1. Why is Pharmacyclics considering an equity issue in March 2000? Why $60 million?

What factor
should Dr. Richard Miller consider in deciding whether to raise equity?

(a) Pharmacyclics considers an equity issue in March 2000 because:

The cost of the Phase clinical trial of Xcytrin
Fund-raising not only enabled PCYC to spend a lot of expenses for the phase clinical trial of
Xcytrin but also have the resources to develop its atherosclerosis drugs without licensing
them.
The high stock price at the end of February 2000
On Friday, February 25, 2000, PCYC closed at $78.75. The stock price was pretty high
compared to the prior prices, which means that it was a good moment for fund-raising. In
addition, PCYC was listed as a hot stock to watch on February 16, 2000, which would appeal
to more investors.
A demand for PCYC shares
There was a demand for a private placement of PCYC shares from four financial institutions
that had received small allocations of PCYC stock in its last public offering.

(b) The equity needs to be $60 million is based on the Pharmacyclics Income Statements, we can
know that the total net loss of PCYC from 1992 to 2000 was about $76 million. As a result, there
was a financial deficit in Pharmacyclics, and PCYC had to increase $60 million to cover the loss.

(c) Dr. Millers decision mainly depend on two factors.

Funding needs
In the past, Miller had retained a large fraction of the firm by delaying funding. However,
there are two purpose of funding in this case. To begin with, funding would provide a cushion
for the completion of the Phase Xcytrin trial. Second, it could be used to push the
development of Antrin forward without bringing on a partner.
Valuation
PCYC stock was always high in the past. However, Miller thought that the market price
incorporated a substantial probability that Xcytrin would not successfully complete the FDA
approval process.
2. What is your forecast after-tax cashflows for PCYC through 2002 assuming Xcytrin and Lutrin are
approved? How would you forecast change if the drugs were not approved?

(1)if Xcytrin and Lutrin both are approved

Xcytrin 2002 2003 2004 2005
Used rate(U.S) 2% 17% 26% 40%
Revenue=170,000*used rate *10,000 34,000,000 289,000,000 442,000,000 680,000,000
Cost=170,000*used rate*2,000 6,800,000 57,800,000 88,400,000 136,000,000
SG&A 35,000,000 53,000,000 62,000,000 62,000,000
R&D expenses 38,000,000 44,000,000 54,500,000
Profits in U.S (45,800,000) 134,200,000 237,100,000 482,000,000

Used rate(Oversea) 5% 15% 25%

Revenues=170,000*used rate*10,000 85,000,000 255,000,000 425,000,000
Profits in Oversea=revenues*0.3 25,500,000 76,500,000 127,500,000
Total Xcytrin profit (45,800,000) 159,700,000 313,600,000 609,500,000
Lutrin 2002 2003 2004 2005
Expected pre-tax income 3,000,000 9,000,000 20,000,000

Total pre-tax profits (42,800,000) 168,700,000 333,600,000 609,500,000

After-tax profits (35%) (42,800,000) 109,655,000 216,840,000 396,175,000

(2)if Xcytrin and Lutrin both are not approved

Xcytrin 2002 2003 2004 2005
Used rate
Revenue

Cost 6,800,000 57,800,000 88,400,000 136,000,000

SG&A 35,000,000 53,000,000 62,000,000 62,000,000
R&D expenses 38,000,000 44,000,000 54,500,000
Loss (79,800,000) (154,800,000) (204,900,000) (198,000,000 )
 (3)if Xcytrin is approved, but Lutrin is not approved
Xcytrin 2002 2003 2004 2005
Used rate(U.S) 2% 17% 26% 40%
Revenue=170,000*used rate *10,000 34,000,000 289,000,000 442,000,000 680,000,000
Cost=170,000*used rate*2,000 6,800,000 57,800,000 88,400,000 136,000,000
SG&A 35,000,000 53,000,000 62,000,000 62,000,000
R&D expenses 38,000,000 44,000,000 54,500,000
Profits in U.S (45,800,000) 134,200,000 237,100,000 482,000,000

Used rate(Oversea) 5% 15% 25%

Revenues=170,000*used rate*10,000 85,000,000 255,000,000 425,000,000
Profits in Oversea=revenues*0.3 25,500,000 76,500,000 127,500,000
Total Xcytrin profit (45,800,000) 159,700,000 313,600,000 609,500,000
After-tax profits (35%) (45,800,000) 103,805,000 203,840,000 396,175,000

(4)if Lutrin is approved, but Xcytrin is not approved

Lutrin 2002 2003 2004 2005
Expected pre-tax income 3,000,000 9,000,000 20,000,000
SG&A 35,000,000 53,000,000 62,000,000 62,000,000
R&D expenses 38,000,000 44,000,000 54,500,000
Total Lutrin profit (70,000,000) (88,000,000) (96,500,000) (62,000,000)
After-tax profits (35%) (70,000,000) (88,000,000) (96,500,000) (62,000,000)

3. Compare these cash flows to PCYCs liquid assets (cash and investments that can be easily converted
to cash). As of March 2000, how many future years of funding does PCYC have?

year 2000 2001 2002 2003 2004 2005

Cash & cash 61,164,000
equivalents
short-term 45,329,000
investment
liquid assets 106,493,000
operating expenses (32,500,000) (57,500,000)
after-tax income (42,800,000) 109,655,000 216,840,000 396,175,000
available funds 73,993,000 16,493,000 (26,307,000) (83,348,000) (300,188,000) (696,363,000)

Conclusion:
As we can see the available funds will be negative in 2002.
As a result, the liquid asset can cover the cash outflow until 2001.
4. What finding strategy is apparent in PCYCs pre-IPO financing? Why would the managers of PCYC
want to follow this strategy? Would its investors also want PCYC to follow this strategy?

Pre-IPO:
According to Exhibit 2, PCYC raised a total of $2.7M in convertible preferred stock from venture
capitalists Asset Management, Kleiner, Perkins, Caufield &Byers, and Venrock Associates by Associates
by April 1992. In December 1992, PCYC raised $7.7M from four venture firms. The company raised a
third round of $7.6M in June 1994 and a final 1994 mezzanine round of $5.6M in July 1995.
Apparently, PCYC adopted the strategy of issuing convertible preferred stock. Though preferred
stock may not have a fixed liquidation valuation associated with it. Also, because in the U.S. dividends
on preferred stock are not tax-deductible at the corporate level (in contrast to interest expense), the
effective cost of capital raised by preferred stock is 35 percent greater than issuing the equivalent
amount of debt at the same interest rate.

After-IPO:
But overall, managers followed the strategy because of below 3 advantages:

No obligation for dividendsA company is not bound to pay a dividend on preference shares if

its profits in a particular year are insufficient.

No interferenceGenerally, preference shares do not carry voting rights. Therefore, a

company can raise capital without dilution of control. Equity shareholders retain exclusive
control over the company.
Trading on equity: The rate of dividend on preference shares is fixed. Therefore, with the rise
in its earnings, the company can provide the benefits of trading on equity to the equity
shareholders.
One main reason that its investors want PCYC to follow this strategy is because they want to
participate in the rise of growth companies while being insulated from a drop in price should
the stocks not live up to expectations. Also, there are income-tax advantages generally
available to corporations investing in preferred stocks in the United States. Therefore,
whether individual or corporate investors would support PCYCs strategy.
5. Forecast after-tax cash flows for PCYC through the expiration of the four drug patents. Use a tax rate
of 35% and the following additional assumptions in your analysis:
a. For Lutrin: 50% probability of FDA approval in 2002
b. For Antrin: 30% probability of FDA approval in 2004. If Antrin is approved by the FDA, its
contribution to pre-tax income would be $191 million in FY05 and peak at $281 million in FY06
c. For Optrin: 30% probability of FDA approval in 2004. Id Optrin is approved by the FDA, its
contribution to pre-tax income would be $25 million in FY05, $40 million in FY06, and peak at $50
million in FY07.
d. For all drugs: Patent protection for these drugs ends ten years after FDA approval. Upon patent
expiration, analysts expected revenue to fall at a perpetual rate of 20% per year (for example, if
revenue is $1.00 prior to patent expiration, the pattern of revenues after patent expiration is
forecast at $0.80, $0.64, $0.51, etc.)
 year 2002 2003 2004 2005 2006 2007 2008
used rate(domestic) 2% 17% 26% 40% 40% 39% 38%
Xcytrin(50%),revenue 34,000,000 289,000,000 442,000,000 680,000,000 680,000,000 663,000,000 646,000,000
cost(domestic) 6,800,000 57,800,000 88,400,000 136,000,000 136,000,000 132,600,000 129,200,000
used rate(foreign) 5% 15% 25% 25% 24% 23%
Xcytrin(50%),revenue 85,000,000 255,000,000 425,000,000 425,000,000 408,000,000 391,000,000
cost(foreign) 17,000,000 51,000,000 85,000,000 85,000,000 81,600,000 78,200,000
Xcytrin(50%),total revenue 34,000,000 374,000,000 697,000,000 1,105,000,000 1,105,000,000 1,071,000,000 1,037,000,000
Xcytrin(50%),COGS 6,800,000 74,800,000 139,400,000 221,000,000 221,000,000 214,200,000 207,400,000
Xcytrin(50%),gross profit 27,200,000 299,200,000 557,600,000 884,000,000 884,000,000 856,800,000 829,600,000

Lutrin(50%),profits 3,000,000 9,000,000 20,000,000 19,800,000 19,602,000 19,405,980 19,211,920

Antrin(30%),profits 19,100,000 28,100,000 27,819,000 27,540,810
Optrin(30%),profits 25,000,000 40,000,000 50,000,000 49,500,000
total profit 30,200,000 308,200,000 577,600,000 947,900,000 971,702,000 954,024,980 925,852,730
R&D expenses 38,000,000 44,000,000 54,500,000 - - - -
SG&A 35,000,000 53,000,000 62,000,000 62,000,000 63,860,000 65,775,800 67,749,074
after-tax profit (27,820,000) 137,280,000 299,715,000 575,835,000 590,097,300 577,361,967 557,767,377
 year 2002 2003 2004 2005 2006 2007 2008
used rate(domestic) 37% 36% 35% 28% 22% 18% 14%
Xcytrin(50%),revenue 629,000,000 612,000,000 595,000,000 476,000,000 380,800,000 304,640,000 243,712,000
cost(domestic) 125,800,000 122,400,000 119,000,000 95,200,000 76,160,000 60,928,000 48,742,400
used rate(foreign) 22% 21% 20% 19% 15% 12% 10%
Xcytrin(50%),revenue 374,000,000 357,000,000 340,000,000 323,000,000 258,400,000 206,720,000 165,376,000
cost(foreign) 74,800,000 71,400,000 68,000,000 64,600,000 51,680,000 41,344,000 33,075,200
Xcytrin(50%),total revenue 1,003,000,000 969,000,000 935,000,000 799,000,000 639,200,000 511,360,000 409,088,000
Xcytrin(50%),COGS 200,600,000 193,800,000 187,000,000 159,800,000 127,840,000 102,272,000 81,817,600
Xcytrin(50%),gross profit 802,400,000 775,200,000 748,000,000 639,200,000 511,360,000 409,088,000 327,270,400

Lutrin(50%),profits 19,019,801 18,829,603 18,641,307 14,913,046 11,930,436 9,544,349 7,635,479

Antrin(30%),profits 27,265,402 26,992,748 26,722,820 26,455,592 26,191,036 25,929,126 20,743,301
Optrin(30%),profits 49,005,000 48,514,950 48,029,801 47,549,502 47,074,007 46,603,267 37,282,614
total profit 897,690,203 869,537,301 841,393,928 728,118,140 596,555,480 491,164,742 392,931,794
R&D expenses - - - - - - -
SG&A 69,781,546 71,874,993 74,031,242 76,252,180 78,539,745 80,895,937 83,322,816
after-tax profit 538,140,627 518,480,500 498,785,746 423,712,874 336,710,228 266,674,723 201,245,836