLL, SLL, HCL, MCL, DLBCL, FL, and MZL). Selected abstracts are highlighted below: Randomized Comparison of Ibrutinib Versus Ofatumumab in Relapsed or Refractory Chronic Lymphocytic Leukemia/Small Lymphocytic Lymphoma: Results From the Phase III RESONATETM Trial (Abstract #LBA7008 - ASCO 2014) IMBRUVICA significantly prolonged progression-free survival (PFS) in patients with relapsed/refractory (R/R) CLL in comparison to those randomized to receive ofatumumab. Patients treated with IMBRUVICA experienced a 78% reduction in risk of progression or death versus patients receiving ofatumumab (HR 0.215, 95% CI, 0.146 to 0.317, p<0.0001) per Independent Review Committee (IRC) evaluation. The median PFS for IMBRUVICA was not reached with a median time on study of 9.4 months. The median PFS for ofatumumab was 8.1 months. IMBRUVICA significantly prolonged overall survival (OS) compared with ofatumumab. IMBRUVICA reduced the risk of death by 57% (HR=0.434, 95% CI, 0.238 to 0.789; p<0.005) compared to the ofatumumab arm. This was observed despite a total of 57 patients who were initially randomized to ofatumumab crossing over to receive IMBRUVICA prior to the analysis. Patient characteristics were well balanced between arms: patients receiving IMBRUVICA had a median of 3 prior therapies with 32% deletion of the short arm of chromosome 17 (del17p), a mutation typically associated with poor prognosis, and 56% RAI stage III/IV (indicative of high risk CLL patients) versus patients receiving ofatumumab who had a median of 2 prior therapies with 33% del17p and 58% RAI stage III/IV. ORR was significantly higher in patients receiving IMBRUVICA by both investigator and IRC evaluations. Investigator assessed ORR (including complete responses (CR), partial responses (PR) and partial responses with lymphocytosis (PR+L)) was 85 % for IMBRUVICA and 23% for patients receiving ofatumumab, evaluated by the investigators based on the International Workshop on CLL (IWCLL) response criteria. The RESONATE study also had the IRC evaluate sequential CT scans (performed per protocol, approximately 12 weeks apart) to assess and confirm response. With this analysis, 63% of 25



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IMBRUVICA patients achieved a partial response (PR or a PR+L) compared to only 4% of patients receiving ofatumumab (p<0.0001). Significant benefit measured by PFS, OS and response rates were observed in the IMBRUVICA arm consistently across all subgroups by baseline disease risk factors, including those patients with del17p or those whose disease was considered refractory to purine analogue therapy. Only 3% of the patients receiving IMBRUVICA experienced progressive disease as a best response versus 10% receiving ofatumumab as evaluated by the IRC. The most commonly occurring adverse events (AE) independent of Grade (AEs in 20% or more of patients) were diarrhea (48% vs.18%), fatigue (28% vs. 30%), pyrexia (fever; 24% vs. 15%), nausea (26% vs.18%), anemia (23% vs. 17%) and neutropenia (22% vs. 15%). Hematologic AEs that were Grade 3 or 4 in the RESONATE trial were neutropenia (decreased amount of white blood cells; 16% in the IMBRUVICA arm vs. 14% in the ofatumumab arm), thrombocytopenia (decrease in platelets in the blood; 6% vs. 4%), and anemia (5% vs. 8%). Atrial fibrillation of any grade was noted more frequently in patients receiving IMBRUVICA (5% versus 0.5% with ofatumumab), these events were manageable and lead to discontinuation for only 1 patient. There was no difference in major bleeding between the IMBRUVICA or ofatumumab arms (reported in 2 patients randomized to IMBRUVICA and 3 patients receiving ofatumumab). The incidence of grade 3 or higher infection was 24% for IMBRUVICA arm and 22% for the ofatumumab arm. Richter's Transformation (RT) occurred in 2 patients in the IMBRUVICA arm and in 2 patients in the ofatumumab arm. With a median follow-up of 9.6 months, patients receiving IMBRUVICA showed a discontinuation rate due to progressive disease, adverse events or death of 13%, with 86% of patients continuing on therapy. Patients receiving ofatumumab showed a discontinuation rate due to progressive disease, adverse events or death of 28%. Independent Evaluation of Ibrutinib Efficacy 3 Years Post-Initiation of Monotherapy in Patients With Chronic Lymphocytic Leukemia/Small Lymphocytic Leukemia Including Deletion 17p Disease (Abstract #7014 - ASCO 2014) In the treatment naÏve group, 31 CLL patients, aged 65 years or older, received single agent IMBRUVICA once daily and were followed in the study for a median time of 32.1 months. The ORR, as assessed by the Investigator, was 87% (CR 13%, nodular PR (nPR) 3%, PR 65%, PR+L 6%). Only one patient had progressive disease during the median follow up of 32.1 months and the PFS at 30 months was 96%. The OS for these patients at 30 months was 97%. In the R/R group, 101 patients with CLL/SLL (median of 4 prior therapies, 57% Rai stage III or IV (indicative of high risk CLL patients), 69% of patients had the high-risk characteristics of deletion of short arm of chromosome 17 or 11 (del 17p or del 11q)) received single-agent IMBRUVICA once daily and were followed in the study for a median time of 26.6 months. Overall 90% of patients achieved a best response of PR+L or higher. For patients without del17p or del11q, the estimated PFS was 89% at 30 months. The median PFS for del17p patients was 28.1 months and for patients with del11q the median PFS had not been reached and was estimated to be 74% at 30 months. The estimated OS for these R/R patients was 79.9%. Following all the patients in this study for up to 3 years, the percentage of patients with AEs as a primary reason leading to discontinuation decreased over time, with 8% in the first year, 2% in the second year and 3% in the third year. Similarly, the percentage of who experienced a death on study decreased over time, with 5% in the first year, 4% in the second year and 3% in the third year. A phase 1b/2 study evaluating activity and tolerability of the BTK inhibitor ibrutinib in combination with ofatumumab in patients with chronic lymphocytic leukemia/small lymphocytic lymphoma (CLL/SLL) and related diseases (Abstract #7009 - ASCO 2014) The study design consisted of three dosing cohorts, group 1 received one month of IMBRUVICA monotherapy followed by IMBRUVICA and ofatumumab in combination thereafter, group 2 received IMBRUVICA and ofatumumab in combination from the outset, and group 3 received two months of ofatumumab monotherapy followed by IMBRUVICA and ofatumumab thereafter. Seventy-one (71) patients with R/R CLL/SLL/Prolymphocytic Leukemia (PLL) and RT, with a median of 3 prior therapies, were enrolled in the study (27, 20 and 24 in groups 1, 2 and 3 respectively). Sixty-one percent (61%) of patients had RAI stage III/IV and were considered high risk, 44% had del17p, and 31% had del11q, genetic mutations typically associated with poor prognosis. The overall response (including CR, PR and PR+L) in CLL/SLL/PLL patients was 100%, 84%, and 75% in groups 1, 2 and 3 respectively, which were achieved within a median of 4.6 months during the study. At the study end, 90% (52 of 58) of responders were progression free with follow up of 16, 12 and 11 months for groups 1, 2 and 3 respectively. At 12 months, the PFS was 89%, 85%, and 75% in groups 1, 2 and 3. The AEs for all 3 cohorts combined were mostly grade 1 or 2. The most frequent events reported in 15% or more of patients were diarrhea (68%, 5 cases of grade ? 3), infusion related reaction (45%, 1 case of grade ? 3), peripheral sensory neuropathy (42%, 2 cases of grade ? 3), and stomatitis (37%, 2 cases of grade ? 3). The grade 3 or higher AE, reported in 15% 26



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or more of patients, was neutropenia (22.5%, 16 cases). Of all 71 patients, 6 patients had AEs leading to IMBRUVICA discontinuation. IMBRUVICA (ibrutinib) - Selected Clinical Trial Updates Chronic Lymphocytic Leukemia/ Small Lymphocytic Lymphoma (CLL/SLL) • RESONATE™ (PCYC-1112): Phase III study of IMBRUVICA versus ofatumumab in

patients with relapsed/refractory (R/R) CLL/SLL was initiated in the

second quarter of 2012. This is a randomized, multi-center, open-label

Phase III trial of IMBRUVICA as a monotherapy. This 391 patient study met

its primary end point of PFS as well as a key secondary endpoint of

overall survival at the pre-planned interim analysis in January 2014.

Based on the study data provided to the FDA in April 2014 we received full

regular approval on July 28, 2014. • RESONATE™-17 (PCYC-1117): Open-label, single-arm, Phase II study of IMBRUVICA as a single agent in patients with CLL who have deletion of chromosome 17p and who did not respond to or relapsed after at least one prior treatment (a high unmet need population) was initiated in the first



quarter of 2013. The primary endpoint of the study is overall response

rate (ORR). This study completed enrollment of 145 patients worldwide in

the third quarter of 2013.

• RESONATE™-2 (PCYC-1115): Phase III study of IMBRUVICA versus chlorambucil

in newly diagnosed elderly CLL/SLL patients was initiated in the first quarter of 2013. This is a randomized, multicenter, open-label trial of IMBRUVICA as a monotherapy versus chlorambucil in patients 65 years or



older with treatment naÏve CLL/SLL. The study design was agreed upon with

the FDA under a Special Protocol Assessment (SPA). The primary objective

of the study is to demonstrate a clinically significant improvement in PFS

when compared to chlorambucil. The study completed enrollment of 273 patients worldwide in the first quarter of 2014. • HELIOS (CLL3001): Phase III study of IMBRUVICA in combination with



bendamustine and rituximab in patients with R/R CLL/SLL was initiated in

the third quarter of 2012. This is a randomized, multi-center,

double-blinded, placebo-controlled trial of IMBRUVICA in combination with

bendamustine and rituximab versus placebo in combination with bendamustine

and rituximab (BR) in R/R CLL/SLL patients who have received at least one

line of prior therapy. The primary objective of the study is to

demonstrate a clinically significant improvement in PFS when compared to

bendamustine and rituximab. This study completed enrollment of 578 patients worldwide in the first quarter of 2014.



• BRILLIANCE (CLL3002): Phase III study of IMBRUVICA versus rituximab in

patients with R/R CLL/SLL was initiated in the fourth quarter of 2013.

This is a randomized, open-label, multi-center study to evaluate the

efficacy and safety of versus rituximab in adult Chinese patients with R/R

CLL or SLL with active disease requiring treatment, who have failed at

least one prior line of therapy and are not considered appropriate

candidates for treatment or retreatment with purine analog-based therapy

or combination chemo-immunotherapy. The primary objective of the study is

to demonstrate a clinically significant improvement in PFS. The enrollment

target of this study is 150 patients.

• Third-party sponsored: Phase III study of IMBRUVICA versus IMBRUVICA +

rituximab versus bendamustine + rituximab in frontline newly diagnosed

elderly (? 65 Years of Age) CLL/SLL patients (Alliance A041202) was initiated by the National Cancer Institute in the fourth quarter of 2013. This is a randomized, multi-center study designed to evaluate the



improvement in PFS of IMBRUVICA with or without rituximab vs bendamustine

and rituximab. Secondary outcome measures include overall survival and

duration of response. The enrollment target of this multi-center study is

523 patients, enrollment initiated during the first quarter 2014. • Third-party sponsored: Phase III study in treatment-naive, young fit



patients with CLL, comparing the combination of IMBRUVICA and Rituxan to

chemo immunotherapy of FCR (fludarabine, cyclophosphamide, and rituximab),

(ECOG1912), was initiated by the Eastern Cooperative Oncology Group in the

first quarter of 2014. This is a randomized study designed to evaluate the

improvement in PFS of IMBRUVICA with rituximab vs FCR. Secondary outcome

measures include overall survival and adverse events. The enrollment target of this multi-center study is 519 patients. • Third-party sponsored: Phase III study in untreated, intermediate and



high-risk patients with CLL, comparing monotherapy IMBRUVICA to placebo or

no therapy, (CLL12), was initiated by the German Study Group in the first quarter of 2014. This is a randomized study designed to evaluate the improvement in event-free survival (EFS) of IMBRUVICA vs. watch and waiting. Secondary outcome measures include ORR and PFS. Enrollment of this multi-center study initiated with a target of 302 patients. 27



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Mantle Cell Lymphoma (MCL) • RAY (MCL3001): Phase III study of IMBRUVICA versus temsirolimus in R/R MCL

patients was initiated in the fourth quarter of 2012. This is a

randomized, multi-center, open-label trial of IMBRUVICA as a monotherapy

versus temsirolimus in R/R MCL patients who received at least one prior rituximab-containing chemotherapy regimen. The primary endpoint of the



study is PFS. This study completed enrollment of 280 patients worldwide in

the fourth quarter of 2013.

• SHINE (MCL3002): Phase III study of IMBRUVICA in combination with BR in

elderly patients with newly diagnosed MCL was initiated in the second

quarter of 2013. This is a randomized, multi-center, double-blinded,

placebo-controlled trial of IMBRUVICA plus BR versus placebo plus BR in

patients 65 years or older with newly diagnosed MCL. The primary endpoint

of the study is PFS. The enrollment target of this global study is 520 patients.



Diffuse Large B-cell Lymphoma (DLBCL) • PHOENIX (DBL3001): Phase III study of IMBRUVICA in combination with R-CHOP

(rituximab, cyclophosphamide, doxorubicin, vincristine, and prednisone) in

patients with newly diagnosed non-GCB subtype of DLBCL was initiated in the third quarter of 2013. This is a randomized, multi-center, double-blinded, controlled trial of IMBRUVICA plus rituximab,



cyclophosphamide, doxorubicin, vincristine, and prednisone (R-CHOP) versus

R-CHOP in patients with newly diagnosed non-GCB subtype DLBCL. The primary

endpoint of the study is to demonstrate a clinically significant

improvement in event-free survival when compared to R-CHOP. The enrollment

target of this global study is 800 patients.

Follicular Lymphoma (FL) • PCYC 1125: Phase II multicenter, open-label, study of IMBRUVICA, in combination with Rituximab in previously untreated subjects with follicular lymphoma was initiated in the fourth quarter of 2013. The



primary endpoint of this study is overall response rate. The enrollment

target of this study is 80 patients.

• DAWN (FLR2002): Phase II study of IMBRUVICA in patients with R/R FL was

initiated in the second quarter of 2013. This is a multi-center,

open-label, single-arm, global trial of IMBRUVICA in patients with

chemoimmunotherapy-resistant FL, whose disease has relapsed from at least

2 prior lines of therapy, including at least one rituximab combination

chemotherapy regimen. The primary endpoint of this study is overall

response rate. This study completed enrollment of 111 patients worldwide

in Q2 of 2014. • SELENE (FLR3001): Phase III study of IMBRUVICA in patients with R/R



indolent Non-Hodgkin's Lymphoma (iNHL) was initiated in the first quarter

of 2014. This is a randomized, multi-center, placebo-controlled trial in

combination with either BR or R-CHOP in patients with previously treated

indolent Non-Hodgkin Lymphoma (iNHL). The primary endpoint of this study is progression free survival. The enrollment target of this global study is 400 patients.



Marginal Zone Lymphoma (MZL) • PCYC-1121: Phase II study of IMBRUVICA in patients with R/R marginal zone

lymphoma was initiated in the fourth quarter of 2013. This is a multi

center, open-label, monotherapy study to evaluate the safety and efficacy

of IMBRUVICA in patients with R/R marginal zone lymphoma. The primary

endpoint of this study is overall response rate and the enrollment target

of this study is 60 patients.

Waldenstrom's Macroglobulinemia (WM) • PCYC-1127: Phase III study of IMBRUVICA or placebo in combination with rituximab in patients with previously treated WM was initiated in the second quarter of 2014. This is a randomized, multi-center,



double-blinded, placebo-controlled trial of IMBRUVICA. The primary outcome

measure of this study is PFS. The secondary outcome measures include ORR, time to next treatment, OS and number of participants with AEs as a measure of safety and tolerability within each treatment arm. The enrollment target of this study is 180 patients.



Multiple Myeloma (MM) • PCYC-1111: Phase II study of IMBRUVICA in patients with R/R multiple

myeloma was initiated in the first quarter of 2012. This is a Phase II,

multi-center, open-label trial designed to assess the safety and efficacy

of IMBRUVICA as a single agent and in combination with dexamethasone in patients with R/R MM. At this time, an expansion of cohorts 1, 2 and 3 (420mg, 560mg with dexamethasone, and 840mg) is not planned due to the fact that the protocol-defined 28



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response rate was not achieved. The Company has expanded the fourth and final dosing cohort to 43 patients (840mg with dexamethasone) as it crossed a minimum pre-defined boundary of efficacy. The clinical development focus of IMBRUVICA in this indication will be in combination therapies. • PCYC-1119: Phase I/IIb study of IMBRUVICA in combination with carfilzomib in patients with R/R MM was initiated in the third quarter of 2013. The Phase I portion of this study is a dose escalation study designed to assess the safety and recommended Phase IIb dose of IMBRUVICA and



carfilzomib. The Phase IIb portion will be a randomized, double-blind,

placebo controlled study to evaluate the efficacy of IMBRUVICA and carfilzomib versus carfilzomib and placebo. The primary endpoint of the Phase IIb portion of the study is progression-free survival. The enrollment target of this study is 176 patients. IMBRUVICA (ibrutinib) - Regulatory Update On October 30, 2013, Janssen-Cilag International NV (Janssen) announced it has submitted a Marketing Authorization Application (MAA) to the European Medicines Agency (EMA) for ibrutinib for the treatment of adult patients with relapsed or refractory CLL/SLL or relapsed or refractory MCL. On November 13, 2013, the Food and Drug Administration (FDA) approved IMBRUVICA monotherapy for the treatment of patients with MCL who have received at least one prior therapy. This indication is based on ORR. An improvement in survival or disease-related symptoms has not been established. On February 12, 2014 the FDA approved IMBRUVICA as a single agent for the treatment of patients with CLL who have received at least one prior therapy. This indication is based on ORR. An improvement in survival or disease-related symptoms has not been established. On July 25, 2014, the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) issued a positive opinion recommending full marketing approval for IMBRUVICA in the European Union. The CHMP recommendation for IMBRUVICA is for the treatment of adult patients with relapsed or refractory MCL, or adult patients with CLL who have received at least one prior therapy, or in first line in the presence of 17p deletion or TP53 mutation in patients unsuitable for chemo­immunotherapy. The positive opinion was based on data from the Phase II study (PCYC-1104) in MCL, a Phase III RESONATE™ study (PCYC-1112-CA) and a Phase II study (PCYC-1102) in CLL. The European Medicines Agency is a decentralized agency of the European Union responsible for the scientific evaluation of medicines developed by pharmaceutical companies for use in the 28 countries of the European Union. The positive opinion of the EMA's CHMP will be reviewed by the European Commission, and a final decision on IMBRUVICA is anticipated later this year. In addition to European markets, a worldwide regulatory filing program for ibrutinib currently is underway. On July 28, 2014, the FDA granted IMBRUVICA full approval for the treatment of CLL patients who have received at least one prior therapy, and for the treatment of CLL patients with deletion of the short arm of chromosome 17 (del 17p CLL), including treatment naÏve (frontline) and previously treated del 17p CLL patients. This was the first full FDA approval for IMBRUVICA, and was granted only five and a half months after the original accelerated approval for patients with previously treated CLL, which was granted in February 2014. This full approval is based on data from the Phase III RESONATE™ study (PCYC-1112-CA), a randomized, multi-center, international head-to-head comparison of single-agent, orally-administered IMBRUVICA versus the intravenous, monoclonal antibody ofatumumab targeting the CD 20 antigen. This study enrolled 373 patients with CLL and 18 patients with SLL, who received at least one prior therapy. The median number of prior treatments was 2 (range, 1 to 13 treatments). At baseline, the median age of these patients was 67 years, 58% of whom had at least one tumor ? 5 cm, and 32% of whom had the del 17p mutation. Patients receiving IMBRUVICA demonstrated a statistically significant improvement in progression-free survival (PFS), overall survival (OS) and overall response rate (ORR) as compared to patients treated with ofatumumab. The median PFS and OS has not been reached on the IMBRUVICA arm. There was a 78% reduction in the risk of progression or death as assessed by an independent review committee (IRC) according to the modified IWCLL criteria (HR 0.22, 95% CI, 0.15 to 0.32, p<0.0001). In addition, the analysis of overall survival demonstrated a 57% statistically significant reduction in the risk of death for patients in the IMBRUVICA arm (HR 0.43; 95 CI, 0.24 to 0.79, p<0.005). This was observed despite a total of 57 patients who were initially randomized to ofatumumab crossing over to receive IMBRUVICA prior to the analysis. For previously treated del 17p CLL patients, there was a 75% reduction in the risk of progression or death as assessed by an IRC (HR 0.25, 95% CI, 0.14 to 0.45, p<0.0001). IMBRUVICA (ibrutinib) - Breakthrough, Fast Track and Orphan Drug Designations 29



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In the U.S., the FDA granted orphan drug designation to IMBRUVICA for the following orphan diseases: CLL on April 6, 2012, MCL on December 3, 2012, MM on May 16, 2013, SLL on May 30, 2013, WM on October 15, 2013 and DLBCL on October 23, 2013. A U.S. orphan drug designation provides the drug developer with several benefits and incentives related to the orphan drug, including a 7-year period of U.S. marketing exclusivity if the drug is the first of its type approved for the specified indication. The FDA also granted Pharmacyclics with a Fast Track designation for IMBRUVICA for the treatment of CLL/SLL on October 29, 2012 and for the treatment of MCL on December 18, 2012. Fast Track is a process designed to facilitate the development, and expedite the review of drugs to treat serious and life-threatening conditions and address unmet medical needs for the condition. The European Commission (EU) adopted the decision that IMBRUVICA is designated as an orphan medicinal product for the following diseases, CLL/SLL on April 26, 2012, MCL on March 12, 2013, DLBCL on November 13, 2013, FL on January 16, 2014 and lymphoplasmacytic lymphoma/WM on April 29, 2014. An EU orphan drug designation provides the drug developer with several benefits and incentives related to the orphan drug, including market exclusivity for 10 years after approval if the drug is the first of its type approved for the specified indication. On February 8, 2013, the U.S. Food and Drug Administration (FDA) granted Breakthrough Therapy Designation to the investigational oral agent IMBRUVICA monotherapy for the treatment of patients with relapsed or refractory MCL and to IMBRUVICA monotherapy for the treatment of patients with WM, both of which are B-cell malignancies. On March 18, 2013, Pharmacyclics announced that the FDA granted an additional Breakthrough Therapy Designation for the investigational oral agent IMBRUVICA as monotherapy for the treatment of CLL/SLL patients with deletion of the short arm of chromosome 17 (deletion 17p). Patients harboring a deletion within chromosome 17 are poor responders to chemoimmunotherapy and have limited treatment options. The presence of deletion 17p is one of the worst prognostic factors in patients with CLL. The Breakthrough Therapy Designation is intended to expedite the development and review of a potential new drug for serious or life-threatening diseases where "preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints, such as substantial treatment effects observed early in clinical development." The designation of a drug as a Breakthrough Therapy was enacted as part of the 2012 Food and Drug Administration Safety and Innovation Act. PCI-27483 - Factor VIIa Inhibitor Our Factor VIIa inhibitor PCI-27483 is a novel first-in-human small molecule inhibitor that selectively targets FVIIa. As an inhibitor of FVIIa, PCI-27483 has two potential mechanisms of action: 1) inhibition of intracellular signaling involved in tumor growth and metastases and 2) inhibition of early coagulation processes associated with thromboembolism. Pharmacyclics is currently defining the next steps for the development of this agent. Abexinostat (formerly PCI-24781) - Histone Deacetylase (HDAC) Inhibitor Abexinostat is an orally dosed, broad spectrum, hydroxamic acid-based small molecule HDAC inhibitor that has been evaluated in Phase I and II clinical trials for refractory solid tumors and lymphoma by Pharmacyclics and its ex-U.S. partner, Les Laboratoires Servier of Paris, France (Servier). Abexinostat has shown promising anti-tumor activity in vitro and in vivo (Buggy et al, Mol Cancer Ther 2006; 5: 1309-17). Abexinostat has been tested in several clinical trials in the U.S. by Pharmacyclics and globally by our partner Servier. In the U.S., Pharmacyclics has completed two Phase I studies using abexinostat as a single agent in patients with advanced solid tumors, a Phase I/II trial testing abexinostat single agent in patients with relapsed or refractory NHL and a Phase I trial in soft-tissue sarcoma patients (in combination with doxorubicin, an anti-tumor agent) co-sponsored by the Massachusetts General Hospital and Dana-Farber Cancer Institute. Results from this trial were presented at the annual meeting of the Connective Tissue Oncology Society in November 2012 in Prague, Czech Republic and updated at the AACR Annual Meeting in April 2013. A Phase II study was undertaken in relapsed/refractory FL and mantle-cell lymphoma (MCL). The results from this study were presented in poster at the 12th International Conference on Malignant Lymphoma (IMCL) in Lugano, Switzerland (June 19-22, 2013). We have been working with our partner Servier to develop a new formulation of our HDAC inhibitor PCI-24781 and are actively considering additional clinical development opportunities.We also continue investigating combination strategies for PCI-24781 through nonclinical studies. Our collaboration partner for ex-U.S. markets, Servier, has initiated a multitude of Phase I/II trials in Europe and Asia in lymphomas and solid tumors with abexinostat as single agent and in combination with other chemotherapeutic agents including cisplatin, liposomal doxorubicin and FOLFOX. Further analysis of these trials and any updates may be released by Servier. 30



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We are subject to risks common to pharmaceutical companies developing products, including risks inherent in our research, development and commercialization efforts, preclinical testing, clinical trials, uncertainty of regulatory and marketing approvals, uncertainty of market acceptance of our products, history of and expectation of future operating losses, reliance on collaborative partners, enforcement of patent and proprietary rights and the need for future capital. In order for a product to be commercialized, we must conduct preclinical tests and clinical trials, demonstrate efficacy and safety of our product candidates to the satisfaction of regulatory authorities, obtain marketing approval, enter into manufacturing, distribution and marketing arrangements, build U.S. commercial capability, obtain market acceptance and, in many cases, obtain adequate coverage of and reimbursement for our products from government and private insurers. We have incurred significant operating losses since our inception in 1991 and we expect to continue to incur substantial additional operating losses until such time, if ever, as the commercialization of IMBRUVICA or our other product candidates generates sufficient revenue to cover our expenses. We commercially launched IMBRUVICA on November 13, 2013. Results of Operations Total Revenue (in thousands): Three Months Ended Six Months Ended June 30, Increase/ June 30, Increase/ 2014 2013 (Decrease) 2014 2013 (Decrease) Product revenue, net $ 109,495 $ - $ 109,495$ 165,674 $ - $ 165,674 License and milestone revenue - 50,000 (50,000 ) 60,000 50,000 10,000 Collaboration services revenue 3,525 4,684 (1,159 ) 6,723 7,530 (807 ) Total revenue $ 113,020$ 54,684$ 58,336$ 232,397$ 57,530$ 174,867 For the three months ended June 30, 2014, total revenue increased by $58.3 million compared to the three months ended June 30, 2013 primarily due to a $109.5 million increase in product revenue, net from sales of IMBRUVICA, partially offset by a $50.0 million decrease in milestone revenue recognized under the worldwide collaboration and license agreement with Janssen (the Agreement) and a $1.2 million decrease in collaboration services revenue primarily related to the Agreement. For the six months ended June 30, 2014, total revenue increased by $174.9 million compared to the six months ended June 30, 2013 primarily due to a a $165.7 million increase in product revenue, net from sales of IMBRUVICA and a $10.0 million increase in milestone revenue earned under the Agreement, partially offset by a $0.8 million decrease in collaboration services revenue primarily related to the Agreement. Product revenue, net Product revenue, net consists of revenue recorded on sales of IMBRUVICA. IMBRUVICA has been approved by the U.S. Food and Drug Administration (FDA) and is currently marketed in the United States as a single agent for the treatment of patients with MCL and patients with CLL who in each case have received at least one prior therapy. IMBRUVICA received approval from the FDA for MCL on November 13, 2013 and for CLL on February 12, 2014. We recognize revenue from the sale of IMBRUVICA when the product's title and risk of loss transfers to the customer. We derive product revenue, net based on net sales to our specialty pharmacy, specialty distributor and direct customers, less estimated government rebates, charge-backs, returns reserve and prompt payment discounts. License and milestone revenue For the six months ended June 30, 2014, we recognized $60.0 million of milestone revenue under the Agreement. As previously announced, the $60.0 million milestone payment to us was triggered on February 12, 2014 as a result of the FDA approval of IMBRUVICA as a single agent for the treatment of patients with chronic lymphocytic leukemia (CLL) who have received at least one prior therapy. For the three months ended June 30, 2013, we recognized $50.0 million of milestone revenue under the Agreement due to our achievement of one clinical milestone during the period. Collaboration services revenue 31



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For the three and six months ended June 30, 2014, collaboration services revenue decreased by $1.2 million and $0.8 million, respectively, compared to the prior year periods primarily due to the timing of development efforts under the Agreement. In December 2011, we entered into the Agreement which provided for a $150.0 million non-refundable upfront payment upon execution (see Note 3 to the condensed consolidated financial statements). The revenue related to the upfront payment was allocated $70.6 million to the licenses, $15.0 million to the committee services and $64.4 million to the development services. Since inception, the $15.0 million and $64.4 million allocated to committee and development services, respectively, is being recognized as revenue as the related services are provided over the estimated service periods of 17 years and 9 years, which are equivalent to the estimated remaining life of the underlying technology and the estimated remaining development period, respectively. As of June 30, 2014, approximately $53.8 million was included in deferred revenue related to the committee and development services, of which $41.7 million was included in deferred revenue non-current. Cost of goods sold (in thousands): Three Months Ended Six Months Ended June 30, Increase/ June 30, Increase/ 2014 2013 (Decrease) 2014 2013 (Decrease)



Cost of goods sold $ 9,305 $ - $ 9,305 $

15,415 $ - $ 15,415

Cost of goods sold includes third-party manufacturing costs of products sold, fixed manufacturing overhead, royalty fees, and other indirect costs such as employee compensation. For the three and six months ended June 30, 2014, cost of goods sold included $6.9 million and $10.9 million, respectively of royalty expense incurred under the Celera agreement (see Note 3 to the condensed consolidated financial statements). We began capitalizing inventory during the year ended December 31, 2013 in connection with the FDA's approval of IMBRUVICA, as the related costs were expected to be recoverable through the commercialization of the product. As of December 31, 2013, inventory related costs of $16.1 million incurred prior to FDA approval were recorded as research and development expenses in our statements of operations, of which $13.5 million was remaining on hand as of June 30, 2014. We expect to sell the remaining pre-commercialization inventory on hand over the next 12 to 15 months. Subsequent to the utilization of all our pre-commercialization inventory, we estimate cost of goods sold as a percentage of product revenue, net will be in the range of high single digit to low double digit percentage. The estimated cost of goods sold percentage of product revenue, net includes third-party manufacturing costs of products sold, fixed manufacturing overhead, royalty fees, and other indirect costs such as employee compensation. The range is impacted by our estimate of materials costs from our suppliers as well the level of our fixed overhead costs estimated in relation to our future sales levels. Research and development (in thousands): Three Months Ended Six Months Ended June 30, Increase/ June 30, Increase/ 2014 2013 (Decrease) 2014 2013 (Decrease) Research and development $ 45,668$ 45,300$ 368$ 80,960$ 81,084$ (124 ) Less: Excess Amounts related to Research and development - (17,377 ) 17,377 - (17,377 ) 17,377 Research and development, net $ 45,668$ 27,923$ 17,745$ 80,960$ 63,707$ 17,253 Research and development expense increased by $17.7 million for the three months ended June 30, 2014 compared to the three months ended June 30, 2013, primarily due to the $17.4 million benefit of Excess Amounts which was recorded as a reduction to costs and expenses in the three months ended June 30, 2013 (see Note 3 to the condensed consolidated financial statements). Research and development expense increased by $17.3 million for the six months ended June 30, 2014 compared to the six months ended June 30, 2013, primarily due to the $17.4 million benefit of Excess Amounts which was recorded as a reduction to costs and expenses six months ended June 30, 2013 (see Note 3 to the condensed consolidated financial statements). Average research and development headcount increased from 222 to 296 for the three months ended June 30, 2014 compared to the three months ended June 30, 2013. Average research and development headcount increased from 206 to 288 32



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for the six months ended June 30, 2014 compared to the six months ended June 30, 2013. In the near term, we intend to hire additional research and development employees, as well as incur costs under our collaboration agreements as we continue to invest in the development of our compounds (see Note 3 to our condensed consolidated financial statements). Accordingly, we expect that our research and development expenses will continue to increase. Research and development costs are identified as either directly attributed to one of our research and development programs or as an indirect cost, with only direct costs being tracked by specific program. Direct costs consist of personnel costs directly associated with a program, preclinical study costs, clinical trial costs, and related clinical drug and manufacturing costs, drug formulation costs, contract services and other research expenditures. Indirect costs consist of personnel costs not directly associated with a program, overhead and facility costs and other support service expenses. The following table summarizes our principal product development initiatives, including the related stages of development for each product, the direct costs attributable to each product and total indirect costs for each respective period. For a discussion of the risks and uncertainties associated with the timing and cost of completing a product development phase, see Item 1A, Risk Factors and the Risk Factors discussed in our Form 10-K for the year ended December 31, 2013. Direct costs by program and indirect costs are as follows (in thousands):



R&D Expenses

Three Months Ended Six Months Ended June 30, June 30, Phase of Program Description Development 2014 2013 2014 2013 Phase BTK Inhibitors Cancer I/II/III $ 26,492$ 34,896$ 47,760$ 53,192 Non-clinical, BTK Inhibitors Autoimmune Phase I 3,934 1,453 6,091 3,018 HDAC Inhibitors Cancer Phase I/II 156 241 215 759 Factor VIIa Inhibitor Cancer Phase II - 165 9 280 Total direct costs 30,582 36,755 54,075 57,249 Indirect costs 15,086 8,545 26,885 23,835 Less: Excess Amounts related to Research and development - (17,377 ) - (17,377 ) Research and development $ 45,668$ 27,923$ 80,960$ 63,707



Selling, general and administrative (in thousands):

Three Months Ended Six Months Ended June 30, Increase/ June 30, Increase/ 2014 2013 (Decrease) 2014 2013 (Decrease) Selling, general and administrative $ 45,002$ 17,736$ 27,266$ 79,717$ 37,762$ 41,955 Less: Excess Amounts related to Selling, general and administrative - (3,006 ) 3,006 - (3,006 ) 3,006 Selling, general and administrative, net $ 45,002$ 14,730$ 30,272$ 79,717$ 34,756$ 44,961 Selling, general and administrative expense for the three months ended June 30, 2014 increased by $30.3 million compared to the three months ended June 30, 2013. The increase was primarily due to an $8.0 million increase in payroll and related expenses, a $5.7 million increase in stock-based compensation expense, a $4.0 million increase in donations to third-party patient assistance foundations and a $1.9 million increase in consulting and outside service expenses. The increase in expense was also due a $3.0 million decrease in Excess Amounts and a $1.8 million increase attributable to the Janssen development cost share (see Note 3 to the condensed consolidated financial statements). Selling, general and administrative expense for the six months ended June 30, 2014 increased by $45.0 million compared to the six months ended June 30, 2013. The increase was primarily due to a $16.9 million increase in payroll and related 33



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expenses, an $8.0 million increase in donations to third-party patient assistance foundations and a $2.8 million increase in consulting and outside service expenses. The increase in expense was also due to a $3.4 million increase attributable to the Janssen development cost share and $3.0 million decrease in Excess Amounts (see Note 3 to the condensed consolidated financial statements). The average selling, general and administrative headcount increased from 80 to 240 in the three months ended June 30, 2014 compared to the three months ended June 30, 2013. The average selling, general and administrative headcount increased from 74 to 233 in the six months ended June 30, 2014 compared to the six months ended June 30, 2013. In the near term, we intend to hire additional commercial and administrative employees, as well as incur costs under our collaboration agreements as we continue to commercialize our products. Costs of collaboration (in thousands): Three Months Ended Six Months Ended June 30, Increase/ June 30, Increase/ 2014 2013 (Decrease) 2014 2013 (Decrease)



Costs of collaboration $ 50,095 $ - $ 50,095$ 75,130 $ - $ 75,130

In connection with the Janssen agreement, net profits from the commercialization of products resulting from the collaboration, including IMBRUVICA, are shared 50% by us and 50% by Janssen (see Note 3 to the condensed consolidated financial statements). For the three and six months ended June 30, 2014, Janssen's share of profits from net product revenue less cost of goods sold of IMBRUVICA of $50.1 million and $75.1 million, respectively was included in costs of collaboration in our condensed consolidated statements of operations. Income tax benefit (in thousands): Three Months Ended Six Months Ended June 30, Increase/ June 30, Increase/ 2014 2013 (Decrease) 2014 2013 (Decrease)



Income tax benefit $ 181$ 343$ (162 )$ 193$ 1,317$ (1,124 )

The difference between the estimated annual effective tax rate and the federal statutory rate of 35% was primarily attributable to a year to date benefit not expected to be realized under the application of the ASC No. 740-270, Income tax - Interim reporting (previously FIN 18, "Accounting for Income Taxes in Interim Period "). For the three and six months ended June 30, 2014, no tax benefit has been recorded under an effective tax rate method as no benefit is expected to be realized for the current year given our full valuation allowance position and also based on our estimate of a tax provision for the year ending December 31, 2014. For the three and six months ended June 30, 2014, the income tax benefit was related to discrete items recorded in the period. Liquidity and Capital Resources As of June 30, 2014, our principal sources of liquidity were cash provided by operating activities and our cash and cash equivalents and marketable securities. At June 30, 2014, we had $678.0 million in cash, cash equivalents and marketable securities. Net cash provided by operating activities of $48.3 million during the six months ended June 30, 2014 primarily consisted of a net loss of $18.8 million, adjusted by $30.2 million for stock-based compensation expense, a $48.1 million decrease in the receivable from collaboration partners, a $40.0 million increase in the payable to collaboration partners primarily due to the increase in costs of collaboration from IMBRUVICA sales and a $14.5 million decrease in advances to manufacturers due to the timing of inventory received. These increases in cash provided by operating activities were partially offset by an increase in trade receivables of $34.3 million due to sales of IMBRUVICA during the six months ended June 30, 2014, and a $25.0 million increase in inventory to meet customer demand. Net cash used in operating activities of $13.1 million during the six months ended June 30, 2013 primarily consisted of net loss of $39.6 million, adjusted by $30.4 million for stock-based compensation expense, a $10.7 million increase in the receivable from collaboration partner, a $9.6 million increase in prepaid expenses and other assets and a $7.4 million decrease in deferred revenue. These decreases in cash flows from operating activities were partially offset by a $24.7 million increase in 34



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accrued liabilities. The increase in accounts receivable was primarily due to an increase in receivables from Janssen related to cost sharing and Excess Amounts under the collaboration agreement. The increase in prepaid expenses and other assets was primarily due to prepayments made in connection with our on-going clinical studies and a deposit paid in connection with the expansion of our contract manufacturing facility. The decrease in deferred revenue was due to the recognition of collaboration revenue primarily related to the Janssen agreement. The increase in accrued liabilities was primarily due to higher accrued contract manufacturing costs, higher accrued payroll and related expenses due to the increase in headcount, higher accrued marketing expenses and increased costs related to our clinical trials activities. Net cash used in investing activities of $19.0 million for the six months ended June 30, 2014 consisted primarily of $9.7 million used to purchase property and equipment, $9.3 million used to purchase intangible assets, $7.9 million used to purchase marketable securities, partially offset by $7.8 million of proceeds from maturities of marketable securities. Net cash used in investing activities of $9.1 million for the six months ended June 30, 2013 consisted primarily of $8.0 million used to purchase property and equipment, $8.1 million used to purchase marketable securities, partially offset by $6.7 million of proceeds from the maturities of marketable securities. Net cash provided by financing activities of $13.0 million for the six months ended June 30, 2014 consisted of $13.0 million of proceeds from the issuance of common stock upon the exercise of stock options and the sale of stock under our employee stock purchase plan. Net cash provided by financing activities of $209.0 million for the six months ended June 30, 2013 consisted primarily of $201.0 million of net proceeds from the issuance of shares in a public stock offering and $7.9 million of proceeds from the issuance of common stock upon the exercise of stock options. During the six months ended June 30, 2013, we sold 2.2 million shares of our common stock in an underwritten public offering at $94.20 per share for net proceeds of $201.0 million after deducting expenses of the offering. The closing of the offering took place on March 13, 2013. In December 2011, we received a $150.0 million upfront payment from our collaboration and license agreement with Janssen. The collaboration and license agreement provided us with the potential to receive future milestone payments of up to $825.0 million. As of June 30, 2014, $445.0 million in milestone payments had been earned by us under the Agreement and we may receive up to an additional $380.0 million in development, regulatory and approval milestone payments. However, clinical development entails risks and we have no assurance as to whether or when the milestone targets might be achieved (see Notes 3 and 13 to the condensed consolidated financial statements for additional information). Under the Janssen Agreement, we have a $50.0 million annual cap on our share of collaboration costs and pre-tax commercial losses for each calendar year until the third profitable calendar quarter for IMBRUVICA, as determined in the Agreement and any Excess Amounts are funded by Janssen. In the event that we achieve a third profitable calendar quarter from sales of IMBRUVICA, which was commercially launched during the year ended December 31, 2013, or in the event that we fully utilize the maximum Excess Amounts provided for in the Agreement, we will no longer receive Excess Amounts and our cash expenditures will increase. Further, Excess Amounts will become payable to Janssen together with interest from our share of pre-tax commercial profits (if any) in calendar quarters subsequent to our third profitable calendar quarter until the Excess Amounts and applicable interest has been fully repaid (see Note 3 to the condensed consolidated financial statements). Based upon the current status of our product development and plans, we believe that our existing cash, cash equivalents and marketable securities will be adequate to satisfy our capital needs through at least the next 12 months. Our actual capital requirements will depend on many factors, including the following: • our ability to successfully market IMBRUVICA; • the amount of sales of IMBRUVICA and any other products that we may commercialize



• the timing of achieving a third profitable calendar quarter for IMBRUVICA,

under the Janssen agreement, which would trigger the repayment of Excess

Amounts;

• the costs of obtaining clinical and commercial supplies of IMBRUVICA;

• progress with preclinical studies and clinical trials;

• the time and costs involved in obtaining additional regulatory approvals;

• continued progress of our research and development programs;

• our ability to maintain and establish collaborative arrangements with third parties; • the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; 35



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• the amount and timing of capital equipment purchases; and

• competing technological and market developments.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. The factors described above will impact our future capital requirements and the adequacy of our available funds. If we are required to raise additional funds, we cannot be certain that such additional funding will be available on terms favorable to us, or at all. Furthermore, any additional equity financing may be highly dilutive, or otherwise disadvantageous, to existing stockholders and debt financing, if available, may involve restrictive covenants. Collaborative arrangements, if necessary to raise additional funds, may require us to relinquish rights to certain of our technologies, products or marketing territories. Our failure to raise capital when needed and on acceptable terms, would require us to reduce our costs and expenses and would limit our ability to respond to competitive pressures or unanticipated requirements to develop our product candidates and to continue operations, any of which would have a material adverse effect on our business, financial condition and results of operations. Contractual Obligations The following table summarizes our primary non-cancelable contractual obligations as of June 30, 2014 (in thousands): Payments due by Period Contractual Remaining six Obligations (1) Total months 2015 2016 2017 2018 2019 Thereafter Operating lease obligations $ 12,334$ 1,228$ 2,204$ 2,161$ 2,112$ 857$ 882$ 2,890 Purchase commitments (2) 21,667 21,667 - - - - - - Total $ 34,001$ 22,895$ 2,204$ 2,161$ 2,112$ 857$ 882$ 2,890 (1) Excluded from the above table are Excess Amounts under the collaboration and license agreement with Janssen. Our worldwide collaboration and license agreement with Janssen provides us with an annual cap on our share of development costs and pre-tax commercial losses for each calendar year until the third profitable calendar quarter for IMBRUVICA, as determined in the agreement and any Excess Amounts are funded by Janssen. As of June 30, 2014, total Excess Amounts of $136.5 million (which is comprised of the cumulative amount funded by Janssen to date of $134.3 million and interest of $2.2 million) would become payable once we reach a third profitable quarter for IMBRUVICA (see Note 3 to the condensed consolidated financial statements). Janssen may recoup the Excess Amounts, together with interest from our share of pre-tax commercial profits (if any) in calendar quarters subsequent to its third profitable quarter for IMBRUVICA until the Excess Amounts and applicable interest has been fully repaid. (2) Purchase commitments primarily consist of non-cancelable orders related to contract manufacturing. Off-Balance Sheet Arrangements None. Critical Accounting Policies, Estimates and Judgments In connection with our commercial launch of IMBRUVICA on November 13, 2013, we implemented the following critical accounting policies and estimates that are used in the determination of product revenue, net: Revenue Recognition Product revenue, net is recognized in accordance with the FASB Accounting Standards Codification (ASC) 605, Revenue Recognition, when the following criteria have been met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the price is fixed or determinable and (4) collectability is reasonably assured. Revenues are deferred for fees received before earned or until no further obligations exist. We exercise judgment in determining that collectability is reasonably assured or that services have been delivered in accordance with the arrangement. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectability based primarily on the customer's payment history and on the creditworthiness of the customer. Product Revenue, Net 36



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Product revenue, net consists of U.S. sales of IMBRUVICA and is recognized once all four revenue recognition criteria described above have been met. We sell IMBRUVICA to direct customers, specialty pharmacies (SP) that sell to individual patients, specialty distributors (SD) that sell to hospital pharmacies and other organizations that we have contracted with. We recognize revenue from sales of IMBRUVICA when the product's title and risk of loss transfers to the customer. We determined that we have the ability to make reasonable estimates of product returns in order to recognize revenue at the time that title and risk of loss transfers to the customer based on the following factors: (1) we believe that we have sufficient insight into the distribution channel at the SP's and SD's in order to ascertain their inventory level and dispense data, (2) due to the price of our product and limited patient population, our SP and SD customers have not built up significant levels of inventory, nor do we expect they will do so for the foreseeable future, (3) inventory on hand at our SP customers was generally less than two weeks as of June 30, 2014, (4) there have been no significant product returns to-date since our commercial launch of IMBRUVICA on November 13, 2013 and (5) we believe there is limited risk of return of inventory in the channel because there is significant remaining shelf life at the point of sale. We recognize product revenue net of adjustments for customer credits, including estimated government rebates and charge-backs, returns, prompt payment discounts, U.S. Department of Veteran's Affairs (VA) negotiated discounts and administrative service fees related to our agreements, patient assistance programs, and Medicare Part D coverage gap reimbursements. Each of the above adjustments is recorded at the time of revenue recognition, resulting in a reduction in product revenue, net and an increase in accrued expenses or a reduction in accounts receivable, net. The above adjustments require significant estimates, judgment and information obtained from external sources. If management's estimates differ from actual results, we will record adjustments that would affect product revenue, net in the period of adjustment. The following table summarizes the provisions, and credits/payments, for these adjustments (in thousands): Total Balance as of December 31, 2013$ 1,206



Provision related to current period sales 19,635 Credits/payments

(9,884 ) Balance as of June 30, 2014$ 10,957 Gross-to-net sales adjustments Rebates We record an allowance for rebates including mandated discounts under the Medicaid Drug Rebate Program, discounts provided to the U.S. Department of Veteran's Affairs (VA) and members of organizations with whom we have contracted with. The allowance for rebates is based upon our contractual agreements and/or legal requirements and public sector benefit providers, including Medicaid. For estimated amounts owed to public sector benefit providers, including Medicaid, the allowance for rebates is based on the estimated rebate percentage of forecasted eligible sales. The estimated rebate percentage is based on statutory discount rates and expected utilization. The forecasted eligible Medicaid sales represent those sales made by us that will ultimately be consumed by patients covered by Medicaid. To estimate the allowance for rebates, we use the estimated patient mix information which is provided by our SP customers, as well as third party sources. For organizations that we have contracted with, the rebate is based upon contracted volume discount amounts. In addition, we incur administrative fees in exchange for administrative services provided that are also accrued at the time of sale. Rebates for public sector benefit providers and organizational discounts are generally invoiced and paid in arrears. As such, the allowance for rebates consists of an estimate of the amount expected to be incurred for the current quarter's shipments to patients, plus an accrual balance for estimated unpaid rebates from prior periods. The allowance for rebates is recorded within accrued liabilities in the condensed consolidated balance sheets. Charge-backs Charge-backs are discounts that result from the difference between the prices at which we make IMBRUVICA available from wholesalers for purchase by discount customers under pricing agreements we have with the discount customers and the sales price paid to us by the wholesalers who service the discount customers. Such discount customers, which primarily consist of the U.S. Department of Defense (DOD), VA, Public Health Services (PHS), other Federal Government institutions, purchase products through wholesalers at a lower price provided for in pricing contracts and the wholesalers then charge the Company the difference between the wholesale acquisition cost and the lower price paid by the discount customer. These reductions are 37



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settled through charge-backs from our wholesalers. Charge-backs are recorded as a reduction to accounts receivable, net in the condensed consolidated balance sheets. Product Returns Consistent with industry practice, we generally offer customers a limited right to return. We generally allow for the return of product that is a few months prior to and up to a few months after the product expiration date. Additionally, we consider several other factors in the estimation process including the expiration dates of product shipped, third party data in monitoring channel inventory levels, shelf life of the product, prescription trends and other relevant factors. Provisions for estimated product returns are recorded within accrued liabilities in the condensed consolidated balance sheets. Medicare Part D coverage gap Medicare Part D, also known as the Medicare prescription drug benefit, is a federal program to subsidize the costs of prescription drugs for Medicare beneficiaries in the United States. The Medicare Part D prescription drug benefit mandates that drug manufacturers fund 50% of the Medicare Part D insurance coverage gap for prescription drugs sold to eligible patients. Funding of the Medicare Part D gap is invoiced and paid in arrears. As such, the allowance for Medicare Part D consists of an estimate of the amount expected to be incurred for the current quarter's shipments to patients, plus an accrual balance for estimated shipments remaining in the channel at period end which are estimated to ship to Medicare Part D patients. The allowance for rebates is recorded within accrued liabilities in the condensed consolidated balance sheets. Prompt payment discounts We generally offer cash discounts to our customers, generally a 2% discount applied to the invoice amount, as an incentive for prompt payment. We expect that all of our customers to whom we offer cash discounts for prompt payment to take advantage of the full amount of the 2% discount. We record the prompt-payment discount as a reduction to Accounts receivable, net in the condensed consolidated balance sheets. Co-payment assistance Patients who have commercial insurance and meet certain eligibility requirements may receive co-payment assistance. We accrue for co-payment assistance based on actual program participation and estimates of program redemption using data provided by third-party administrators. Long-lived Assets We evaluate long-lived assets (including finite-lived intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. In accordance with ASC 350-10, Goodwill and Other Intangible Assets, intangible assets with estimable useful lives are amortized over their respective estimated useful lives, and reviewed for impairment in accordance with ASC 360-10, "Accounting for the Impairment or Disposal of Long-Lived Assets." We review long-lived assets, such as acquired intangibles and property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We measure recoverability of assets to be held and used by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, we recognize an impairment charge at the amount by which the carrying amount of the asset exceeds the fair value of the asset. Our impairment review requires significant judgment with respect to future revenue and expense growth rates, selection of appropriate discount rate and other assumptions and estimates. There were no impairment losses recognized during the three and six months ended June 30, 2014. For a complete listing of our critical accounting policies, estimates and judgments, please see Item 7 to our consolidated financial statements included in our Form 10-K for the year ended December 31, 2013. Recent Accounting Pronouncements During the fiscal first quarter of 2013, the FASB issued amended guidance clarifying the release of accumulated Foreign Currency Translation from Accumulated Other Comprehensive Income (AOCI) into current year Net Earnings. The amendment requires that when the parent company ceases to have a controlling interest in a subsidiary or a business within a foreign entity the parent is to release accumulated Foreign Currency Translation from AOCI. This update was required to be adopted for all annual periods and interim reporting periods beginning after December 15, 2013, with early adoption permitted. The adoption of this standard did not have a material impact on our results of operations, cash flows or financial position. In July 2013, FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force)." The amendments in this ASU provide guidance on the financial statement presentation of an unrecognized tax benefit 38



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when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward with certain exceptions, in which case such an unrecognized tax benefit should be presented in the financial statements as a liability. The amendments in this ASU do not require new recurring disclosures. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-11 did not have a material impact on our results of operations, cash flows or financial position. In April 2014, the FASB issued ASU No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity", or ASU 2014-08. Under ASU 2014-08, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization's operations and financial results. Additionally, ASU 2014-08 requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. ASU 2014-08 is effective for fiscal and interim periods beginning on or after December 15, 2014, with early adoption permitted. We are currently evaluating the impact of the adoption of this accounting standard on our results of operations, financial position and cash flows. In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)," which provides guidance for revenue recognition. This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today's guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. This standard is effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is not permitted. We are currently evaluating the impact of the adoption of this accounting standard update on our consolidated financial statements. Item 3. Quantitative and Qualitative Disclosures about Market Risk There was no significant change in our exposure to market risk since December 31, 2013.


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