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EXCEL - IDEA: XBRL DOCUMENT - PHARMACYCLICS INCFinancial_Report.xls
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO EXCHANGE ACT RULES - PHARMACYCLICS INCpcyc20140630exhibit312.htm
EX-32.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER - PHARMACYCLICS INCpcyc20140630exhibit321.htm
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO EXCHANGE ACT RULES - PHARMACYCLICS INCpcyc20140630exhibit311.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014
 
or
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                 to                                

Commission File Number:  000-26658
Pharmacyclics, Inc.
(Exact name of registrant as specified in its charter)
Delaware
94-3148201
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
995 E. Arques Avenue
Sunnyvale, CA
94085-4521
(Address of principal executive offices)
(Zip Code)
(408) 774-0330
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes ý  No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes ý     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o    No ý
 
As of July 29, 2014 there were 75,269,926 shares of the registrant's Common Stock, par value $0.0001 per share, outstanding.



PHARMACYCLICS, INC.
Form 10-Q
Table of Contents
 
PART I.
Page No.
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II.
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.

2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
PHARMACYCLICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited; in thousands, except share and per share amounts)
 
 
June 30, 2014
 
December 31, 2013
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
666,279

 
$
623,956

Marketable securities
 
11,704

 
11,672

Accounts receivable, net
 
45,335

 
11,044

Receivable from collaboration partners
 
3,872

 
51,957

Inventory
 
38,301

 
12,603

Advances to manufacturers
 
5,793

 
20,316

Prepaid expenses and other current assets
 
12,248

 
9,253

Total current assets
 
783,532

 
740,801

Property and equipment, net
 
30,490

 
25,471

Intangible assets, net
 
9,096

 

Other assets
 
2,970

 
2,479

Total assets
 
$
826,088

 
$
768,751

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 

Current liabilities:
 
 
 
 

Accounts payable
 
$
6,313

 
$
4,026

Accrued liabilities
 
65,177

 
71,188

Payable to collaboration partner
 
43,359

 
3,388

Income tax payable
 
23

 
1,448

Deferred revenue - current portion
 
15,165

 
7,581

Total current liabilities
 
130,037

 
87,631

Deferred revenue - non-current portion
 
41,716

 
52,025

Other long-term liabilities
 
1,664

 
1,472

Total liabilities
 
173,417

 
141,128

Commitments and contingencies (see Notes 3 and 9)
 


 


Stockholders’ equity:
 
 
 
 

Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued and outstanding
 

 

Common stock, $0.0001 par value; 150,000,000 shares authorized at June 30, 2014 and December 31, 2013, respectively; shares issued and outstanding 75,263,823 and 74,167,169 at June 30, 2014 and December 31, 2013, respectively
 
8

 
7

Additional paid-in capital
 
888,057

 
844,220

Accumulated other comprehensive loss
 
(16
)
 
(8
)
Accumulated deficit
 
(235,378
)
 
(216,596
)
Total stockholders’ equity
 
652,671

 
627,623

Total liabilities and stockholders’ equity
 
$
826,088

 
$
768,751


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3


PHARMACYCLICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in thousands, except per share data)

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue:
 
 
 
 
 
 
 
Product revenue, net
$
109,495

 
$

 
$
165,674

 
$

License and milestone revenue

 
50,000

 
60,000

 
50,000

Collaboration services revenue
3,525

 
4,684

 
6,723

 
7,530

Total revenue
113,020

 
54,684

 
232,397

 
57,530

Costs and expenses:
 

 
 

 
 
 
 
Cost of goods sold
9,305

 

 
15,415

 

Research and development
45,668

 
45,300

 
80,960

 
81,084

Less: Excess Amounts related to Research and development (see Note 3)

 
(17,377
)
 

 
(17,377
)
Research and development, net
45,668

 
27,923

 
80,960

 
63,707

Selling, general and administrative
45,002

 
17,736

 
79,717

 
37,762

Less: Excess Amounts related to Selling, general and administrative (see Note 3)

 
(3,006
)
 

 
(3,006
)
Selling, general and administrative, net
45,002

 
14,730

 
79,717

 
34,756

Costs of collaboration (see Note 3)
50,095

 

 
75,130

 

Amortization of intangible assets (see Note 7)
154

 

 
154

 

Total costs and expenses
150,224

 
42,653

 
251,376

 
98,463

Income (loss) from operations
(37,204
)
 
12,031

 
(18,979
)
 
(40,933
)
Interest income
82

 
110

 
162

 
186

Other expense, net
(116
)
 
(133
)
 
(158
)
 
(130
)
Income (loss) before income taxes
(37,238
)
 
12,008

 
(18,975
)
 
(40,877
)
Income tax benefit
181

 
343

 
193

 
1,317

Net income (loss)
$
(37,057
)
 
$
12,351

 
$
(18,782
)
 
$
(39,560
)
Net income (loss) per share:
 

 
 

 
 
 
 
Basic
$
(0.49
)
 
$
0.17

 
$
(0.25
)
 
$
(0.55
)
Diluted
$
(0.49
)
 
$
0.16

 
$
(0.25
)
 
$
(0.55
)
Weighted average shares used to compute net income (loss) per share:
 

 
 

 
 
 
 
Basic
75,139

 
72,953

 
74,947

 
71,948

Diluted
75,139

 
77,194

 
74,947

 
71,948

 
 
 
 
 
 
 
 



The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4


PHARMACYCLICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited; in thousands)

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Comprehensive income (loss), net of taxes
 
 
 
 
 
 
 
Net income (loss)
$
(37,057
)
 
$
12,351

 
$
(18,782
)
 
$
(39,560
)
Change in unrealized gain (loss) on marketable securities
(7
)
 
(11
)
 
(8
)
 
(11
)
Comprehensive income (loss)
$
(37,064
)
 
$
12,340

 
$
(18,790
)
 
$
(39,571
)




The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


5


PHARMACYCLICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in thousands)

 
Six Months Ended
 
June 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net loss
$
(18,782
)
 
$
(39,560
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
1,997

 
878

Stock-based compensation expense
30,177

 
30,439

Loss on property and equipment

 
117

Changes in assets and liabilities:
 
 
 
Accounts receivable, net
(34,291
)
 

Receivable from collaboration partners
48,085

 
(10,711
)
Inventory
(25,022
)
 

Advances to manufacturers
14,523

 

Prepaid expenses and other assets
(3,496
)
 
(9,608
)
Accounts payable
2,163

 
(638
)
Accrued liabilities
(3,088
)
 
24,746

Payable to collaboration partners
39,971

 

Income taxes payable
(1,425
)
 
(1,389
)
Deferred revenue
(2,725
)
 
(7,416
)
Other long-term liabilities
192

 
16

Net cash provided by (used in) operating activities
48,279

 
(13,126
)
Cash flows from investing activities:
 
 
 
Purchase of property and equipment
(9,661
)
 
(7,950
)
Purchase of marketable securities
(7,880
)
 
(8,080
)
Proceeds from sales of marketable securities

 
240

Proceeds from maturities of marketable securities
7,840

 
6,680

Purchase of intangible assets
(9,250
)
 

Net cash used in investing activities
(18,951
)
 
(9,110
)
Cash flows from financing activities:
 
 
 
Issuance of common stock, net of issuance costs

 
201,023

Proceeds from exercise of stock options and stock purchase rights
12,995

 
7,934

Net cash provided by financing activities
12,995

 
208,957

Increase in cash and cash equivalents
42,323

 
186,721

Cash and cash equivalents at beginning of period
623,956

 
307,433

Cash and cash equivalents at end of period
$
666,279

 
$
494,154

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Property and equipment purchases included in Accounts payable and Accrued liabilities
$
1,241

 
$
1,897


 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

6


PHARMACYCLICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1 — The Company and Significant Accounting Policies
Company Overview
Pharmacyclics, Inc. (Pharmacyclics or the Company) is a biopharmaceutical company focused on developing and commercializing innovative small-molecule drugs for the treatment of cancer and immune-mediated diseases.
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 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-1102 and PCYC-1104 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, the Company received additional FDA approval for IMBRUVICA on July 28, 2014 (please see Note 13 - Subsequent Events).
IMBRUVICA is the first once-daily, single-agent, oral kinase inhibitor 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.
Pharmacyclics markets IMBRUVICA and has three product candidates in clinical development and several preclinical molecules in lead optimization.
Basis of Presentation
The accompanying condensed consolidated financial statements include the accounts of Pharmacyclics, Inc. and its wholly-owned subsidiaries, Pharmacyclics (Europe) Limited, Pharmacyclics Switzerland GmbH, Pharmacyclics Cayman Ltd. and Pharmacyclics (Shanghai) Management Consulting Service Limited. All intercompany accounts and transactions have been eliminated. The U.S. dollar is the functional currency for all of the Company's consolidated operations.
The interim condensed consolidated financial statements have been prepared by the Company, without audit, in accordance with Article 10 of Regulation S-X which governs quarterly reporting and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of the Company's financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States (GAAP). The December 31, 2013 condensed consolidated balance sheet data contained within this Form 10-Q was derived from audited consolidated financial statements included in the Company's Form 10-K for the year ended December 31, 2013, but does not include all disclosures required by accounting principles generally accepted in the United States.
In the opinion of management, the unaudited financial information for the interim periods presented reflects all normal and recurring adjustments necessary for a fair statement of results of operations, financial position and cash flows. These condensed consolidated financial statements should be read in conjunction with the financial statements included in the Company's Form 10-K for the year ended December 31, 2013. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in the Company's condensed consolidated financial statements and the accompanying notes. Actual results could differ from those estimates.
Reclassification
Certain amounts within the condensed consolidated balance sheet for the prior periods have been reclassified to conform with the current period presentation. These reclassifications had no impact on the Company's previously reported financial position.
Significant Accounting Policies

7


In connection with the Company's commercial launch of IMBRUVICA on November 13, 2013, it implemented the following significant 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. The Company exercises judgment in determining that collectability is reasonably assured or that services have been delivered in accordance with the arrangement. The Company assesses 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. The Company assesses collectability based primarily on the customer's payment history and on the creditworthiness of the customer.
Product Revenue, Net
Product revenue, net consists of U.S. sales of IMBRUVICA and is recognized once all four revenue recognition criteria described above have been met. The Company sells IMBRUVICA to direct customers, specialty pharmacies (SP) that sell to individual patients, specialty distributors (SD) that sell to hospital pharmacies and other organizations that the Company has contracted with. The Company recognizes revenue from sales of IMBRUVICA when the product’s title and risk of loss transfers to the customer. The Company determined that it has 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) the Company believes that it has 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 the Company's product and limited patient population, its SP and SD customers have not built up significant levels of inventory, nor does the Company expect they will do so for the foreseeable future, (3) inventory on hand at the Company's SP customers was generally less than two weeks as of June 30, 2014, (4) there have been no significant product returns to-date since the Company's commercial launch of IMBRUVICA on November 13, 2013 and (5) the Company believes there is limited risk of return of inventory in the channel because there is significant remaining shelf life at the point of sale.
The Company recognizes 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 its 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, the Company will record adjustments that would affect product revenue, net in the period of adjustment.
Gross-to-net sales adjustments
Rebates
The Company records 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 the Company has contracted with. The allowance for rebates is based upon the Company's 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 the Company that will ultimately be consumed by patients covered by Medicaid. To estimate the allowance for rebates, the Company uses the estimated patient mix information which is provided by its SP customers, as well as third party sources. For organizations that the Company has contracted with, the rebate is based upon contracted volume discount amounts. In addition, the Company incurs 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 the Company makes IMBRUVICA available from wholesalers for purchase by discount customers under pricing agreements the Company has with the discount

8


customers and the sales price paid to the Company 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 settled through charge-backs from the Company's wholesalers. Charge-backs are recorded as a reduction to accounts receivable, net in the condensed consolidated balance sheets.
Product Returns
Consistent with industry practice, the Company generally offers its customers a limited right to return. The Company generally allows for the return of product that is a few months prior to and up to a few months after the product expiration date. Additionally, the Company considers 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
The Company generally offers cash discounts to its customers, generally a 2% discount applied to the invoice amount, as an incentive for prompt payment. The Company expects that all of its customers to whom it offers cash discounts for prompt payment to take advantage of the full amount of the 2% discount. The Company records 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. The Company accrues for co-payment assistance based on actual program participation and estimates of program redemption using data provided by third-party administrators.
Donations to Third-Party Patient Assistance Foundations
The Company provides cash donations to independent third-party patient assistance foundations that, in turn, make grants to help qualifying patients meet their out-of-pocket costs (including co-pay payments or co-insurance obligations) in connection with their use of the Company's products as well as those of other pharmaceutical and biotechnology companies. These independent patient assistance foundations maintain their own patient eligibility criteria and independently determine for which medicinal products patients can receive financial assistance. Given the non-reciprocal nature of these transactions with parties who are not considered direct or indirect customers, and for which the Company does not receive any consideration, and the fact that the donation of cash does not have any conditions attached to the donation, the Company accounts for the cash donations as a component of selling, general and administrative expenses in the condensed consolidated statements of operations.
Long-lived Assets
The Company evaluates 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." The Company reviews 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. The Company measures 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, the Company recognizes an impairment charge at the amount by which the carrying

9


amount of the asset exceeds the fair value of the asset. The Company's 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 the Company's significant accounting policies, please see Note 2 to its consolidated financial statements included in its Form 10-K for the year ended December 31, 2013.
Concentration of credit risk
Financial instruments that potentially subject the Company to credit risk consist principally of cash, cash equivalents, marketable securities, accounts receivable and receivables from collaboration partners. The Company places its cash and cash equivalents with high-credit quality financial institutions and invests in debt instruments of financial institutions, corporations and government entities with strong credit ratings. The Company's management believes it has established guidelines relative to credit quality, diversification and maturities that maintain safety and liquidity.
The Company sells IMBRUVICA to direct customers and through a limited number of specialty pharmacies and specialty distributors. The Company continuously monitors the creditworthiness of its customers and has internal policies regarding customer credit limits. The Company's policy is to estimate the allowance for doubtful accounts based on the credit worthiness of its customers, historical payment patterns, the aging of accounts receivable balances and general economic conditions. As of June 30, 2014, the Company had no allowance for doubtful accounts. As of June 30, 2014, four individual customers accounted for 30%, 20% , 16% and 16% of accounts receivable, net, respectively. As of December 31, 2013, three individual customers accounted for 26%, 26% and 16% of accounts receivable, net, respectively.
Note 2 - Product Revenue, Net
Product revenue, net consists of revenue recorded from the sale of IMBRUVICA which first came to market on November 13, 2013. All product sales during three and six months ended June 30, 2014 were sold to specialty pharmacies, specialty distributors and direct customers in the United States.
The following table summarizes the provisions, and credits/payments, for product revenue, net 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

The Company recorded no product revenue for the three and six months ended June 30, 2013, as these periods were prior to FDA approval for IMBRUVICA. The following table sets forth customers who represented 10% or more of the Company's product revenue, net for the three and six months ended June 30, 2014:
 
 
Three Months Ended
 
Six Months Ended
Customer
 
June 30, 2014
 
June 30, 2014
A
 
31
%
 
30
%
B
 
19
%
 
19
%
C
 
16
%
 
16
%
D
 
14
%
 
13
%
E
 
11
%
 
12
%

Note 3 - Collaboration and Other Agreements
The Company recognized revenue related to its collaboration and license arrangements as follows (in thousands):

10


 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Janssen
$
3,495

 
$
54,630

 
$
66,630

 
$
57,416

Les Laboratoires Servier ("Servier") and other
30

 
54

 
93

 
114

Total
$
3,525

 
$
54,684

 
$
66,723

 
$
57,530

Collaboration and License Agreement with Janssen Biotech, Inc.
Background
In December 2011, the Company entered into a worldwide collaboration and license agreement (the Agreement) with Janssen for the joint development and commercialization of IMBRUVICA, a novel, orally active, selective covalent inhibitor of Bruton’s Tyrosine Kinase (BTK), and certain compounds structurally related to IMBRUVICA, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the U.S. and outside the U.S.
The collaboration provides Janssen with an exclusive license to exploit the underlying technology outside of the U.S. (the License Territory) and co-exclusively with Pharmacyclics in the U.S. Both parties are responsible for the development, manufacturing and marketing of any products resulting from the Agreement. The Company continues to work with Janssen on protocols and the design, schedules and timing of trials.
The collaboration has no fixed duration or expiration date and provided for payments by Janssen to the Company of a $150.0 million non-refundable upfront payment upon execution, as well as potential future milestone payments of up to $825.0 million, based upon continued development progress ($250.0 million), regulatory progress ($225.0 million) and approval of the product in both the U.S. and the License Territory ($350.0 million). As of June 30, 2014, $445.0 million in milestone payments had been earned by the Company under the Agreement and it may receive up to an additional $380.0 million in development, regulatory and approval milestone payments (see Note 13 - Subsequent Events). However, clinical development entails risks and we have no assurance as to whether or when the milestone targets might be achieved.
The development, regulatory and approval milestones represents non-refundable amounts that would be paid by Janssen to the Company if certain milestones are achieved in the future. The Company has elected to apply the guidance in ASC 605-28 to the milestones. These milestones, if achieved, are substantive as they relate solely to past performance, are commensurate with estimated enhancement of value associated with the achievement of each milestone as a result of the Company's performance, which are reasonable relative to the other deliverables and terms of the arrangement, and are unrelated to the delivery of any further elements under the arrangement.
The Agreement includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, in general Janssen is responsible for approximately 60% of collaboration development costs and the Company is responsible for the remaining 40% of collaboration development costs. Generally, costs associated with commercialization will be included in determining pre-tax commercial profits or pre-tax commercial losses, which are to be shared 50% by the Company and 50% by Janssen.
The collaboration with Janssen provides the Company with an annual cap of its share of IMBRUVICA related research and development expenses and selling, general and administrative expenses offset by pre-tax commercial profits for each calendar year. In the event that the Company's share of aggregate development costs in any given calendar year, together with any other amounts that become due from the Company, plus the Company's share of pre-tax commercial losses (if any) for any calendar quarter in such calendar year, less the Company's share of pre-tax commercial profits (if any) for any calendar quarter in such calendar year, exceeds $50.0 million, then amounts that are in excess of $50.0 million (Excess Amounts) are funded by Janssen. Under the Agreement, the total Excess Amounts plus interest may not exceed $225.0 million at any given time.  Interest shall be accrued on the outstanding balance with interest calculated at the average annual European Interbank Offered Rate (EURIBOR) for the EURO or average annual London Interbank Offered Rate (LIBOR) for U.S. Dollars as reported in the Wall Street Journal, plus 2%, calculated on the number of days from the date on which the Company's payment would be due to Janssen. The interest rate on outstanding Excess Amounts shall not exceed 5% per annum, and the cumulative interest on Excess Amounts shall not in the aggregate exceed $25.0 million.
In the event the Excess Amounts plus interest reaches a maximum of $225.0 million, the Company shall be responsible for its share of development costs, together with any other amounts that become due from the Company, plus its share of any pre-tax commercial loss beyond such maximum. For all calendar quarters following the Company's third profitable calendar

11


quarter, as determined in the Agreement, the Company can no longer add to Excess Amounts and shall be responsible for its own share of development costs along with its share of pre-tax commercial losses incurred in such quarters. Janssen may only recoup the Excess Amounts, together with interest from the Company's share of pre-tax commercial profits (if any) in calendar quarters subsequent to its third profitable calendar quarter until the Excess Amounts and applicable interest has been fully repaid. As per the Agreement, a profitable quarter shall mean a full calendar quarter beginning after the first commercial sale of IMBRUVICA in which the combined pre-tax profit or loss for the United States and the License Territory is positive and exceeds the development costs for such calendar quarter.
The Company recognizes Excess Amounts as a reduction to costs and expenses as the Company's repayment of Excess Amounts to Janssen is contingent and would become payable only after the third profitable calendar quarter for IMBRUVICA. Further, Excess Amounts shall be reimbursable only as a reduction of the Company's share of pre-tax commercial profits (if any) after the third profitable quarter for IMBRUVICA.
The Agreement also provides that any net profits from the commercialization of products resulting from the collaboration will be shared 50% by the Company and 50% by Janssen. Janssen has sole responsibility and exclusive rights to commercialize the products in the License Territory. The parties hold joint responsibility and co-exclusive rights to commercialize the products in the U.S., and Pharmacyclics will serve as the lead party in such effort.
In accordance with ASU No. 2009-13 (and as incorporated into ASC Topic 605-25), the Company identified all of the deliverables at the inception of the Agreement. The significant deliverables were determined to be the license, committee services, development services and commercialization services. The commercialization services represent a contingent deliverable for which there is not a significant incremental discount.
The Company has determined that the license represents a separate unit of accounting as the license, which includes rights to the underlying technologies for IMBRUVICA, has standalone value apart from the committee and development services because the development, manufacturing and commercialization rights conveyed would permit Janssen to perform all efforts necessary to bring the compound to commercialization and begin selling the drug upon regulatory approval. The Company has also determined that the committee and development services each represent individual units of accounting as they have standalone value from each other.  The Company has determined its best estimate of selling prices for the license unit of accounting based on the income approach as defined in ASC 820-10-35-32. This measurement is based on the value indicated by current estimates about those future amounts and reflects management determined estimates and assumptions. These estimates and assumptions include, but are not limited to, how a market participant would use the license, estimated market opportunity and expected market share and assumed royalty rates that would be paid for sales resulting from products developed using the license, similar arrangements entered into by third parties and entity-specific factors such as the terms of the Company's previous collaborative agreement, the Company's pricing practices and pricing objectives, the likelihood that clinical trials will be successful, the likelihood that regulatory approval will be received and that the products will become commercialized and the markets served. These estimates and assumptions led to an expected future cash flow which was discounted based on estimated weighted average cost of capital of 12% and royalty rates ranging from 30% to 40%. The Company has also determined its best estimate of selling prices for the committee and development services, based on the nature of the services to be performed and estimates of the associated effort as well as estimated market rates for similar services. The arrangement consideration of $150.0 million was allocated to the units of accounting based on the relative selling price method.
Of the $150.0 million upfront payment received, $70.6 million was allocated to the licenses, $15.0 million to the committee services and $64.4 million to the development services. The Company has recognized license revenue upon execution of the arrangement as the associated unit of accounting had been delivered pursuant to the terms of the Agreement. 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.
Janssen Collaboration Revenue
Total revenue recognized with respect to the Agreement consisted of the following (in thousands):

12


 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
License and milestone revenue
$

 
$
50,000

 
$
60,000

 
$
50,000

Collaboration services revenue
3,495

 
4,630

 
6,630

 
7,416

Total
$
3,495

 
$
54,630

 
$
66,630

 
$
57,416

As of June 30, 2014, total deferred revenue related to committee and development services under the Agreement with Janssen was $53.8 million, of which $41.7 million was included in deferred revenue non-current portion.
Janssen Collaboration Cost Sharing and Excess Amounts
The Company recognized development costs under the collaboration as a component of research and development expense in the condensed consolidated statements of operations. The Company also recognized certain selling, general and administrative expenses under the collaboration, including marketing costs, patent costs and the Company's share of pre-tax commercial losses on IMBRUVICA outside of the U.S. as a component of selling, general and administrative in the condensed consolidated statements of operations. Expenses which were charged to the collaboration are as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Collaboration expenses, unadjusted
$
39,939

 
$
56,870

 
$
72,304

 
$
95,333

Decrease for cost sharing
(9,867
)
 
(18,069
)
 
(17,830
)
 
(34,360
)
Excess Amounts

 
(17,377
)
 

 
(17,377
)
Research and development
$
30,072

 
$
21,424

 
$
54,474

 
$
43,596

 
 
 
 
 
 
 
 
Collaboration expenses, unadjusted
$
23,099

 
$
5,595

 
$
40,436

 
$
9,103

Increase for cost sharing
2,885

 
1,118

 
3,713

 
307

Excess Amounts

 
(3,006
)
 

 
(3,006
)
Selling, general and administrative
$
25,984

 
$
3,707

 
$
44,149

 
$
6,404

During the three and six months ended June 30, 2014, the Company's share of IMBRUVICA related net costs under the Agreement was calculated as follows (in thousands):

13


 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Pharmacyclics' 50% share of U.S. product revenue, net
$
54,748

 
$

 
$
82,837

 
$

Less: Pharmacyclics' 50% share of U.S. cost of goods sold
(4,653
)
 

 
(7,707
)
 

Less: Pharmacyclics' share of selling, general and administrative costs under the Agreement, net of Excess Amounts
(25,984
)
 
(3,707
)
 
(44,149
)
 
(6,404
)
Pre-tax commercial profits from the commercialization of IMBRUVICA under the Agreement
24,111

 
(3,707
)
 
30,981

 
(6,404
)
 
 
 
 
 
 
 
 
Less: Pharmacyclics' share of research and development costs under the Agreement, net of Excess Amounts
(30,072
)
 
(21,424
)
 
(54,474
)
 
(43,596
)
Pharmacyclics' share of IMBRUVICA related net costs under the Agreement(1)
$
(5,961
)
 
$
(25,131
)
 
$
(23,493
)
 
$
(50,000
)
(1) As of June 30, 2014, the Company has not achieved a first calendar quarter of profitability for IMBRUVICA under the Agreement. Under the Agreement, Excess Amounts would become payable only after the third profitable calendar quarter for IMBRUVICA, from the Company's share of pre-tax commercial profits (if any) commencing in the fourth quarter of profitability under the Agreement until the Excess amounts and applicable interest has been fully repaid. For the three and six months ended June 30, 2014, the Company's total share of IMBRUVICA related net costs under the Agreement did not exceed the $50.0 million annual cap provided for in the Agreement. As such, no Excess Amounts were recorded for the three and six months ended June 30, 2014.
For the three and six months ended June 30, 2014, Janssen's 50% share of U.S. net product revenue less cost of goods sold of IMBRUVICA, which was included in costs of collaboration in the Company's condensed consolidated statements of operations, was calculated as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Product revenue, net
$
109,495

 
$

 
$
165,674

 
$

Less: Cost of goods sold
9,305

 

 
15,415

 


100,190

 

 
150,259

 

Janssen's share of U.S. pre-tax commercial profits
50
%
 
50
%
 
50
%
 
50
%
Total cost of collaboration (Janssen's 50% share as per the Agreement)
$
50,095

 
$

 
$
75,130

 
$

Pharmacyclics' 50% share of U.S. net product revenue less cost of goods sold
$
50,095

 
$

 
$
75,130

 
$

As of June 30, 2014, the Company had $3.9 million receivable from Janssen which primarily was related to material and product sales. As of December 31, 2013, the Company had $50.2 million receivable from Janssen related to Excess Amounts and $1.6 million due from Janssen related to value added taxes. The receivable from Janssen is included within receivable from collaboration partners on the condensed consolidated balance sheets.
As of June 30, 2014, the Company had $43.4 million payable to Janssen which primarily consisted of amounts due for Janssen's share of pre-tax commercial profits and R&D cost share. As of December 31, 2013, the Company had $3.1 million payable to Janssen under the cost sharing arrangement and $0.2 million due to Janssen related to value added taxes. The payable to Janssen is included within payable to collaboration partner on the condensed consolidated balance sheets.
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 the Company reaches a third

14


profitable calendar quarter for IMBRUVICA. Further, Excess Amounts shall be reimbursable only from the Company's share of pre-tax commercial profits (if any) after the third profitable calendar quarter for IMBRUVICA.
Collaboration and License Agreement with Servier
In April 2009, the Company entered into a collaboration and license agreement with Servier to research, develop and commercialize abexinostat (PCI-24781), an orally active, novel, small molecule inhibitor of pan-HDAC enzymes. Under the terms of the agreement, Servier acquired the exclusive right to develop and commercialize the pan-HDAC inhibitor product worldwide except for the United States and will pay development and regulatory milestones and a royalty to the Company on sales outside of the United States. Servier is solely responsible for conducting and paying for all development activities outside the United States. The Company continues to own all rights within the United States.
In May 2009, the Company received an upfront payment from Servier of $11.0 million ($10.5 million net of withholding taxes) and the Company received an additional $4.0 million for research collaboration paid over a period of twenty-four months through April 2011. The revenue related to these payments was recognized over the period of two-years, which ended in April 2011.
Under this agreement with Servier, the Company is also eligible to receive up to $24.5 million in milestone payments upon achievement of pre-specified events; including up to $10.5 million for the achievement of development milestones ($7.0 million of which was paid to the Company, in advance, during April 2011), up to $5.0 million for the achievement of regulatory progress and up to $9.0 million for regulatory approval of the pan HDAC product in major jurisdictions. In addition, Servier agreed to make royalty payments on net sales of the licensed product as defined in the agreement. In October 2011, the milestone related to the $7.0 million advance payment was achieved and the Company recognized the amount as revenue.
Total revenue recognized with respect to the Company's collaboration and license agreement with Servier consisted of the following (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Collaboration services revenue
$
30

 
$
54

 
$
93

 
$
101

License agreement with Novo Nordisk A/S
In October 2012, the Company entered into a license agreement with Novo Nordisk A/S (Novo Nordisk). Under the terms of the agreement, Novo Nordisk acquired the exclusive worldwide rights for the Company's small molecule Factor VIIa inhibitor, PCI-27483 as an excipient in a product containing a Novo Nordisk active pharmaceutical ingredient for a restricted disease indication outside of oncology. Novo Nordisk will utilize PCI-27483 as an excipient in a product within Novo Nordisk's biopharmaceutical unit. Novo Nordisk is solely responsible for all further research and development activities within the restricted disease indication outside of oncology.
In connection with entering into the license agreement with Novo Nordisk, the Company received an upfront payment of $5.0 million in October 2012. In addition, the Company may receive up to $55.0 million based on the achievement of certain development, regulatory and sales milestones. Upon commercialization, the Company will also receive low single digit tiered royalties on Novo Nordisk's net sales of biopharmaceutical formulations utilizing the addition of PCI-27483.
On June 28, 2013, the Company entered into an amended and restated license agreement with Novo Nordisk to expand the scope of the license granted by the Company to Novo Nordisk in October 2012. Under the amended and restated license agreement with Novo Nordisk, the Company has no additional obligations related to the delivery of the license.
Celera Corporation
In April 2006, the Company 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). Future milestone payments under the agreement, as amended, could total as much as approximately $97.0 million, although the Company currently cannot predict if or when any of the milestones will be achieved. Approximately two-thirds of the milestone payments relate to the Company's HDAC inhibitor program and approximately one-third relates to the Company's Factor VIIa inhibitor program. Approximately 90% of the potential future milestone payments would be paid to Celera after obtaining regulatory approval in various countries. To date, no milestone payments have been triggered related to the Company's HDAC inhibitor or Factor VIIa programs.

15


In addition to the milestone payments, the Company is required to make single-digit royalty payments based on annual sales of IMBRUVICA and would be required to make single-digit royalty payments based on annual sales of drugs commercialized from the Company's HDAC inhibitor, Factor VIIa inhibitor and certain other BTK inhibitor programs. For the three and six months ended June 30, 2014, the Company recognized royalty expense under the Celera agreement of approximately $6.9 million and $10.9 million, respectively, on net product sales of IMBRUVICA in the United States. Royalty expense related to net product sales of IMBRUVICA is included within cost of goods sold in the condensed consolidated statement of operations. No royalty expense was recognized under the Celera agreement for the three and six months ended June 30, 2013.
For any BTK inhibitor product or Factor VIIa inhibitor product obtained from Celera, the agreement with Celera expires on a product-by-product and country-by-country basis. The term of the agreement for a given BTK inhibitor product or Factor VIIa inhibitor product shall expire in a given country upon the expiration of the last-to-expire Celera patent assigned to the Company that covers the manufacture, use, sale, offer for sale, or importation of such product in such country. For any HDAC inhibitor product obtained from Celera, the agreement with Celera expires on a product-by-product and country-by-country basis. The term of the agreement for a given HDAC inhibitor product shall expire in a given country upon the expiration of the last-to-expire Celera patent assigned to the Company that covers the sale of such product in such country.
The Company may terminate the agreement with Celera in its entirety, or with respect to one or more of the three classes of products (BTK inhibitor products, HDAC inhibitor products and Factor VIIa inhibitor products) obtained from Celera, at any time by giving Celera at least 60 days' prior written notice. If the Company terminates the agreement with respect to a particular class of products, ownership of the Celera intellectual property assigned to the Company relating to the products in the terminated product class will revert to Celera. If the Company terminates the agreement in its entirety, ownership of all of the Celera intellectual property assigned to the Company will revert to Celera.
The agreement with Celera may be terminated effective immediately upon a party's written notice to the other party for a breach by the other party that remains uncured for 90 days after notice of the breach is given to the breaching party. If the Company breaches the agreement only with respect to one or two of the three classes of products obtained from Celera, but not with respect to all three classes of products, and if the Company's breach remains uncured for 90 days after the Company has received notice of breach from Celera, Celera may terminate the agreement solely with respect to the class or classes of products affected by the Company's breach, but may not terminate the agreement with respect to the class or classes of products unaffected by the Company's breach.
Note 4 - Inventory
Inventories consist of raw materials, work-in-process and finished goods related to the production of IMBRUVICA. Raw materials include IMBRUVICA active pharmaceutical ingredient (API). Work-in-process includes third-party manufacturing and associated labor costs relating to the Company’s personnel involved in the production process. Included in inventories are raw materials and work-in-process that may be used as clinical products, which are charged to research and development expense when the product enters the research and development process.
The components of inventory are as follows (in thousands):
 
June 30,
 
December 31,
 
2014
 
2013
Raw materials
$
8,002

 
$
8,007

Work-in-process
26,276

 
3,489

Finished goods
4,023

 
1,107

 
$
38,301

 
$
12,603

The Company records cash advances that it pays prior to the receipt of inventory as advances to manufacturers in the condensed consolidated balance sheets. The cash advances may be forfeited if the Company terminates the scheduled production. The Company expects the carrying value of the advances to manufacturers to be fully realized.
Note 5 – Fair Value Measurements and Marketable Securities
The Company's marketable securities are classified as “available-for-sale.” The Company includes these investments in current assets and carries them at fair value. Unrealized gains and losses on available-for-sale securities are included in accumulated other comprehensive loss. The amortized cost of debt securities is adjusted for the amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income in the condensed consolidated statements of

16


operations. Gains and losses on securities sold are recorded based on the specific identification method and are included in other income (expense), net in the condensed consolidated statements of operations. The Company records all investment purchases and sales based on the trade date.
Management assesses whether declines in the fair value of marketable securities are other than temporary. If the decline is judged to be other than temporary, the cost basis of the individual security is written down to fair value and the amount of the write down is included in the statement of operations. In determining whether a decline is other than temporary, management considers various factors including the length of time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer and the Company's intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value. To date, the Company has not recorded any impairment charges on marketable securities related to other-than-temporary declines in market value.
The fair value of the Company's financial assets and liabilities is determined by using three levels of input which are defined as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities. At June 30, 2014, the Company's Level 1 assets were comprised of U.S. treasury securities and money market funds.
Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company's short-term investments primarily utilize broker quotes in markets with infrequent transactions for valuation of these securities. At June 30, 2014, the Company's Level 2 assets were comprised of U.S. agency securities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. At June 30, 2014, the Company did not hold any Level 3 assets.
The Company utilizes the market approach to measure fair value for its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
The following is a summary of the Company's available-for-sale securities at June 30, 2014 and December 31, 2013, respectively (in thousands):
As of June 30, 2014
 
Amortized Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
U.S. agency securities – FDIC insured
 
$
11,720

 
$

 
$
(16
)
 
$
11,704

Total marketable securities
 
$
11,720

 
$

 
$
(16
)
 
$
11,704

As of December 31, 2013
 
Amortized Cost
 
Unrealized Gain
 
Unrealized Loss
 
Estimated Fair Value
U.S. agency securities – FDIC insured
 
$
11,680

 
$

 
$
(8
)
 
$
11,672

Total marketable securities
 
$
11,680

 
$

 
$
(8
)
 
$
11,672

At June 30, 2014, the Company's marketable securities had the following remaining contractual maturities (in thousands):
 
Amortized Cost
 
Estimated Fair Value
Less than one year
$
11,720

 
$
11,704

The following table sets forth the basis of fair value measurements for the Company's cash equivalents and available-for-sale securities as of June 30, 2014 and December 31, 2013 (in thousands):

17


 
June 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Fair value
Cash equivalents:
 
 
 
 
 
 
 
U.S. treasury bills
$
381,039

 
$

 
$

 
$
381,039

Money market funds
62,422

 

 

 
62,422

U.S. agency securities - FDIC insured

 
240

 

 
240

Marketable securities:
 
 
 
 
 
 
 
U.S. agency securities - FDIC insured

 
11,704

 

 
11,704

 
$
443,461

 
$
11,944

 
$

 
$
455,405

 
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Fair value
Cash equivalents:
 
 
 
 
 
 
 
U.S. treasury bills
$
269,488

 
$

 
$

 
$
269,488

Money market funds
129,193

 

 

 
129,193

U.S. agency securities - FDIC insured

 
240

 

 
240

Marketable securities:
 
 
 
 
 
 
 
U.S. agency securities - FDIC insured

 
11,672

 

 
11,672

 
$
398,681

 
$
11,912

 
$

 
$
410,593


Note 6 – Balance Sheet Components
Property and equipment, net, consists of the following (in thousands):
 
June 30,
2014
 
December 31,
2013
Equipment
$
12,695

 
$
11,827

Leasehold improvements
5,528

 
5,493

Furniture and fixtures
1,278

 
1,278

Construction in progress
20,548

 
14,592

 
40,049

 
33,190

Less: Accumulated depreciation and amortization
(9,559
)
 
(7,719
)
 
$
30,490

 
$
25,471

Accrued liabilities consist of the following (in thousands):

18


 
June 30,
2014
 
December 31,
2013
Accrued clinical related
$
17,610

 
$
17,062

Accrued payroll and employee related expenses
16,171

 
20,500

Accrued inventory
1,765

 
7,592

Accrued discounts and rebates
7,841

 
905

Accrued contract manufacturing
1,584

 
1,556

Accrued royalty
7,529

 
949

Accrued outside services
3,725

 
5,077

Accrued property and equipment purchases
1,117

 
4,039

Accrued value added taxes
19

 
7,041

Accrued other
7,816

 
6,467

 
$
65,177

 
$
71,188

Deferred revenue consists of the following (in thousands):
Current portion:
June 30,
 
December 31,
 
2014
 
2013
Deferred revenue related to the Agreement (see Note 3)
$
12,095

 
$
7,505

Deferred revenue from sales to collaboration partner
3,070

 
76

 
$
15,165

 
$
7,581

 
 
 
 
 
 
 
 
Non-current portion:
June 30,
 
December 31,
 
2014
 
2013
Deferred revenue related to the Agreement (see Note 3)
$
41,716

 
$
52,025

Note 7 – Intangible Assets
On April 15, 2014, the Company entered into an agreement with a third party to acquire technology assets in the amount of $9.3 million in cash. The Company expects to amortize the technology assets over an estimated life of 13 years. Amortization expense was $0.2 million and $0.2 million for each of the three and six months ended June 30, 2014. Accumulated amortization as of June 30, 2014 was $0.2 million.
The following table presents the Company's estimate of amortization expense for the remainder of 2014 and the succeeding five fiscal years (in thousands):
Fiscal Year
 
Future Amortization of Intangible Assets
2014 (remaining six months)
 
$
364

2015
 
728

2016
 
728

2017
 
728

2018
 
728

2019
 
728

Thereafter
 
5,092

Total
 
$
9,096


Note 8 – Income Taxes

19


The income tax provision includes U.S. federal, state and local, and foreign income taxes and is based on the application of a forecasted annual income tax rate applied to the year-to-date pre-tax income (loss). In determining the estimated annual effective income tax rate, the Company analyzes various factors including projections of its annual earnings, the tax jurisdictions in which the earnings will be generated, the impact of state and local income taxes, its ability to use tax credits and net operating loss carryforwards and available tax planning alternatives. Discrete items including the effect of changes in tax laws, tax rates and certain circumstances with respect to valuation allowances or other unusual or non-recurring tax adjustments are reflected in the period in which they occur.
For the three months ended June 30, 2014, the Company recorded an income tax benefit of $0.2 million, compared to an income tax benefit of $0.3 million for the three months ended June 30, 2013. For the six months ended June 30, 2014, the Company recorded an income tax benefit of $0.2 million, compared to an income tax benefit of $1.3 million for the six months ended June 30, 2013. 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 the Company's full valuation allowance position and also based on the Company's 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.
The Company recorded a valuation allowance against all of its net deferred tax assets at both June 30, 2014 and December 31, 2013. The Company intends to continue maintaining a full valuation allowance on its deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. However, considering the Company's current assessment of income from potential future sales of IMBRUVICA, there is a reasonable possibility that, within the next year, sufficient positive evidence may become available to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. As such, the Company may release a significant portion of its valuation allowance against its deferred tax assets within the next 12 months. This release would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period such release is recorded.
The total amount of the unrecognized tax benefits if recognized would be an adjustment to the amount of deferred tax assets reported. The Company may from time to time be assessed interest or penalties by major tax jurisdictions, although there have been no material assessments. In the event the Company receives an assessment for interest and/or penalties, it would be classified in the financial statements as income tax expense. As of June 30, 2014, all tax years in the U.S. remain open due to the taxing authorities' ability to adjust operating loss carry forwards. The Company does not expect any material changes to the unrecognized tax benefits reported above during the next 12 months. The Company is unable to make a reasonable estimate as to when cash settlements with the relevant taxing authorities will occur.
During the year ended December 31, 2013, the Company was notified by the Internal Revenue Service (IRS) that it will be audited for the tax years ended June 30, 2012 and 2011. As of June 30, 2014, no adjustments have been proposed by the IRS.
Note 9 – Commitments and Contingencies
Facilities Lease
As of June 30, 2014, the Company leases 132,176 square feet for its corporate headquarters in Sunnyvale, California. Of this total space, 79,776 square feet are leased under an operating lease that expires in November 2017, with an option to extend the lease term for an additional five years. The remaining 52,400 square feet, of which 32,000 square feet represents additional space that the Company exercised an option to lease during the year ended December 31, 2013, is leased under an operating lease which expires in February 2023, which provides for an option to early terminate the lease in 2018 and an option to extend the lease term for an additional five years. In addition, the Company leases approximately 8,000 square feet for its Pharmacyclics Switzerland GmbH office under an agreement that expires in May 2015. During the year ended December 31, 2013, the Company entered into an agreement to lease 7,000 square feet of office space in South San Francisco, California under an operating lease which expires in September 2014.
The Company recognizes rental expense on the facilities on a straight-line basis over the lease term. Differences between the straight line rent expense and rent payments are classified as deferred rent liability on the balance sheet. As of June 30, 2014, the Company's future minimum lease payments under non-cancelable operating leases are as follows (in thousands):

20


Fiscal year
Operating Lease Commitments
2014 (remaining six months)
$
1,228

2015
2,204

2016
2,161

2017
2,112

2018
857

2019
882

Thereafter
2,890

Total
$
12,334

Purchase Commitments
The Company had non-cancelable purchase obligations for approximately $21.7 million and $34.8 million as of June 30, 2014 and December 31, 2013, respectively.
Excess Amounts under collaboration and license agreement with Janssen
The Company's worldwide collaboration and license agreement with Janssen provides the Company with an annual cap of its 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 the Company reaches a third profitable calendar quarter for IMBRUVICA (see Note 3). Janssen may recoup the Excess Amounts, together with interest from the Company's 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.
Legal Proceedings
The Company may be involved, from time to time, in legal proceedings and claims arising in the ordinary course of its business. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. The Company accrues amounts, to the extent they can be reasonably estimated, that it believes are adequate to address any liabilities related to legal proceedings and other loss contingencies that the Company believes will result in a probable loss. While there can be no assurances as to the ultimate outcome of any legal proceeding or other loss contingency involving the Company, management does not believe any pending matter will be resolved in a manner that would have a material adverse effect on the Company’s condensed consolidated financial position, results of operations or cash flows.

Note 10 - Basic and Diluted Net Income (Loss) Per Share
Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, including performance-based stock options and restricted stock units for which performance criteria have been achieved, restricted stock units with time-based vesting and shares to be purchased under the employee stock purchase plan. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per common share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company's common stock can result in a greater dilutive effect from potentially dilutive securities.
The computations of basic and diluted net income (loss) per share are as follows (in thousands, except per share amounts): 

21


 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
(37,057
)
 
$
12,351

 
$
(18,782
)
 
$
(39,560
)
Denominator:
 

 
 

 
 
 
 
Weighted average common shares - basic
75,139

 
72,953

 
74,947

 
71,948

Effect of dilutive securities:
 
 
 

 
 
 
 
Employee stock options

 
4,173

 

 

Employee stock purchase plan

 
68

 

 

Restricted stock units

 

 

 

Weighted average common shares - diluted
75,139

 
77,194

 
74,947

 
71,948

Net income (loss) per share:
 

 
 

 
 
 
 
Basic
$
(0.49
)
 
$
0.17

 
$
(0.25
)
 
$
(0.55
)
Diluted
$
(0.49
)
 
$
0.16

 
$
(0.25
)
 
$
(0.55
)
Potentially dilutive securities excluded from net income (loss) per share - diluted because their effect is anti-dilutive
4,428

 
650

 
4,556

 
5,988


Note 11 - Stock-Based Compensation and Stockholders’ Equity
Common Stock
In March 2013, the Company sold 2.2 million shares of its 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.
Stock Plans
At the Company's annual meeting of stockholders on May 8, 2014, the Company's stockholders approved the 2014 Equity Incentive Award Plan (2014 Plan). The 2014 Plan replaced the Company's expiring 2004 Equity Incentive Award Plan (2004 Plan). The 2014 Plan provides for the issuance of various forms of awards including among others, incentive and non-qualified stock options and restricted stock units.
Stock-based compensation expense recognized in the condensed consolidated statements of operations was as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Cost of goods sold
$
174

 
$

 
$
591

 
$

Research and development
8,215

 
3,760

 
13,750

 
14,940

Selling, general and administrative
8,802

 
3,101

 
15,836

 
15,499

Total stock-based compensation
$
17,191

 
$
6,861

 
$
30,177

 
$
30,439

The following table summarizes the Company's stock option activity for the six months ended June 30, 2014 (in thousands, except per share amounts):

22


 
Number
of
Shares
 
Weighted
Average
Exercise
Price per Share
Balance at December 31, 2013
5,111

 
$
23.54

Exercised
(1,046
)
 
8.50

Granted
921

 
85.67

Forfeited
(173
)
 
54.00

Balance at June 30, 2014
4,813

 
$
37.60


The following table summarizes all of the Company's restricted stock unit activity for the six months ended June 30, 2014 (in thousands, except per share amounts):
 
Shares
 
Weighted Average Grant Date Fair Value
Balance at December 31, 2013

 
$

Granted
127

 
110.52

Forfeited
(1
)
 
133.21

Balance at June 30, 2014
126

 
$
110.41

The accounting grant date for employee stock options and restricted stock units with performance obligations is the date on which the performance goals have been defined and a mutual understanding of the terms has been reached. The Company's time-based stock option awards and restricted stock units typically vest over a four-year period subject to the employee’s continued service. The Company's performance-based stock options and performance-based restricted stock units granted to executive officers typically vest over a four-year period and five-year period, respectively, subject to the satisfaction of performance criteria established annually for such executive as determined by the Compensation Committee after reviewing the performance reports. The tables above exclude 0.8 million performance stock options and less than 0.1 million performance based restricted stock units granted in current and prior fiscal years for which the performance criteria had not been established as of June 30, 2014.
 At June 30, 2014, 2.0 million shares were available for grant under the Company's 2014 Equity Incentive Award Plan.
Sales under the ESPP for the six months ended June 30, 2014 and 2013 were approximately 0.1 million shares and 0.1 million shares at an average price of $80.39 and $17.79, respectively. Shares available for future purchase under the ESPP were 0.5 million at June 30, 2014.
Additional paid-in capital increased by $43.8 million during the six months ended June 30, 2014 as a result of stock-based compensation of $30.8 million and the issuance of common stock upon exercise of stock options of $13.0 million.
Note 12 – 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 the Company's 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 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,

23


2013. The adoption of ASU 2013-11 did not have a material impact on the Company's 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. The Company is currently evaluating the impact of the adoption of this accounting standard on its 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. The Company is currently evaluating the impact of the adoption of this accounting standard update on its consolidated financial statements.
Note 13 – Subsequent Events
On July 28, 2014, the Company announced that the FDA granted IMBRUVICA regular (full) approval for the treatment of patients with CLL 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 naive and previously treated del 17p CLL patients. This approval of IMBRUVICA triggered $60.0 million of milestone payments to the Company under its collaboration agreement with Janssen Biotech Inc. The Company will recognize this milestone as revenue during the three months ending September 30, 2014.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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 (CLL)
 
treatment naive and in 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 Inhibitor
 
Autoimmune and anti-inflammatory disease
 
Non-clinical testing, Phase I
Abexinostat HDAC Inhibitor (PCI-24781)
 
Relapsed/refractory lymphomas and solid tumors
 
Multiple trials (Phase I, II)
Factor VIIa Inhibitor (PCI-27483)
 
Cancer
 
Phase II complete
(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.

24


"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


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


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


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


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 chemo‑immunotherapy. 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


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


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


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


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,
Program
 
Description
 
Phase of Development
 
2014
 
2013
 
2014
 
2013
BTK Inhibitors
 
Cancer
 
Phase I/II/III
 
$
26,492

 
$
34,896

 
$
47,760

 
$
53,192

BTK Inhibitors
 
Autoimmune
 
Non-clinical, 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


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