In addition to historical information, this report contains predictions, estimates, assumptions and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from any future performance suggested in this report as a result of the risks, uncertainties and other factors described herein and elsewhere in this report, including those discussed in "Risk Factors."

Company Overview

We are a clinical-stage biopharmaceutical company focused on developing and commercializing innovative small-molecule drugs for the treatment of immune mediated disease and cancer. Our purpose is to create a profitable company by generating income from products we develop, license and commercialize, either with one or several potential collaborators/partners or alone as may best forward the economic interest of our stakeholders. We endeavor to create novel, patentable, differentiated products that have the potential to significantly improve the standard of care in the markets we serve.

Presently, we have four product candidates in clinical development and two product candidates in pre-clinical development. It is our business strategy to establish collaborations with large pharmaceutical and biotechnology companies for the purpose of generating present and future income in exchange for adding to their product pipelines. In addition, we strive to generate collaborations that allow us to retain valuable territorial rights and simultaneously fast forward the clinical development and commercialization of our products.

It is our intention to identify product candidates based on exceptional scientific and development expertise, develop them in a rapid, cost-effective manner, and then seek development and/or commercialization partners. We are committed to high standards of ethics, scientific rigor, and operational efficiency as we move each of these programs to viable commercialization.

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 anticipate the generation of any product commercial revenues until we receive the necessary regulatory and marketing approvals to launch one of our products.

We have incurred significant operating losses since our inception in 1991, and as of June 30, 2009 have an accumulated deficit of approximately $362.9 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, or partner collaborations, generate 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, to successfully complete the development of our products, obtain required regulatory approvals and successfully manufacture and market our products.

In preclinical models, we have identified synergy of PCI-24781 with several approved cancer therapeutics, and some of these combinations will be tested in the clinic, including the sarcoma trial due to begin before the end of calendar year 2009. This trial will also test the novel biomarker RAD51 that we have developed in collaboration with scientists at Stanford University, which may be useful as predictive biomarker in clinical testing by improving patient selection. We are also continuing the development of our first-in-class HDAC8 selective inhibitor for the potential treatment of cancer and autoimmune diseases by optimizing the pharmacokinetics, metabolic stability and in-vivo efficacy of the lead compounds.

In April 2009, the company entered into a collaboration agreement with Servier pursuant to which Pharmacyclics granted to Servier an exclusive license for its Pan-HDAC inhibitors, including PCI-24781, for territories throughout the world excluding the United States. 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 a royalty to Pharmacyclics on sales outside of the United States. Pharmacyclics will continue to own all rights within the United States. Servier has committed significant resources to the clinical development of PCI-24781, with two Phase I trials in lymphoma and solid tumors due to commence in Europe in the last quarter of this year.

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 block the growth of tumors that express TF.

We have completed our initial Phase I testing of PCI-27483 in healthy volunteers. The primary objective of the ascending dose Phase I study was to assess the

A multicenter Phase I/II study is planned to begin in the fourth quarter of calendar 2009. The target patient population is locally advanced and metastatic pancreatic cancer within two months of diagnosis either receiving or planned to receive gemcitabine therapy. The goals will be to; a) assess the safety of PCI-27483 at pharmacologically active dose levels; b) to assess potential survival benefit and c) obtain initial information of the effects on the incidence of thromboembolic events.

PCI-32765 is an orally active small molecule inhibitor of Bruton's tyrosine kinase (Btk) that is being developed by Pharmacyclics for the treatment of patients with B-cell lymphoma. Btk plays a prominent role in B-cell lymphocyte maturation by mediating B-cell receptor (BCR) signal transduction. In the human genetic immunodeficiency disease X-linked agammaglobulinemia, mutation of the gene that encodes the Btk protein results in reduced BCR signaling and a failure to generate mature B-cells. Recent studies indicate that some large B-cell lymphomas have activation of the kinases downstream of the BCR and that inhibition of this signaling can induce apoptosis. Primary follicular lymphoma cells have also been found to maintain enhanced signaling from the BCR as compared to normal B cells. In preclinical models, inhibition of Btk by PCI-32765 led to apoptosis in multiple B-cell lymphoma cell lines, and inhibited B-cell lymphoma progression in vivo.

PCI-32765 also blocks B-cell activation and inhibits autoantibody production in vivo. Rheumatoid arthritis (RA) and lupus are two chronic inflammatory diseases characterized by polyclonal B-cell activation and the production of autoantibodies. By selectively inhibiting Btk, PCI-32765 has demonstrated a dose-dependent ability to inhibit disease development in RA and lupus in animal models. In the collagen-induced arthritis mouse model for example, oral administration of PCI-32765 led to a regression of established disease. Btk is also required for signaling in mast cells and basophils, which are involved in allergic inflammation. The activation of mast cells and basophils leads to the release of histamine and other mediators that lead to allergic symptoms, and thus Btk inhibition may also be effective in allergy and other mast cell-mediated diseases. PCI-32765 potently inhibits histamine release from human basophils and orally dosed PCI-32765 blocks mast cell release in vivo in mouse studies.

A multicenter U.S. Phase I trial in B-cell lymphoma is currently enrolling patients. We have developed a proprietary molecular probe that we are using as a biomarker to optimize our treatment regimen in our Phase I trial. The Phase I trial is designed to determine the safety and tolerability of a 28-day dosing regimen and to evaluate effects on pharmacodynamic assays and tumor response.

MGd, is a radiation and chemotherapy sensitizing agent with a novel mechanism of action. MGd is designed to accumulate selectively in cancer cells. Once inside cancer

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 capability, 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.

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

We recognize revenue in accordance with SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition. SAB No. 104 requires that certain criteria must be met before revenue can be recognized: persuasive evidence of an arrangement exists; delivery has

Up-front payments under agreements which include future performance requirements are recorded as deferred revenue and are recognized over the performance period. The performance period is estimated at the inception of the arrangement and is reevaluated at each reporting period. The reevaluation of the performance period may shorten or lengthen the period during which the deferred revenue is recognized. Revenues related to substantive, at-risk collaboration milestones are recognized upon achievement of the event specified in the underlying agreement. Revenues for research activities are recognized as the related research efforts are performed.

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.

Our cost accruals for clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with 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 agreements are subject to negotiation and vary from contract to contract and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events, the successful enrollment of patients, the completion of portions of the clinical trial or similar conditions. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. As such, expense accruals related to clinical trials are recognized based on our estimate of the degree of completion of the event or events specified in the specific clinical study or trial contract.

Share-Based Compensation

We adopted SFAS 123R, Share-Based Payments, effective beginning July 1, 2005 using the modified prospective application transition method. The modified prospective application transition method requires that companies recognize compensation expense on new share-based payment awards and existing share-based payment awards that are modified, repurchased, or cancelled after the effective date. Additionally, compensation cost of the portion of awards of which the requisite service has not been rendered that are outstanding as of the July 1, 2005 has been expensed as the requisite service was rendered.

The fair value of each stock option is estimated on the date of grant using the Black-Scholes valuation model. Expected volatility is based on historical volatility data of the company's stock. The expected term of stock options granted is based on historical data and represents the period of time that stock options are expected to be outstanding. The expected term is calculated for and applied to one group of stock options as the company does not expect substantially different exercise or post-vesting termination behavior among its employee population. The risk-free interest rate is based on a zero-coupon United States Treasury bond whose maturity period equals the expected term of the company's options.

In November 2007, the EITF issued a consensus, EITF 07-1, Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property, which is focused on how the parties to a collaborative agreement should account for costs incurred and revenue generated on sales to third parties, how sharing payments pursuant to a collaboration agreement should be presented in the income statement and certain related disclosure questions. EITF 07-1 is to be applied retrospectively for collaboration arrangements in fiscal years beginning after December 15, 2008. The company does not expect the adoption of EITF 07-1 to have a material impact on its results of operations or financial position.

In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157" ("FSP 157-2"), to partially defer FASB Statement No. 157, "Fair Value Measurements" ("SFAS 157"). FSP 157-2 defers the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The company adopted SFAS No. 157 for valuation and disclosures of its financial assets and liabilities in the first quarter of fiscal 2009 and is currently evaluating the impact of adopting the provisions of FSP 157-2.

In April 2009, the FASB issued FSP No. 115-2 and 124-2 (FSP No. 115-2), Recognition and Presentation of Other-Than- Temporary Impairments. FSP No. 115-2 amends the other-than-temporary impairment guidance in U.S. generally accepted accounting principles (GAAP) for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in financial statements. FSP No. 115-2 is effective for periods ending after June 15, 2009. The adoption of FSP No. 115-2 did not have a material impact on the company's financial statements.

In April 2009, the FASB issued FSP No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That are Not Orderly. FSP No. 157-4 provides additional guidance

In April 2009, the FASB issued FSP SFAS 107-1 and Accounting Principles Board ("APB") No. 28-1 ("FSP SFAS 107-1 and APB 28-1"), "Interim Disclosures about Fair Value of Financial Instruments." FSP SFAS 107-1 and APB 28-1 enhance consistency in financial reporting by increasing the frequency of fair value disclosures to a quarterly instead of annual basis for any financial instruments that are not currently reflected on the balance sheet at fair value. FSP SFAS 107-1 and APB 28-1 are effective for financial statements issued for interim and annual periods ending after June 15, 2009. The adoption of FSP SFAS 107-1 and APB 28-1 did not have a material impact on the company's financial statements.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 establishes general standards of accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this statement sets forth: the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS No. 165 is effective for periods ending after June 15, 2009.

Results of Operations

Revenues

The following table summarizes the period over period changes in our revenue
over the last three fiscal years:

                                2009   Change     2008   Change       2007
                                ----   ------     ----   ------     --------
Grant and contract revenues   $  -         0%   $   -     -100%   $ 126,000

Revenues in fiscal year 2007 was the result of a federal grant awarded by the National Institutes of Health (NIH). Work under this grant was completed in fiscal year 2007.

Research and Development Expenses

The following table summarizes the period over period changes in our research
and development (R&D) expenses over the last three fiscal years:

                      2009       Change        2008       Change        2007
                   -----------   ------     -----------   ------     -----------
R & D expenses   $ 13,954,000      -23%   $ 18,180,000      -14%   $ 21,115,000

R&D expenses in fiscal 2009 decreased by $4,226,000 compared to fiscal 2008 primarily due to a decrease of $1,736,000 in personnel costs due to lower headcount and a

R&D expenses in fiscal 2008 decreased by $2,935,000 compared to fiscal 2007 primarily due to a decrease of $3,656,000 in personnel costs due to lower headcount, a decrease in share-based compensation of $821,000 and a reduction in consulting costs of $539,000 partially offset by increases of $2,146,000 in drug manufacturing costs and $710,000 in outside preclinical costs associated with our HDAC, Btk and Factor VIIa programs.

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. Prior to 1999, we did not track our historical research and development costs 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
                                                                           Years ended June 30,
                                                               ---------------------------------------------
                                                  Estimated
                                     Phase of     Completion
Product      Description            Development    of Phase         2009            2008            2007
----------   --------------------   -----------   ----------     -----------     -----------     -----------
HDAC
Inhibitors   Cancer/autoimmune      Phase I/II     Unknown     $  3,731,000    $  3,429,000    $  2,547,000

Factor
VIIa
Inhibitor    Cancer                   Phase I      Unknown        1,475,000       2,349,000         919,000

Btk
Inhibitors   Cancer/autoimmune        Phase I      Unknown        3,075,000       3,402,000       1,150,000

MGd          Cancer                  Phase II      Unknown          964,000       2,413,000       7,680,000

. . .