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 June 30, 2008 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on September 5, 2008.

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 in Part II, Item IA, "Risk Factors", and elsewhere in this report, in the company's Annual Report on Form 10-K for the fiscal year ended June 30, 2008 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.

Overview

Pharmacyclics is a pharmaceutical company leveraging our expertise in small-molecule chemistry and drug development to develop therapeutic products in oncology and immune mediated diseases based on novel targets, pathways, and mechanisms. Our pharmaceutical agents are synthetic small molecules designed to target key biochemical pathways in diseased cells. Our late stage product candidate, motexafin gadolinium (MGd, formerly Xcytrin®) has completed Phase 3 trials in patients with

To date, substantially all of our resources have been dedicated to the research and development of our products, and we have not generated any commercial revenues from the sale of our products. We do not expect to generate any product revenues until we receive the necessary regulatory and marketing approvals and launch one of our products, if at all.

We have incurred significant operating losses since our inception in 1991, and as of September 30, 2008, had an accumulated deficit of approximately $346.0 million. The process of developing and commercializing our products requires significant research and development, preclinical testing and clinical trials, manufacturing arrangements as well as regulatory and marketing approvals. These activities, together with our general and administrative expenses, are expected to result in significant operating losses until the commercialization of our products generates sufficient revenues to cover our expenses. We expect that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. Our achieving profitability depends upon our ability, alone or with others, to successfully complete the development of our products under development, obtain required regulatory approvals and successfully manufacture and market our products.

MGd is an anti-cancer agent with a novel mechanism of action. MGd is designed to accumulate selectively in cancer cells. Once inside cancer cells, MGd induces apoptosis (programmed cell death) by inhibiting thioredoxin reductase and disrupting redox-dependent pathways. We believe MGd has the potential to be used for treating many types of cancer either as a stand-alone agent or in combination with other treatments such as chemotherapy, targeted therapy or radiation therapy. MGd is also detectable by magnetic resonance imaging (MRI) and may allow for more precise tumor detection.

In the previously conducted pivotal SMART trial, (Study of Neurologic Progression with Motexafin Gadolinium and Radiation Therapy), investigators found that patients given MGd in addition to whole brain radiation therapy (WBRT) had a median time to neurologic progession of 15.4 months, compared to 10.0 months for patients who received only WBRT (p=0.12, hazard ratio=0.78), a trend in favor of MGd. In the U.S. (N=185) where WBRT was delivered more promptly, the median time to neurologic progression was increased from 8.7 months for patients treated with WBRT alone compared to 24.2 months for patients receiving WBRT plus MGd (P=0.0048, hazard ratio=0.392). We subsequently concluded that prompt delivery of radiation therapy, as typically given in the U.S., is an important factor in treatment effect. The percentage of U.S. patients who received MGd within four weeks of brain metastases diagnosis was 92% compared to France where only 44% of patients received such prompt treatment. In December 2006, we submitted a New Drug Application (NDA) to the Food and Drug Administration (FDA) for the use of MGd in combination with radiation therapy for the treatment of patients with brain metastases from NSCLC. In December 2007, we announced that the FDA determined that our NDA was non-approvable which will require us, among other things, to conduct additional clinical studies and submit that data before the FDA will approve MGd for marketing. We have also completed a Phase 2 clinical trial of MGd plus stereotactic radiosurgery for the treatment of brain metastases. The results, presented at the 2007 Annual Meeting of the American Society of Clinical Oncology indicated that MGd may improve the efficacy of stereotactic radiosurgery by providing more accurate magnetic resonance imagining (MRI) treatment-planning and better defining the treatment field in patients with brain metastases from solid tumors. MGd allowed physicians to identify occult brain metastases in 24% of patients that were missed with standard MRI contrast agents and were amenable to stereotactic radiosurgery.

Based on the results of these two trials, we are planning to conduct another Phase 3 pivotal trial for the use of MGd in combination with WBRT for the treatment of patients with brain metastases from NSCLC. Currently, MGd is under evaluation in multicenter studies sponsored by the NCI, a Phase 2 trial in adults with newly diagnosed glioblastoma and a Phase 2 trial in children with brain stem gliomas. The FDA has also designated MGd as an orphan drug for the treatment of brain metastases arising from solid tumors.

PCI-24781 is a histone deacetylase (HDAC) inhibitor that is now in a Phase 1 trial in patients with advanced relapsed solid tumors and a Phase 1/2 trial in patients with recurrent lymphomas. PCI-24781 targets histone deacetylase (HDAC) enzymes and inhibits their function. HDAC enzymes are required for control of gene expression and inhibition of these enzymes leads to tumor cell cytotoxicity. To date, clinical trials have demonstrated that PCI-24781 is well-absorbed following oral administration and causes inhibition of the target enzyme. Published laboratory studies done in collaboration with scientists at Stanford University have identified a novel biomarker that may optimize clinical testing by improving patient selection.

PCI-27483 is a small molecule inhibitor of Factor VIIa. This drug selectively inhibits Factor VIIa when it is complexed with a protein called tissue factor (TF). In cancer, the Factor VIIa:TF complex is found in abundance in pancreatic, gastric, colon and other tumors, and triggers a host of physiologic processes that facilitate tumor angiogenesis, growth and invasion. The Factor VIIa:TF complex is thought to be the cause of the increased propensity to develop thromboses seen in cancer patients. Laboratory studies and animal models indicate that inhibitors of Factor VIIa may block tumor growth and metastases. We are enrolling patients in a Phase 1 trial in normal volunteers, designed to assess safety and activity against the target protein. We believe that PCI-27483 may be useful for treating the thrombotic complications of cancer and also as an anti-cancer agent.

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 a U.S. commercial oncology franchise, obtain market acceptance and, in many cases, obtain adequate coverage of and reimbursement for our products from government and private insurers. We cannot provide assurance that we will generate revenues or achieve and sustain profitability in the future.

Results of Operations

Research and Development


                                        Three Months ended
                                            September 30,
                                      -----------------------    Percent
                                          2008        2007        change
------------------------------------  ----------- -----------  ------------
Research and development expenses     $3,203,000  $5,240,000       -39%

The decrease of 39% or $2,037,000 in research and development expenses for the three months ended September 30, 2008 as compared to the three months ended September 30, 2007 was primarily due to a decrease of $594,000 in personnel costs due to lower headcount and a decrease of $672,000 in drug manufacturing costs and a decrease of $579,000 in outside preclinical costs associated with our HDAC, Btk and Factor VIIa programs.

We expect research and development expenses in our fiscal second quarter to increase slightly as compared to our fiscal first quarter.

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 device development 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. The information in the column labeled "Estimated Completion of Phase" is only our estimate of the timing of completion of the current in-process development phase. The actual timing of completion of those phases could differ materially from the estimates provided in the

Prior to fiscal 1999, we did not track our research and development expenses by specific program and for this reason we cannot accurately estimate our total historical costs on a specific program basis. Direct costs by program and indirect costs are as follows:

                                                                                     Related R&D Expenses
                                                                                      Three Months ended
                                                                                         September 30,
                                                                                    -----------------------
                                                                        Estimated
                                                     Phase of          Completion
Program                  Description                Development         of Phase        2008        2007
--------------- ----------------------------- ----------------------- ------------- ----------- -----------
MGd             Cancer                        Phase 3                 Unknown       $  231,000  $  977,000

HDAC Inhibitors Cancer                        Phase 1/2               Unknown          510,000     909,000

Btk Inhibitors  Cancer                        Phase 1                 Unknown          886,000     595,000

Factor VIIa     Cancer                        Phase 1                 Fiscal 2009      344,000   1,071,000
                                                                                    ----------- ----------

                Total direct costs.................................................  1,971,000   3,552,000
                Indirect costs.....................................................  1,232,000   1,688,000
                                                                                    ----------- ----------
                Total research and
                   development expenses............................................ $3,203,000  $5,240,000
                                                                                    =========== ==========

General and Administrative


                                         Three Months ended
                                            September 30,
                                      -----------------------    Percent
                                          2008        2007        change
------------------------------------  ----------- -----------  ------------

General and administrative expenses   $3,439,000  $2,067,000       66%

The increase of 66% or $1,372,000 in general and administrative expenses for the three months ended September 30, 2008 as compared to the three months ended September 30, 2007 was primarily due to severance expenses including stock compensation expense of $1,394,000 and $536,000 of cash-based severance expenses associated with separation agreements entered into with the company's CEO and CFO in September 2008, partially offset by lower personnel costs of $170,000 due to lower headcount and a reduction of $263,000 in consulting expenses.

Under the CFO's separation agreement, our CFO resigned his position as of October 31, 2008. We therefore expect to record stock compensation expense of approximately $400,000 and $200,000 of cash-based severance expenses in our fiscal second quarter associated with our CFO's separation agreement. We also expect general and administrative expenses in our fiscal second quarter to be lower by approximately $1,300,000 as compared to our first fiscal quarter as all of the expense associated with the CEO's separation agreement were recorded in the company's first fiscal quarter.

Interest and Other, Net


                                         Three Months ended
                                            September 30,
                                      -----------------------    Percent
                                          2008        2007        change
------------------------------------  ----------- -----------  ------------

Interest and other, net               $  100,000  $  477,000       -79%

The decrease of 79% or $377,000 in interest and other, net for the three months ended September 30, 2008 as compared to the three months ended September 30, 2007 was due to lower investment balances and lower average interest rates. Our cash equivalents and marketable securities consist primarily of fixed rate instruments.

Liquidity and Capital Resources

Our principal sources of working capital have been private and public equity financings and proceeds from collaborative research and development agreements, as well as interest income.

As of September 30, 2008, we had approximately $12,467,000 in cash, cash equivalents and marketable securities. Net cash used in operating activities of $4,276,000 during the three months ended September 30, 2008, resulted primarily from our net loss, net of depreciation and amortization, share-based compensation expense and an increase in accrued liabilities.

Net cash used in investing activities of $1,196,000 in the three months ended September 30, 2008 consisted primarily purchases of marketable securities, partially offset by maturities and sales of marketable securities.

Net cash provided by financing activities was $0 in the three months ended September 30, 2008.

In November 2006, we completed a public offering of common stock and sold 4,830,000 shares of common stock at a price of $4.75 per share for net proceeds of approximately $21,300,000. In February 2007, we filed a registration statement on Form S-3 to offer and sell, from time to time, equity, debt securities and warrants in one or more offerings up to a total dollar amount of $100 million. We may seek to raise funds through additional public offerings in the future but cannot guarantee that such efforts will be successful.

Our future contractual obligations at September 30, 2008 are as follows:

                                          Operating
                                            Lease
                                         Commitments
                                       ---------------
Remaining 9 months of fiscal 2009 ..   $      687,000
Fiscal 2010.........................          763,000
Fiscal 2011 ........................          644,000
Fiscal 2012.........................          330,000
                                       ---------------
     Total .........................   $    2,424,000
                                       ===============

In April 2006, we acquired multiple small molecule drug candidates for the treatment of cancer and other diseases from Celera Genomics, an Applera Corporation (now Celera Corporation) business. Future milestone payments under the agreement, as amended, could total as much as $104 million, although we currently cannot predict if or when any of the milestones will be achieved. In addition, Celera will also be entitled to royalty payments in the mid- to high single digits based on annual sales of any drugs commercialized from these programs.

Based upon the current status of our product development plans, we believe that our existing cash, cash equivalents and marketable securities will be adequate to satisfy our capital needs through at least the next six months. We expect research and development expenses, as a result of on-going and future clinical trials, to consume a large portion of our existing cash resources. Changes in our research and development plans or other changes affecting our operating expenses may affect actual

º our ability to establish and the scope of any new collaborations;

º the progress and success of clinical trials of our product candidates; and

º the costs and timing of obtaining regulatory approvals.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. The factors described above will impact our future capital requirements and the adequacy of our available funds. If we are required to raise additional funds, we cannot be certain that such additional funding will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be highly dilutive, or otherwise disadvantageous, to existing stockholders and debt financing, if available, may involve restrictive covenants. Collaborative arrangements, if necessary to raise additional funds, may require us to relinquish rights to certain of our technologies, products or marketing territories. Our failure to raise capital when needed and on acceptable terms, would require us to reduce our operating expenses and would limit our ability to respond to competitive pressures or unanticipated requirements to develop our product candidates and to continue operations, any of which would have a material adverse effect on our business, financial condition and results of operations.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies, Estimates and Judgments

This discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. On an on-going basis, we evaluate our estimates, including those related to revenue recognition and clinical trial accruals. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results, however, may differ significantly from these estimates under different assumptions or conditions and may adversely affect the financial statements.

We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our financial statements and accompanying notes.

Revenue Recognition

Revenues are recognized when persuasive evidence of an arrangement exists, title has transferred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. License revenue is typically recognized over the term of the arrangement and milestone revenue is recognized when earned as evidenced by achievement of the specified milestone and the absence of any on-going obligation. License, milestone, contract and grant revenues are not subject to repayment. Any amounts received in advance of performance are recorded as deferred revenues.

We maintain investment portfolio holdings of various issuers, types and maturities. We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. At September 30, 2008, all other investment securities are classified as available-for-sale and consequently are recorded on the balance sheet at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income (loss) within stockholders' equity. Management assesses whether declines in the fair value of investment securities are other than temporary. If the decline in fair value 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 the following factors:

º Length of the time and the extent to which the market value has been less than cost;

º The financial condition and near-term prospects of the issuer; and

º Our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.

To date we have had no declines in fair value that have been identified as other than temporary.

Research and Development Expenses and Accruals

Research and development expenses include personnel and facility-related expenses, outside contracted services including clinical trial costs, manufacturing and process development costs, research costs and other consulting services. Research and development costs are expensed as incurred. In instances where we enter into agreements with third parties for clinical trials, manufacturing and process development, research and other consulting activities, costs are expensed upon the earlier of when non-refundable amounts are due or as services are performed. Amounts due under such arrangements may be either fixed fee or fee for service, and may include upfront payments, monthly payments, and payments upon the completion of milestones or receipt of deliverables.

Our cost accruals for clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with numerous clinical trial centers and clinical research organizations. In the normal course of business we contract with third parties to perform various clinical trial activities in the on-going development of potential products. The financial terms of these . . .