**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-Q**
| **x** | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|------------|---------------------------------------------------------------------------------------------------------|

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006.**

**OR**
| **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

**FOR THE TRANSITION PERIOD FROM          TO          **

**CommissionFile Number 0-29889**

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**RigelPharmaceuticals, Inc.**

(Exact name of registrant as specified in its charter)

| **Delaware**                                                      |   | **94-3248524**                        |
|-------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or   organization) |   | (I.R.S. Employer  Identification No.) |
|                                                              |   |                                  |
| **1180  Veterans Blvd.  South San Francisco, CA**                 |   | **94080**                             |
| (Address of  principal executive offices)                         |   | (Zip Code)                            |
|                                                              |   |                                  |
| **(650) 624-1100**                                           |   | ** **                            |
| (Registrant’s  telephone number, including area code)        |   |                                  |

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  x  No  o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act) (Check one):
| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes  o  No  x

As ofNovember 2, 2006, there were 25,091,811 shares of the registrant’s common stockoutstanding.

 

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**RIGEL PHARMACEUTICALS, INC.****QUARTERLYREPORT ON FORM 10-QFOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006**

**INDEX**
| **PART I**  | ** ** | **FINANCIAL  INFORMATION**                                                                          | ** ** | **3**  |
|------------------|------------|-----------------------------------------------------------------------------------------------------|------------|--------|
| **Item  1.**     |       | Financial  Statements (unaudited)                                                                   |       | 3      |
|             |       | Balance  Sheets - September 30, 2006 and December 31, 2005                                     |       | 3      |
|             |       | Condensed  Statements of Operations – three and nine months ended September 30, 2006 and  2005 |       | 4      |
|             |       | Condensed  Statements of Cash Flows - nine months ended September 30, 2006 and 2005            |       | 5      |
|             |       | Notes  to Condensed Financial Statements                                                            |       | 6      |
|             |       | Report  of Independent Registered Public Accounting Firm                                            |       | 14     |
| **Item 2.**      |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations         |       | 15     |
| **Item 3.**      |       | Quantitative  and Qualitative Disclosures About Market Risk                                         |       | 23     |
| **Item  4.**     |       | Controls  and Procedures                                                                            |       | 23     |
| **PART II** | ** ** | **OTHER  INFORMATION**                                                                              | ** ** | **24** |
| **Item 1A.**     |       | Risk Factors                                                                                        |       | 24     |
| **Item 2.**      |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                        |       | 33     |
| **Item 6.**      |       | Exhibits                                                                                            |       | 33     |
|             |       |                                                                                                |       |   |
| **Signatures**   |       |                                                                                                |       | 34     |

 

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**PART I  FINANCIAL INFORMATION**

**Item 1.****    Financial Statements**

**RIGELPHARMACEUTICALS, INC.****BALANCESHEETS(in thousands, except shareamounts)**
| ** **                                                                                                                                                                               | ** ** | **September 30,  2006** | ** ** | **December 31,   2005(1)** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **(unaudited)**              | ** ** |
| **Assets**                                                                                                                                                                               | ** ** | ** **                   | ** ** | ** **                           | ** ** |
| Current assets:                                                                                                                                                                          |       |                         |       |                                 |       |
| Cash and cash  equivalents                                                                                                                                                               |       | $                            | 55,421     |                                 | $          | 76,779 |   |
| Available-for-sale  securities                                                                                                                                                           |       | 59,591                       |       | 61,417                               |       |
| Accounts  receivable                                                                                                                                                                     |       | 1,050                        |       | 1,050                                |       |
| Other  receivables                                                                                                                                                                       |       | 702                          |       | 777                                  |       |
| Prepaid expenses  and other current assets                                                                                                                                               |       | 2,158                        |       | 2,573                                |       |
| Total current  assets                                                                                                                                                                    |       | 118,922                      |       | 142,596                              |       |
|                                                                                                                                                                                     |       |                         |       |                                 |       |
| Property and equipment,  net                                                                                                                                                             |       | 3,163                        |       | 3,457                                |       |
| Other assets                                                                                                                                                                             |       | 2,289                        |       | 1,615                                |       |
|                                                                                                                                                                                     |       | $                            | 124,374    |                                 | $          | 147,668 |   |
|                                                                                                                                                                                     |       |                         |       |                                 |       |
| Liabilities and  stockholders’ equity                                                                                                                                               |       |                         |       |                                 |       |
| Current liabilities:                                                                                                                                                                     |       |                         |       |                                 |       |
| Accounts payable                                                                                                                                                                         |       | $                            | 1,452      |                                 | $          | 2,497 |   |
| Accrued  compensation                                                                                                                                                                    |       | 1,772                        |       | 2,189                                |       |
| Other accrued liabilities                                                                                                                                                                |       | 1,091                        |       | 2,324                                |       |
| Deferred revenue                                                                                                                                                                         |       | 5,143                        |       | 15,567                               |       |
| Capital lease  obligations                                                                                                                                                               |       | 1,278                        |       | 1,070                                |       |
| Total current  liabilities                                                                                                                                                               |       | 10,736                       |       | 23,647                               |       |
|                                                                                                                                                                                     |       |                         |       |                                 |       |
| Long-term portion of  capital lease obligations                                                                                                                                          |       | 1,298                        |       | 1,132                                |       |
| Long-term portion of  deferred revenue                                                                                                                                                   |       | —                       |       | 2,771                                |       |
| Long-term portion of  deferred rent                                                                                                                                                      |       | 12,535                       |       | 11,121                               |       |
| Other long-term  liabilities                                                                                                                                                             |       | 374                          |       | 409                                  |       |
|                                                                                                                                                                                     |       |                         |       |                                 |       |
| Commitments                                                                                                                                                                              |       |                         |       |                                 |       |
|                                                                                                                                                                                     |       |                         |       |                                 |       |
| Stockholders’ equity:                                                                                                                                                               |       |                         |       |                                 |       |
| Common stock,  $0.001 par value; 100,000,000 shares authorized; 25,073,387 and 24,814,671 shares  issued and outstanding on September 30, 2006 and December 31, 2005,  respectively |       | 25                           |       | 25                                   |       |
| Additional  paid-in capital                                                                                                                                                              |       | 379,105                      |       | 366,203                              |       |
| Deferred stock  compensation                                                                                                                                                             |       | —                       |       | (26                                  | )          |
| Accumulated  other comprehensive gain (loss)                                                                                                                                             |       | 4                            |       | (92                                  | )          |
| Accumulated  deficit                                                                                                                                                                     |       | (279,703                     | )          | (257,522                             | )          |
| Total stockholders’  equity                                                                                                                                                         |       | 99,431                       |       | 108,588                              |       |
|                                                                                                                                                                                     |       | $                            | 124,374    |                                 | $          | 147,668 |   |

 

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Note (1)     Thebalance sheet at December 31, 2005 has been derived from the auditedfinancial statements at that date included in Rigel’s Annual Report on Form 10-Kfor the year ended December 31, 2005.

See accompanying notes.

3

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**RIGELPHARMACEUTICALS, INC.****CONDENSEDSTATEMENTS OF OPERATIONS(in thousands, except per share amounts)****(unaudited)**
| ** **                                                                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Contract  revenues from collaborations                                                  |       | $                                                    | 6,127      |                                                | $          | 3,282 |   | $ | 30,345 |   | $ | 10,506 |   |
| Costs and  expenses:                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Research and development                                                                |       | 14,050                                               |       | 13,676                                              |       | 41,966 |   | 38,656 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| General and administrative                                                              |       | 4,804                                                |       | 3,383                                               |       | 14,532 |   | 9,686 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
|                                                                                    |       | 18,854                                               |       | 17,059                                              |       | 56,498 |   | 48,342 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from  operations                                                                   |       | (12,727                                              | )          | (13,777                                             | )          | (26,153 | ) | (37,836 | ) |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Interest income                                                                         |       | 1,447                                                |       | 935                                                 |       | 4,287 |   | 1,667 |   |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Interest expense                                                                        |       | (102                                                 | )          | (64                                                 | )          | (315 | ) | (194 | ) |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                                                                                |       | $                                                    | (11,382    | )                                                   | $          | (12,906 | ) | $ | (22,181 | ) | $ | (36,363 | ) |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss per  common share, basic and diluted                                           |       | $                                                    | (0.46      | )                                                   | $          | (0.56 | ) | $ | (0.89 | ) | $ | (1.74 | ) |
|                                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average shares  used in computing net loss per common share, basic and diluted |       | 24,987                                               |       | 23,235                                              |       | 24,882 |   | 20,958 |   |

 

See accompanying notes.

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**RIGELPHARMACEUTICALS, INC.****CONDENSED STATEMENTSOF CASH FLOWS****(in thousands)(unaudited**)
| ** **                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **Operating  activities**                                                    |       |                                                |       |   |   |
| Net loss                                                                     |       | $                                                   | (22,181    | ) | $ | (36,363 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                                |       |   |   |
| Depreciation and amortization                                                |       | 989                                                 |       | 683 |   |
| Non-cash stock compensation expense                                          |       | 10,137                                              |       | 138 |   |
| Changes in assets and liabilities:                                           |       |                                                |       |   |   |
| Accounts receivable                                                          |       | —                                              |       | (1,050 | ) |
| Other receivables                                                            |       | 75                                                  |       | 129 |   |
| Prepaid expenses and other current assets                                    |       | 415                                                 |       | (43 | ) |
| Other assets                                                                 |       | 127                                                 |       | 113 |   |
| Accounts payable                                                             |       | (1,045                                              | )          | 793 |   |
| Accrued compensation                                                         |       | (417                                                | )          | (44 | ) |
| Other accrued liabilities                                                    |       | (1,233                                              | )          | 191 |   |
| Deferred revenue                                                             |       | (13,195                                             | )          | 4,900 |   |
| Deferred rent and other long-term liabilities                                |       | 1,379                                               |       | (122 | ) |
|                                                                         |       |                                                |       |   |   |
| Net cash used in operating activities                                        |       | (24,949                                             | )          | (30,675 | ) |
|                                                                         |       |                                                |       |   |   |
| **Investing  activities**                                                    |       |                                                |       |   |   |
| Purchases of available-for-sale securities                                   |       | (53,526                                             | )          | (45,984 | ) |
| Maturities of available-for-sale securities                                  |       | 55,448                                              |       | 70,894 |   |
| Capital expenditures                                                         |       | (695                                                | )          | (533 | ) |
| Net cash provided by investing activities                                    |       | 1,227                                               |       | 24,377 |   |
| ** **                                                                   |       |                                                |       |   |   |
| **Financing  activities**                                                    |       |                                                |       |   |   |
| Proceeds from capital lease financings                                       |       | 1,350                                               |       | 1,191 |   |
| Payments on capital lease obligations                                        |       | (976                                                | )          | (1,291 | ) |
| Net proceeds from issuances of common stock                                  |       | 1,990                                               |       | 87,659 |   |
| Net cash provided by financing activities                                    |       | 2,364                                               |       | 87,559 |   |
|                                                                         |       |                                                |       |   |   |
| Net (decrease)  increase in cash and cash equivalents                        |       | (21,358                                             | )          | 81,261 |   |
| Cash and cash  equivalents at beginning of period                            |       | 76,779                                              |       | 10,495 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                                   | 55,421     |   | $ | 91,756 |   |

 

See accompanying notes.

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**RigelPharmaceuticals, Inc.Notes to Condensed Financial Statements(unaudited)**

In this Quarterly Report, “Rigel,” “we,” “us” and “our”refer to Rigel Pharmaceuticals, Inc.

**1. Natureof Operations**

We were incorporated in the state of Delaware onJune 14, 1996. We are engaged in the discovery and development of novel,small-molecule drugs for the treatment of inflammatory diseases, cancer andviral diseases.

**2. Basisof Presentation**

Our accompanying unaudited condensed financialstatements have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial information and pursuant to theinstructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and notes required bygenerally accepted accounting principles for complete financial statements.These unaudited condensed financial statements include all normal and recurringadjustments that we believe are necessary to fairly state our financialposition and the results of our operations and cash flows. Interim-periodresults are not necessarily indicative of results of operations or cash flowsfor a full-year period. The balance sheet at December 31, 2005 has beenderived from audited financial statements at that date, but does not includeall disclosures required by U.S. generally accepted accounting principles forcomplete financial statements.  Becauseall of the disclosure required by U.S. generally accepted accounting principlesfor complete financial statements are not included herein, these unauditedinterim condensed financial statements and the notes accompanying them shouldbe read in conjunction with our audited financial statements and the notesthereto included in our Annual Report on Form 10-K for the year endedDecember 31, 2005.

The preparation of financial statements in conformitywith U.S. generally accepted accounting principles requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from theseestimates.

Comprehensive net loss did not differ materially fromthe net loss as reported.

**3. Basicand Diluted Net Loss Per Share**

Basic net loss per share was computed by dividing thenet loss for the period by the number of weighted average shares of commonstock outstanding during the period. The calculation of diluted net loss pershare excluded shares of potential common stock, consisting of stock optionsand warrants, because their effect would have been anti-dilutive.

**4. StockAward Plans**

We have two stockoption plans, the 2000 Equity Incentive Plan and 2000 Non-Employee DirectorsStock Option Plan, that provide for granting to our officers, directors and allother employees and consultants options to purchase shares of our common stock.Under the plans, we may issue non-qualified options or incentive stock options.We also have an employee stock purchase plan, or ESPP, where eligible employeescan purchase shares of our common stock at a price per share equal to thelesser of 85% of the fair market value on the first day of the offering period or85% of the fair market value on the purchase date. The benefits provided underthese plans are share-based payments subject to the provisions of Statement ofFinancial Accounting Standards, or SFAS, No. 123(R), “Share-Based Payment(Revised 2004),” or SFAS 123(R), and guidance under the Securities and ExchangeCommission’s Staff Accounting Bulletin 107, or SAB No. 107.

Effective January 1, 2006, we adopted the provisionsof SFAS 123(R) using the modified prospective application transition method.Under this method, the share-based compensation cost recognized beginningJanuary 1, 2006 includes compensation cost for (i) all share-based paymentsgranted prior to, but not vested as of January 1, 2006, based on the grant datefair value originally estimated in accordance with the provisions of SFAS No.123, “Accounting for Stock-Based Compensation,” or SFAS 123, and calculated forpro forma disclosures under SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition and Disclosure,” or SFAS 148, and (ii) all share-based

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payments grantedsubsequent to January 1, 2006, based on the grant date fair value estimated inaccordance with the provisions of SFAS 123(R). Compensation cost under SFAS123(R) for awards granted prior to January 1, 2006 is recognized using anaccelerated method pursuant to the Financial Accounting Standards Board, orFASB, Interpretation No. 28, “Accounting for Stock Appreciation Rights andOther Variable Stock Option or Award Plans,” or FIN 28. For awards grantedafter January 1, 2006, we have adopted the use of the straight-line attributionmethod over the requisite service period for the entire award. Results of priorperiods do not reflect any restated amounts, and we had no cumulative effectadjustment upon adoption of SFAS No. 123(R) under the modified prospectivemethod.

***Impact of the Adoption of SFAS 123(R)***

Total stock-based compensation expense related to allof the Company’s share-based awards that we recognized for the three and ninemonths ended September 30, 2006 and 2005 was comprised as follows (inthousands, except per share amounts):
| ** **                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Research and  development                   |       | $                                                    | 1,734      |                                                | $          | 570 |   | $ | 5,198 |   | $ | 109 |   |
| General and  administrative                 |       | 1,715                                                |       | 214                                                 |       | 4,939 |   | 29 |   |
| Stock-based  compensation expense           |       | $                                                    | 3,449      |                                                | $          | 784 |   | $ | 10,137 |   | $ | 138 |   |
|                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Stock-based  compensation expense per share |       |                                                 |       |                                                |       |   |   |   |   |
| Basic and diluted                           |       | $                                                    | 0.14       |                                                | $          | 0.03 |   | $ | 0.41 |   | $ | 0.01 |   |

 

We recorded approximately $3.4 million in stock-basedcompensation expense for the three months ended September 30, 2006, consistingof approximately $3.4 million in stock-based awards granted to officers, directorsand all other employees from our stock option plans and ESPP and approximately$11,000 from options granted to consultants. We recorded approximately $10.1 million in stock-based compensationexpense for the nine months ended September 30, 2006, consisting ofapproximately $9.9 million in stock-based awards granted to officers, directorsand all other employees from our stock option plans and ESPP and approximately$195,000 from options granted to consultants. Pursuant to SFAS 123(R), we arerequired to estimate the amount of expected forfeitures when calculatingcompensation costs, instead of accounting for forfeitures as incurred, whichwas our previous method. Our annual weighted average forfeiture rate was 7.7%as of September 30, 2006, as compared to 7.6% as of June 30, 2006.  The slight increase was due to employees whoterminated employment in the third quarter of 2006.  We will record actual forfeitures as they occur,and we will review our forfeiture rates each quarter and make changes to ourestimate.

For the three and nine months ended September 30,2006, we recorded stock-based compensation expense of approximately $11,000 and$195,000, respectively, associated with options granted to consultants,reflecting the fair value and periodic fair value remeasurement of outstandingconsultant options under Emerging Issues Task Force No. 96-18, “Accounting forEquity Instruments That are Issued to Other Than Employees for Acquiring, or inConjunction with Selling Goods or Services,” or EITF 96-18.   The valuation is based upon the currentmarket value of our common stock and other assumptions, including the expectedfuture volatility of our stock price, risk-free interest rate and expectedterm. For consultant options granted in 2006, we amortized stock-basedcompensation using a straight-line attribution method consistent with themethod used for employees and with the attribution election we made uponadoption of SFAS 123(R). For options granted prior to January 1, 2006, we usedthe accelerated method for expensing stock-based compensation, which was themethod we used prior to adoption. We recorded stock-based compensation expenseof approximately $139,000 and $24,000 for the three and nine months endedSeptember 30, 2005, respectively, relating to consultant options. We expect tosee continued fluctuations in the future as a portion of these options areremeasured based on the changes in the current market price of our commonstock.

In 2005, werecorded charges associated with the stock options that were eligible forre-pricing under a tender offer initiated in June 2003. All replacementoptions, as well as the eligible options that were not surrendered under theoriginal offer to exchange, were treated for financial reporting purposes as variableawards. Therefore, for

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the period prior toadoption of SFAS 123(R), we recorded a non-cash charge, generally for theintrinsic value of the options as they vested in accordance with AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees,” orAPB 25, utilizing the accelerated vesting method, reflecting increases anddecreases (down to, but not below, the exercise price) in the price of ourcommon stock as compensation expense (recovery) in connection with thereplacement options and the eligible options that were not exchanged. For thethree and nine months ended September 30, 2005, we recorded stock-basedcompensation expense of approximately $633,000 and $82,000, respectively,related to all employee options eligible for replacement options.  The expense resulted from the increase in themarket price of our common stock during the three and nine-month period endedSeptember 30, 2006.   For periods afterthe adoption of SFAS 123(R), we continue to account for the vested portion ofthe options repriced prior to the adoption of SFAS 123(R) in accordance withprovisions of SFAS 123.  In August 2006,our board of directors granted new options to officers, directors and all otheremployees and consultants who held these repriced options that had expired inAugust 2006.  We granted approximately179,000 options with an exercise price of $9.56 per share.  The options vested 50% at the date of thegrant and the remaining 50% will vest monthly over two years.  We recorded stock-based compensation expenseof approximately $616,000 relating to these new options for the three and ninemonths ended September 30 2006.

Under SFAS 123(R), the fair value of each option awardis estimated on the date of grant using the Black-Scholes option pricing model.We have segregated option awards into three homogenous groups (i.e., Officersand Directors, All Other Employees and Consultants) for purposes of determiningfair values of options.

We determinedweighted-average valuation assumptions separately for the groups as follows:

·      Volatility -  We estimated volatility using the historicalshare price performance over the expected life of the option up to the pointwhere we have historical market data. As our publicly listed options are notactively traded, implied volatility was not representative of our currentvolatility. We also considered other factors such as our current clinicaltrials and other company activities that may affect volatility of our stock inthe future but determined that at this time, the historical volatility was moreindicative of our expected future stock performance.

·      Expectedterm - We worked with various data points to determine the most applicableexpected term for each option group. The data points included: (1) expectedterm of the options from option grant date to exercise date; (2) cancellationterm of options from grant date to cancellation date and excluding unvestedoption forfeitures from the determination; and (3) term of options that remainoutstanding from grant date to the end of the reporting period. The analysis ofthe above data points gave us a range of expected terms to consider; however,we also considered the vesting schedules of the options granted and factorssurrounding exercise behavior of our groups, our current market price andcompany activity that may affect our market price. In addition, we alsoconsidered the vesting schedules of the options, the optionee type (i.e.,officers and directors, all other employees and consultants) and other factorsthat may affect the expected term of the option. For options granted toconsultants, we use the contractual term of the option, which is generally tenyears, for the initial valuation of the option and the remaining contractualterm of the option for the succeeding years.

·      Risk-freeinterest rate - The risk-free interest rate is based on U.S. Treasury constantmaturity rates with similar terms to the expected term of the options for eachoption group.

·      Forfeiturerate - We estimated the forfeiture rate using our historical experience withpre-vesting options. Our annual weighted-average forfeiture rate wasapproximately 7.7% as of September 30, 2006, as compared to 7.6% as of June 30,2006.  We review our forfeiture rates eachquarter and make changes as factors affecting our forfeiture rate calculationsand assumptions change.

·      Dividendyield - The expected dividend yield is 0% as we have not paid and do not expectto pay dividends.

The following table summarizes the weighted-averageassumptions relating to our employee options for the three and nine monthsended September 30, 2006 and 2005, as permitted under SFAS 123(R) for 2006 andSFAS 123 for 2005:

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|                           | ** ** | **Stock Option Plans  Three Months Ended  September 30,** | ** ** | **Stock Option Plans  Nine Months Ended  September 30,** | ** ** |
|---------------------------|------------|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                                                           | ** ** | **2005**                                                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Risk-free  interest rate  |       | 4.8                                                                                | %          | 4.1                                                                               | %          | 4.7 | % | 4.1 | % |
| Expected term (in  years) |       | 4.0                                                                                |       | 3.3                                                                               |       | 4.4 |   | 2.9 |   |
| Dividend yield            |       | 0.0                                                                                | %          | 0.0                                                                               | %          | 0.0 | % | 0.0 | % |
| Expected volatility       |       | 90.0                                                                               | %          | 75.0                                                                              | %          | 95.7 | % | 75.0 | % |

 

Option prices are not less than the market price ofour common stock on the date of grant, become exercisable at varying dates andgenerally expire ten years from the date of grant. At September 30, 2006,options to purchase 1,435,173 shares of common stock were available for grantunder our stock option plans.

***EmployeeStock Purchase Plan***

The fair value of awards granted under our ESPP isestimated on the date of grant using the Black-Scholes option pricing model,which uses the weighted-average assumptions set forth in the table below. OurESPP provides for a twenty-four month offering period comprised of foursix-month purchase periods with a look-back option. A look-back option is aprovision in our ESPP where eligible employees can purchase shares of ourcommon stock at a price per share equal to the lesser of 85% of the fair marketvalue on the first day of the offering period or 85% of the fair market valueon the purchase date. The plan also includes a feature whereby a new offeringperiod begins when the fair market value of our common stock on a purchase dateduring an offering falls below the fair market value of our common stock on thefirst day of such offering period. Participants are automatically enrolled in the new offering period.Expected volatilities are based on historical volatility of our stock. Expectedterm represents the purchase periods within our offering period. The risk-freerate for periods within the contractual life of the option is based on U.S.Treasury constant maturity rates. Stock-basedcompensation expense relating to our ESPP is recognized according to the FASBTechnical Bulletin No. 97-1, “Accounting under Statement 123 for CertainEmployee Stock Purchase Plans with a Look-back Option,” or FTB 97-1. As ofSeptember 30, 2006, there were approximately 56,000 shares in reserve forfuture issuance under the ESPP. The following table summarizes theweighted-average assumptions relating to our ESPP for the nine months endedSeptember 30, 2006 and 2005:
|                           | ** ** | **Employee Stock Purchase Plan  Nine Months Ended  September 30,** | ** ** |
|---------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                                                                         | ** ** | **2005** | ** ** |
| Risk-free  interest rate  |       | 4.6                                                                                              | %          | 4.1 | % |
| Expected term (in  years) |       | 1.2                                                                                              |       | 0.5 |   |
| Dividend yield            |       | 0.0                                                                                              | %          | 0.0 | % |
| Expected volatility       |       | 109.9                                                                                            | %          | 88.3 | % |

 

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***Stock-based Compensation Award Activity***

The following tablesummarizes activity under our equity incentive and stock option plans as ofSeptember 30, 2006 (in thousands, except per share amounts):
| ** **                                         | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------------------------|------------|------------|------------|---------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **                                  | ** ** | **(Years)**                                        | ** ** | ** **                          | ** ** |
| Outstanding at  December 31, 2005                  |       | 3,893,219  |       | $                                           | 15.98      |                                               |       |                                |       |   |
| Granted                                            |       | 1,221,592  |       | $                                           | 8.78       |                                               |       |                                |       |   |
| Exercised                                          |       | (176,586   | )          | $                                           | 7.93       |                                               |       |                                |       |   |
| Forfeited/Expired/Cancelled                        |       | (461,931   | )          | $                                           | 14.49      |                                               |       |                                |       |   |
| Outstanding at  September 30, 2006                 |       | 4,476,294  |       | $                                           | 14.49      |                                               | 8.11       |                                | $          | 4,934,064 |   |
| Vested and  expected to vest at September 30, 2006 |       | 4,323,810  |       | $                                           | 14.25      |                                               |       |                                |       |   |
| Exercisable at  September 30, 2006                 |       | 2,488,237  |       | $                                           | 12.90      |                                               | 7.60       |                                | $          | 3,516,754 |   |

 

The aggregate intrinsic value is calculated as thedifference between the exercise price of the underlying awards and the quotedprice of our common stock for the options to acquire 2.3 million shares thatwere in-the-money at September 30, 2006. During the nine months ended September30, 2006 and 2005, the aggregate intrinsic value of options exercised under ourstock option plans were approximately $366,000 and $911,000, respectively,determined as of the date of option exercise. As of September 30, 2006, therewas approximately $12.1 million of total unrecognized compensation cost, net offorfeitures, related to unvested share-based compensation arrangements grantedunder our stock option plans and $618,000 of total unamortized compensationcost related to our ESPP. These costs are expected to be recognized over a weighted-averageperiod of 1.63 years. We also had approximately 2.0 million of unvested stockoptions at September 30, 2006. Future option grants and their valuation willincrease our compensation cost in the future as the options are granted, valuedand expensed ratably according to their vesting periods. The weighted averagegrant-date fair values of options granted in the nine months ended September30, 2006 and 2005 were $6.23 and $10.88, respectively.

***Pro Forma Information under SFAS123 for Periods Prior to Fiscal 2006***

Prior to adopting SFAS 123(R) on January 1, 2006, weaccounted for equity-based employee compensation costs under the recognitionand measurement principles of APB 25. Under APB 25, the intrinsic value methodof accounting, no compensation expense is recognized, because the exerciseprice of our employee stock options equals the market price of the underlyingstock on the date of grant. Pro forma information regarding net loss and netloss per share was determined as if we had accounted for issuances under ourstock option plans and ESPP under the fair value method prescribed bySFAS 123, as amended by SFAS No. 148. The fair value for theseoptions was estimated at the date of grant using the Black-Scholes optionpricing model. See the weighted-average assumptions discussed above.

For purposes of pro forma disclosures, the estimatedfair value of the options was amortized to expense over the vesting period ofthe options prior to adopting SFAS 123(R). Our pro forma information is asfollows (in thousands, except per share amounts):
| ** **                                                                                                                 | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net loss—as  reported:                                                                                                |       | $                                                              | (12,906    | )                                                             | $          | (36,363 | ) |
| Add: Total  stock-based employee compensation expense determined under APB 25                                         |       | 645                                                            |       | 114                                                           |       |
| Deduct: Total  stock-based employee compensation expense determined under under the fair  value based method of all awards |       | (1,962                                                         | )          | (5,824                                                        | )          |
| Pro forma net  loss                                                                                                        |       | $                                                              | (14,223    | )                                                             | $          | (42,073 | ) |
| Basic and  diluted net loss per common share:                                                                              |       |                                                           |       |                                                          |       |
| As reported                                                                                                                |       | $                                                              | (0.56      | )                                                             | $          | (1.74 | ) |
| Pro forma                                                                                                                  |       | $                                                              | (0.61      | )                                                             | $          | (2.01 | ) |

 

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**5.Revenue Recognition**

We recognize revenue from our contract arrangements.Our revenue arrangements with multiple elements are evaluated under EITFNo. 00-21, *“Revenue Arrangements withMultiple Deliverables,”* and are divided into separate units ofaccounting if certain criteria are met, including whether the delivered elementhas stand-alone value to the customer and whether there is objective andreliable evidence of the fair value of the undelivered items. The considerationwe receive is allocated among the separate units based on their respective fairvalues, and the applicable revenue recognition criteria is applied to each ofthe separate units. Advance payments received in excess of amounts earned areclassified as deferred revenue until earned.

Non-refundable, up-front payments received inconnection with research and development collaboration agreements, includingtechnology access fees, are deferred and recognized on a straight-line basisover the relevant periods of continuing involvement, generally the researchterm.  When a research term is notspecified, we estimate the time it will take us to complete our deliverablesunder the contract and recognize the upfront fee using the straight-line methodover that time period.  We review ourestimates every quarter for reasonableness.

Revenue related to collaborative research with ourcorporate collaborators is recognized as research services are performed overthe related development funding periods for each contract. Under theseagreements, we are required to perform research and development activities asspecified in the applicable agreement. The payments received are not refundableand are generally based on a contractual cost per full-time equivalent employeeworking on the project. Research and development expenses under thecollaborative research agreements, except for the Merck collaboration signed inNovember 2004 related to ubiquitin ligases, approximate or exceed therevenue recognized under such agreements over the term of the respectiveagreements. For the Merck collaboration, we are recognizing a pro-rata portionof the invoiced amounts for funding of our research scientists based on theheadcount dedicated to the project. It is our policy to recognize revenue basedon our level of effort expended, and that revenue recognized will not exceedamounts billable under the arrangement.

Revenue associated with at-risk milestones pursuant tocollaborative agreements is recognized based upon the achievement of themilestones as set forth in the applicable agreement.

Royalties will be recognized as earned in accordancewith the contract terms when the third party results are reliably measurableand collectibility is reasonably assured.

**6. Cash,Cash Equivalents and Available-For-Sale Securities**

Cash, cash equivalentsand available-for-sale securities consist of the following (in thousands):
| ** **                     | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Checking account               |       | $                            | 142        |                        | $          | 742 |   |
| Money market  funds            |       | 14,381                       |       | 3,421                       |       |
| Federal agency  securities     |       | 14,723                       |       | 21,067                      |       |
| Corporate bonds  and notes     |       | 85,766                       |       | 112,966                     |       |
|                           |       |                         |       |                        |       |
|                           |       | $                            | 115,012    |                        | $          | 138,196 |   |
|                           |       |                         |       |                        |       |
| Reported as:                   |       |                         |       |                        |       |
| Cash and cash  equivalents     |       | $                            | 55,421     |                        | $          | 76,779 |   |
| Available-for-sale  securities |       | 59,591                       |       | 61,417                      |       |
|                           |       |                         |       |                        |       |
|                           |       | $                            | 115,012    |                        | $          | 138,196 |   |

 

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| **September 30, 2006** | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|----------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| Federal agency  securities       |       | $                   | 14,741     |                         | $          | 2                             |       | $                   | (20        | ) | $ | 14,723 |   |
| Corporate bonds  and note        |       | 44,846              |       | 31                           |       | (9                            | )          | 44,868              |       |
|                             |       |                |       |                         |       |                          |       |                |       |
| Total                            |       | $                   | 59,587     |                         | $          | 33                            |       | $                   | (29        | ) | $ | 59,591 |   |

 
| **December 31, 2005** | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|---------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| Federal agency  securities      |       | $                   | 17,090     |                         | $          | 1                             |       | $                   | (17        | ) | $ | 17,074 |   |
| Corporate bonds  and note       |       | 44,419              |       | 1                            |       | (77                           | )          | 44,343              |       |
|                            |       |                |       |                         |       |                          |       |                |       |
| Total                           |       | 61,509              |       | 2                            |       | (94                           | )          | 61,417              |       |
|                                 |            |                     |            |                              |            |                               |            |                     |            |  |  |  |  |

 

At September 30, 2006, the above debt securities had aweighted average maturity of approximately 114 days.  Two federal agency securities with a fairmarket value of $3.0 million had a maturity greater than 360 days.

The following table shows the gross unrealized lossesand fair values of our investments in individual securities that are in anunrealized loss position, aggregated by investment category (in thousands):
| September 30, 2006 | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
|------------------------------|------------|---------------------|------------|------------------------|------------|
| Federal agency  securities   |       | $                   | 10,241     |                   | $          | (20 | ) |
| Corporate bonds  and notes   |       | 14,155              |       | (9                     | )          |
| Total                        |       | $                   | 24,396     |                   | $          | (29 | ) |

 
| December 31, 2005 | ** ** | **Fair Value** | ** ** | **Unrealized  Losses** | ** ** |
|-----------------------------|------------|---------------------|------------|------------------------|------------|
| Federal agency  securities  |       | $                   | 12,879     |                   | $          | (17 | ) |
| Corporate bonds  and notes  |       | 40,615              |       | (77                    | )          |
|                        |       |                |       |                   |       |
| Total                       |       | $                   | 53,494     |                   | $          | (94 | ) |

 

At September 30, 2006, we had two investments with acombined fair market value of approximately $3.5 million that had been in acontinuous unrealized loss position for more than twelve months.  As of September 30, 2006, this unrealizedloss amount was approximately $2,000.  Wehave not recorded an impairment charge as of September 30, 2006, since we havethe ability and intent to hold these investments to maturity at which time nogain or loss would be recognized.  Bothof these investments will mature by October 31, 2006.  As of December 31, 2005, we had an investmentin corporate bonds and notes with a fair market value of approximately $1.0million that was in a continuous unrealized loss position for more than twelvemonths. During the periods presented, there were no recorded realized gains orlosses on investments.

As of September 30, 2006, a total of 15 individualsecurities were in an unrealized loss position for twelve months or less anddeemed to be temporary. As of December 31, 2005, 34 individual securitieswere in an unrealized loss position for less than twelve months and deemed tobe temporary.

**7. Serono Collaboration**

InOctober 2005, we entered into a collaborative research and licenseagreement with Serono granting it an exclusive license to develop andcommercialize product candidates from our Aurora kinase inhibitor program. Thecollaboration and our efforts under the agreement were focused on R763. We wereresponsible for all costs

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associated with thepreparation and filing of an Investigational New Drug application, or IND, forR763, which we filed in December 2005. Serono is responsible for all development of R763 following regulatoryacceptance of the IND and will bear all costs thereafter. In connection withthis collaboration, Serono paid us an upfront payment of $10.0 million.  In addition, Serono purchased $15.0 millionof our common stock at a premium.

DuringFebruary 2006, we received a payment of $5.0 million in connection withthe regulatory acceptance of the R763 IND in January 2006. We amortizedthe payment on a straight-line basis thru April 2006, when our involvement withthe amended IND was completed.  We will beeligible to receive additional milestone payments, under certain conditions,upon commencement of a Phase I clinical trial for R763, certain other clinicalevents and marketing approval, as well as royalties on any future productsales.

Wewere originally amortizing the $10.0 million upfront payment into revenue overa nine-month period commencing with the initiation of the collaboration inOctober 2005.  This was the period oftime that we originally estimated it would take to perform our deliverablesunder the contract.  When we reevaluatedthis estimate in the second quarter of 2006, we concluded that we had achievedall our deliverables and should therefore recognize all of the remainingunamortized amount. This change in estimate resulted in the recognition ofapproximately $860,000 of revenue in the second quarter of 2006 instead of inthe third quarter of 2006.

InSeptember 2006, we received a $3.0 million milestone payment from Serono inconnection with the initiation of the Phase I study of R763.

**8. Pfizer Collaboration**

InJanuary 2005, we signed a collaborative research and license agreement withPfizer for the development of inhaled products for the treatment of allergicasthma and chronic obstructive pulmonary disease.  The agreement gives Pfizer the exclusiveright to nominate up to two spleen tyrosine kinase, or Syk, inhibitors, undercertain conditions, to commence advanced preclinical development.  Pfizer will have the exclusive right todevelop any nominated compound, and we will earn milestone payments upon theselection of each of the two compounds and other clinical events as well asroyalties on any future product sales. Pfizer is responsible for the manufacture of all preclinical andclinical materials for each compound or product and all costs associated withdevelopment and commercialization.

In May2006, we achieved the first milestone payment when Pfizer nominated R343 tocommence advanced preclinical development in allergic asthma.  Pfizer paid us $5.0 million for the exclusiveright to R343 and will be responsible for all development related to R343 goingforward.

**9. Facility Lease Amendment**

In July 2006, weamended our facility lease in order to defer certain rent payments tooriginally occur in 2006 and 2007.  Thedeferred payments are due to be paid to the landlord over the period startingfrom 2009 to 2012, but we may prepay the deferred amount at any time withoutpenalty.  We reevaluated the leaseamendment under FAS 13, “Accounting for Leases” and determined that the amendedlease still qualified as an operating lease. In conjunction with the lease amendment, a warrant was issued topurchase 100,000 shares of our common stock at $10.57 per share.  The warrant remains exercisable until July2013 and is exercisable at the option of the holder.  The fair value of the warrant using theBlack-Scholes valuation method was approximately $800,000, which we determinedusing an estimated volatility rate of 99%, risk-free interest rate ofapproximately 5% and an expected term of 7 years, the term of the warrant.  The fair value of the warrant is recorded in “Prepaidexpenses and other current assets” on our balance sheet and is being amortizedapproximately over 12 years, the remaining life of the lease.

**10. Equipment Lease Line**

In June 2006, weobtained approval to extend our equipment lease line to create a new totalborrowing limit of $1.5 million.  We havethe ability to draw down on this line through June 2007. The repaymentperiod will be for three years beginning on the first draw down with theinterest rate on the line fixed at each drawdown. Each line has a bargainpurchase buyout provision of $101. During the three months ended September 30,2006, we drew down approximately $93,000, which is included in our capitallease obligation on the balance sheet. Approximately $1.2 million remainedavailable under the line as of September 30, 2006.

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## **Reportof Independent Registered Public Accounting Firm**

TheBoard of Directors

Rigel Pharmaceuticals, Inc.

We have reviewed the accompanying balance sheet ofRigel Pharmaceuticals, Inc. as of September 30, 2006, the related condensed statements of operations forthe three and nine-month periods ended September 30, 2006 and 2005, and thecondensed statements of cash flows for the nine-month period ended September30, 2006 and 2005. These interim financial statements are the responsibility ofthe Company’s management.

We conducted our review in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Areview of interim financial information consists principally of applyinganalytical procedures and making inquiries of persons responsible for financialand accounting matters. It is substantially less in scope than an auditconducted in accordance with the standards of the Public Company AccountingOversight Board, the objective of which is the expression of an opinion regardingthe financial statements taken as a whole. Accordingly, we do not express suchan opinion.

Based on our review, we are not aware of anymaterial modifications that should be made to the condensed interim financialstatements referred to above for them to be in conformity with U.S. generallyaccepted accounting principles.

We have previously audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), thebalance sheet of Rigel Pharmaceuticals, Inc. as of December 31, 2005,and the related statements of operations, shareholders’ equity, and cash flowsfor the year then ended (not presented herein), and in our report datedMarch 3, 2006, we expressed an unqualified opinion on those financialstatements. In our opinion, the information set forth in the accompanyingbalance sheet as of December 31, 2005, is fairly stated, in all materialrespects, in relation to the balance sheet from which it has been derived.
|                        | /s/  Ernst & Young LLP |
|------------------------|---------------------------------|
| Palo Alto,  California |                            |
| October 20, 2006       |                            |

 

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**Item2.****    Management’s Discussion and Analysisof Financial Condition and Results of Operations**

*This discussion and analysis should be read inconjunction with our financial statements and accompanying notes included inthis report and the 2005 audited financial statements and accompanying notesincluded in our Annual Report on Form 10-K for the year endedDecember 31, 2005. Operating results for the three and nine months endedSeptember 30, 2006 are not necessarily indicative of results that may occur infuture periods.*

*We usually use words such as “may,”“will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,”“predict,” “future,” “intend,” “potential” or “continue” or the negative ofthese terms or similar expressions to identify these forward-lookingstatements. These statements appear throughout this quarterly report onForm 10-Q and are statements regarding our current intent, belief orexpectation, primarily with respect to our operations and related industrydevelopments. Examples of these statements include, but are not limited to,statements regarding the following: our business and scientific strategies; theprogress of our product development programs, including clinical testing; ourcorporate collaborations, including revenues that may be received from thesecollaborations; our drug discovery technologies; our research and developmentexpenses; protection of our intellectual property; sufficiency of our cashresources; and our operations and legal risks. You should not place unduereliance on these forward-looking statements. Our actual results could differmaterially from those anticipated in these forward-looking statements for manyreasons, including as a result of the risks and uncertainties discussed in the “RiskFactors” in Item 1A of Part II of this quarterly report on Form 10-Q. Anyforward-looking statement speaks only as of the date on which it is made, andwe undertake no obligation to update any forward-looking statement to reflectevents or circumstances after the date on which the statement is made or toreflect the occurrence of unanticipated events. New factors emerge from time totime, and it is not possible for us to predict which factors will arise. Inaddition, we cannot assess the impact of each factor on our business or theextent to which any factor, or combination of factors, may cause actual resultsto differ materially from those contained in any forward-looking statements*

**Overview**

Rigel is a clinical-stage drug development companythat discovers and develops novel, small-molecule drugs for the treatment ofinflammatory diseases, cancer and viral diseases. Our goal is to file one newinvestigative new drug (IND) application in a significant indication each year.We have achieved this goal each year beginning in 2002. Our pioneering researchfocuses on intracellular signaling pathways and related targets that arecritical to disease mechanisms. Our productivity has resulted in strategic collaborationswith large pharmaceutical partners to develop and market our productcandidates. We have product development programs in inflammatory/autoimmunediseases such as rheumatoid arthritis, thrombocytopenia, asthma and allergy aswell as in cancer*.*

Rigel has multiple product candidates in developmentas follows:

·      *R788—Product Candidate for Rheumatoid Arthritis (RA). *R788 is our lead product candidate. It has anovel mechanism of action-blocking IgG receptor signaling in macrophages andB-cells. Previously, we studied R788 in a Phase I single center, double-blind,randomized, placebo-controlled trial evaluating the safety and pharmacokineticsof escalating single and multiple doses of R788. We completed R788 studies toevaluate its safety and pharmacokinetics in combination with methotrexate, acommonly prescribed treatment for RA. Results of this trial suggest no adverseinteraction. In September 2006, we commenced a Phase II, multicenter,ascending dose, randomized, double-blind, placebo-controlled, dose rangingstudy to evaluate up to three doses of R788 in RA patients failing to respondto methotrexate.  We expect to receiveresults from the study in the second half of 2007.

·      *R788**—*ProductCandidate for Immune Thombocytopenic Purpura (ITP).* *Plateletdestruction from ITP is mediated by IgG signaling. R788 is a potent inhibitorof IgG signaling. In preclinical studies, R788 was shown to improvethrombocytopenia in an ITP mouse model. We plan to commence Phase II clinicaltrials of R788 to evaluate its safety and efficacy in refractory ITP patientsby the end of 2006.

·      *R788**—*ProductCandidate for B-Cell Lymphoma.* *Research has shownthat Syk overactivity is an essential mechanism in several types of B-celllymphoma survival and that R788 inhibits the growth of B-cell lymphoma drivenby Syk overactivity.  We expect to filean IND for this indication by the end of the 2006 and begin clinical trials inthe first half of 2007.

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·      *R763—Product Candidate for Oncology. *R763 is a potent,highly-selective, small-molecule inhibitor of Aurora kinase targeting cancercell proliferation. In October 2005, we signed a licensing agreement withSerono that grants to Serono an exclusive license to develop and commercialize inhibitorsin our Aurora kinase program, including R763. Under the agreement, we were responsible for filing an IND for R763,which we filed with the Food and Drug Administration, or FDA, in December 2005,and were allowed to proceed under the IND in January 2006.  Serono is responsible for the furtherdevelopment and commercialization of R763. During February 2006, we received a payment of $5.0 million fromSerono triggered by the regulatory acceptance. In September 2006, we received a payment of $3.0 million from Seronotriggered by Serono’s initiation of a Phase I trial for R763.  The Phase I trial is a multicenter study onpatients with refractory solid tumors.

In the first quarter of 2005, we announced that weentered into a collaborative research and license agreement with Pfizer for thedevelopment of inhaled products for the treatment of allergic asthma and otherrespiratory diseases, such as chronic obstructive pulmonary disease, or COPD.The collaboration is focused on our preclinical small molecule compounds, whichinhibit IgE receptor signaling in respiratory tract mast cells by blocking thesignaling enzyme Syk, a novel drug target for respiratory diseases. Mast cellsplay important roles in both early and late phase allergic reactions, and Sykinhibitors could prevent both phases. In May 2006, we achieved the first collaboration milestone whenPfizer nominated R343 to commence advanced preclinical development in allergicasthma.  Pfizer paid us $5.0 million forthe exclusive right to R343, which is expected to be delivered using Pfizer’sdry powder inhaler and is expected to enter the clinic in 2007.

In October 2006,we announced that we selected R348, an orally-available, potent and selectiveinhibitor of Janus Kinase 3, or JAK3, to enter preclinical studies tosupport an IND application planned for 2007. We are also studying Axl inhibition in oncology.  In addition to the aforementioned productcandidates, we have ongoing research programs involving back-up candidates forthe product candidates above and drug discovery efforts in ourimmunology/inflammation, virology and oncology programs.

**Corporate Collaborations**

We carry onresearch and development programs in connection with our corporatecollaborations. As of September 30, 2006, we had collaborations with six majorpharmaceutical/biotech companies comprised of: one with Janssen PharmaceuticaN.V., a division of Johnson & Johnson, relating to oncologytherapeutics and diagnostics, two with Pfizer Inc., one initiated in 1999and the other in the first quarter of 2005, relating to intrapulmonary asthmaand allergy therapeutics, one with Novartis Pharma AG with respect to fourdifferent programs relating to immunology, oncology and chronic bronchitis, onewith Daiichi Pharmaceuticals Co., Ltd. in the area of oncology, one withMerck, in the area of oncology, and one with Serono in the area of oncology.All of these collaborations, excluding the recent Pfizer and the Seronocollaborations, have a research phase during which we receive or receivedfunding based on the level of headcount allocated to a program. In all of thesecollaborations, if certain conditions are met, we are entitled to receivefuture milestone payments and royalties. We cannot guarantee that theseconditions will be met or that research and development efforts will besuccessful. As a result, we may not receive any further milestone payments orroyalties under these agreements. Only the Merck program currently provides forregular research reimbursement payments.

We are exploring new opportunities with existing andpotential collaborators. Our earliest partnerships focused on the early stagesof drug discovery, specifically on target discovery and validation. Ourcollaborations with Daiichi and recently with Merck are both later stage,focusing on drug discovery and development. Our 2005 collaboration with Pfizercovers a compound that Pfizer selected for advanced preclinical development inMay 2006, while our 2005 collaboration with Serono covers a compound that beganclinical trials in September 2006. We currently anticipate that in order tosupport our current research programs, we will need to self-fund our ownresearch programs, which involves an increased rate of spending on later stagesof development prior to partnering with collaborative partners. Therefore, itis expected that future collaborations may have an expanded focus and couldinclude high throughput screening, combinatorial and medicinal chemistry,preclinical evaluations and/or clinical development of compounds we havediscovered. In addition, we believe these future collaborations could bestructured to consist of upfront payments, the purchase of our common stock,milestone payments upon meeting certain conditions, research or developmentreimbursement payments and/or royalties upon commercialization of productsresulting from the collaboration.

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**Critical Accounting Policies and the Use of Estimates**

Our discussion and analysis of our financial conditionand results of operations is based upon our financial statements, which havebeen prepared in accordance with U.S generally accepted accounting principles.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities.  We evaluate our estimates, including thoserelated to terms of the research collaborations (i.e., amortization of upfrontfees and certain milestones), investments, stock compensation, impairmentissues, the estimated useful life of assets and contingencies, on an on-goingbasis.  In June 2006, we evaluated theperiod for amortizing the Serono upfront payment and concluded that we hadachieved all of our deliverables under the contract.  See further discussion in Note 7 to thefinancial statements included in this report. We base our estimates on historical experience and on various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions. We believe the following critical accounting policies affect ourmore significant judgments and estimates used in the preparation of ourfinancial statements.

We believe that there have been no significant changesin our critical accounting policies during the period ended September 30, 2006as compared to those previously disclosed in our Annual Report onForm 10-K for the year ended December 31, 2005, except for the adoptionof Statement of Financial Accounting Standards, or SFAS, No. 123(R), “Share-BasedPayment (Revised 2004),” or SFAS 123(R), for equity-based compensation costs inJanuary 2006.

***Revenue Recognition***

We recognize revenue from our contract arrangements. Ourrevenue arrangements with multiple elements are evaluated under Emerging IssuesTask Force No. 00-21, *“RevenueArrangements with Multiple Deliverables,”* and are divided intoseparate units of accounting if certain criteria are met, including whether thedelivered element has stand-alone value to the customer and whether there isobjective and reliable evidence of the fair value of the undelivered items. Theconsideration we receive is allocated among the separate units based on theirrespective fair values, and the applicable revenue recognition criteria isapplied to each of the separate units. Advance payments received in excess ofamounts earned are classified as deferred revenue until earned.

Non-refundable, up-front payments received inconnection with research and development collaboration agreements, includingtechnology access fees, are deferred and recognized on a straight-line basisover the relevant periods of continuing involvement, generally the researchterm.  When a research term is not specified,we estimate the time it will take us to complete our deliverables under thecontract and recognize the upfront fee using the straight-line method over thattime period.  We review our estimatesevery quarter for reasonableness.

Revenue related to collaborative research with ourcorporate collaborators is recognized as research services are performed overthe related development funding periods for each contract. Under theseagreements, we are required to perform research and development activities asspecified in the applicable agreement. The payments received are not refundableand are generally based on a contractual cost per full-time equivalent employeeworking on the project. Research and development expenses under thecollaborative research agreements, except for the Merck collaboration signed inNovember 2004 related to ubiquitin ligases, approximate or exceed therevenue recognized under such agreements over the term of the respectiveagreements. For the Merck collaboration, we are recognizing a pro-rata portionof the invoiced amounts for funding of our research scientists based on theheadcount dedicated to the project. It is our policy to recognize revenue basedon our level of effort expended and that revenue recognized will not exceed amountsbillable under the arrangement.

Revenue associated with at-risk milestones pursuant tocollaborative agreements is recognized based upon the achievement of themilestones as set forth in the applicable agreement.

Royalties will be recognized as earned in accordancewith the contract terms when the third party results are reliably measurableand collectibility is reasonably assured.

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***Stock-based Compensatio**n***
| ** **                                    | ** ** | **Three months ended  September 30,** | ** ** | **Aggregate Change** | ** ** | **Nine months ended  September 30,** | ** ** | **Aggregate Change** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------|------------|-----------------------------------------------------|------------|---------------------------|------------|
| ** **                                    | ** ** | **2006**                                             | ** ** | **2005**                  | ** ** | **2006 from 2005**                        | ** ** | **2006**                  | ** ** | **2005** | ** ** | **2006 from 2005** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                              | ** ** | **(in thousands)**   | ** ** |
| **Stock-based compensation  expense from:**   | ** ** | ** **                                           | ** ** | ** **                | ** ** | ** **                                          | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| ***Officer,  director and employee options*** |       | $                                                    | 3,438      |                      | $          | 633                                                 |       | $                         | 2,805      |   | $ | 9,942 |   | $ | 82 |   | $ | 9,860 |   |
| ***Consultant  options***                     |       | 11                                                   |       | 139                       |       | (128                                                | )          | 195                       |       | 24 |   | 171 |   |
| ***Other  employee options***                 |       | —                                               |       | 12                        |       | (12                                                 | )          | —                    |       | 32 |   | (32 | ) |
| *** ***                                  |       |                                                 |       |                      |       |                                                |       |                      |       |   |   |   |   |
| ***Total***                                   |       | $                                                    | 3,449      |                      | $          | 784                                                 |       | $                         | 2,665      |   | $ | 10,137 |   | $ | 138 |   | $ | 9,999 |   |

 

We grant options to purchase our common stock to ourofficers, directors and all other employees and consultants under our stockoption plans. Eligible employees can also purchase shares of our common stockat a price per share equal to the lesser of 85% of the fair market value on thefirst day of the offering period or 85% of the fair market value on thepurchase date under our employee stock purchase plan, or ESPP.  The benefits provided under these plans areshare-based payments subject to the provisions of SFAS 123(R). EffectiveJanuary 1, 2006, we adopted the provisions of SFAS 123(R) using the modifiedprospective application transition method. Under this method, the share-basedcompensation cost recognized beginning January 1, 2006 includes compensationcost for (i) all share-based payments granted prior to, but not vested as ofJanuary 1, 2006, based on the grant date fair value originally estimated inaccordance with the provisions of SFAS 123, “Accounting for Stock-BasedCompensation,” or SFAS 123, and calculated for pro forma disclosures under SFASNo. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,”or SFAS 148, and (ii) all share-based payments granted subsequent to January 1,2006, based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R) and Staff Accounting Bulletin No. 107, or SAB 107.Compensation cost under SFAS 123(R) for awards granted prior to January 1, 2006is recognized using an accelerated method pursuant to the FASB InterpretationNo. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Optionor Award Plans,” or FIN 28. For awards granted after January 1, 2006, we haveadopted the use of the straight-line attribution method over the requisiteservice period for the entire award. Results of prior periods do not reflectany restated amounts, and the cumulative effect of a change in accountingprinciple was insignificant upon adoption of SFAS No. 123(R) under the modifiedprospective method. In addition pursuant to SFAS 123(R), we are required toestimate the amount of expected forfeitures when calculating compensationcosts, instead of accounting for forfeitures as incurred, which was ourprevious method. We will record actual forfeitures as they occur, and we willreview our forfeiture rates each quarter and make any necessary changes our estimates.

Prior to adopting SFAS 123(R) on January 1, 2006, weaccounted for equity-based employee compensation costs under the recognitionand measurement principles of Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” or APB 25. Under APB 25, the intrinsic valuemethod of accounting, no compensation expense is recognized, because theexercise price of our employee stock options equals the market price of theunderlying stock on the date of grant. Pro forma information regarding net lossand net loss per share was determined as if we had accounted for issuancesunder our stock option plans and ESPP under the fair value method prescribed bySFAS 123, as amended by SFAS 148. The fair value for these options wasestimated at the date of grant using the Black-Scholes option pricing model.

In 2005, werecorded charges associated with the stock options that were eligible forre-pricing under a tender offer initiated in June 2003. All replacementoptions, as well as the eligible options that were not surrendered under theoriginal offer to exchange, were treated for financial reporting purposes asvariable awards. Therefore, for the period prior to adoption of SFAS 123(R), werecorded a non-cash charge, generally for the intrinsic value of the options asthey vested, utilizing the accelerated vesting method, reflecting increases anddecreases (down to, but not below, the exercise price) in the price of ourcommon stock as compensation expense (recovery) in connection with the replacementoptions and the eligible options that were not exchanged. For the three andnine months ended September 30, 2005, we recorded non-cash compensation expenseof approximately $633,000 and $82,000 respectively, related to all employeeoptions eligible for replacement options. The expense resulted from the

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increase in the marketprice of our common stock during the three and nine-month periods endedSeptember 30, 2005.  For periods afterthe adoption of SFAS 123(R), we continue to account for the repriced optionsprior to the adoption of SFAS 123(R) in accordance with provisions of SFAS123.  In August 2006, our board ofdirectors granted new options to employees, non-employee directors andconsultants who held repriced options that had expired in August 2006.  We granted approximately 179,000 options withan exercise price of $9.56 per share. The options vested 50% at the date of the grant and the remaining 50%will vest monthly over two years.  Werecorded stock-based compensation expense of approximately $616,000 relating tothese new options that vested during the period ended September 30, 2006.

We also record charges associated with options grantedto consultants reflecting the fair value valuation and periodic fair valueremeasurement of outstanding consultant options under Emerging Issues TaskForce No. 96-18, “Accounting for Equity Instruments That are Issued to OtherEmployees for Acquiring, or in Conjunction with Selling Goods or Services,” orEITF 96-18.The valuation is based upon the current market value of our commonstock and other assumptions, including the expected future volatility of ourstock price, risk-free interest rate and expected term. For consultant optionsgranted in 2006, we amortize stock-based compensation using a straight-lineattribution method consistent with the method used for employees and with theattribution election we made upon adoption of SFAS 123(R). For options grantedprior to January 1, 2006, we used the accelerated method for expensingstock-based compensation, which was the method we used prior to adoption. Weexpect to see continued fluctuations in the future as a portion of theseoptions are remeasured based on the changes in the current market price of ourcommon stock.

The determination of the fair value of share-basedpayment awards on the date of grant using an option-pricing model is affectedby our stock price as well as assumptions regarding a number of complex andsubjective variables. These variables include, but are not limited to, ourexpected stock price volatility over the term of the awards, actual andprojected employee stock option exercise behaviors, risk-free interest rate andexpected dividends.

If factors change and we employ different assumptionsin the application of SFAS 123(R) in future periods, the compensation expensethat we record under SFAS 123(R) may differ significantly from what we haverecorded in the current period. Therefore, we believe it is important to beaware of the high degree of subjectivity involved when using option pricingmodels to estimate share-based compensation under SFAS 123(R).

The guidance in and application of SFAS 123(R) and theSecurities and Exchange Commission’s Staff Accounting Bulleting No. 107, or SAB107, may be subject to further interpretation and refinement over time. Thereare significant differences among valuation models, and there is a possibilitythat we may adopt different valuation models in the future. This may result ina lack of consistency in future periods and materially affect the fair valueestimate of share-based payments. It may also result in a lack of comparabilitywith other companies that use different models, methods and assumptions.

**Three andNine Months Ended September 30, 2006 and 2005**

**Revenues**
| ** **                                   | ** ** | **Three months ended  September 30,** | ** ** | **Aggregate Change** | ** ** | **Nine months ended  September 30,** | ** ** | **Aggregate Change** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|---------------------------|------------|-----------------------------------------------------|------------|---------------------------|------------|
| ** **                                   | ** ** | **2006**                                             | ** ** | **2005**                  | ** ** | **2006 from 2005**                        | ** ** | **2006**                  | ** ** | **2005** | ** ** | **2006 from 2005** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                              | ** ** | **(in thousands)**   | ** ** |
| ***Contract  revenues from collaborations*** |       | $                                                    | 6,127      |                      | $          | 3,282                                               |       | $                         | 2,845      |   | $ | 30,345 |   | $ | 10,506 |   | $ | 19,839 |   |
|                                              |            |                                                      |            |                           |            |                                                     |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

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Revenues by collaboratorwere:
| ** **    | ** ** | **Three months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** | **Nine months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** |
|---------------|------------|---------------------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|---------------------------|------------|
| ** **    | ** ** | **2006**                                    | ** ** | **2005**                  | ** ** | **2006 from 2005**               | ** ** | **2006**                  | ** ** | **2005** | ** ** | **2006 from 2005** | ** ** |
| ** **    | ** ** | **(in thousands)**                     | ** ** | **(in thousands)**   | ** ** |
| ***Serono***  |       | $                                           | 3,000      |                      | $          | —                                     |       | $                         | 3,000      |   | $ | 15,527 |   | $ | — |   | $ | 15,527 |   |
| ***Merck***   |       | 1,877                                       |       | 1,812                     |       | 65                                         |       | 6,068                     |       | 5,072 |   | 996 |   |
| ***Pfizer***  |       | 1,250                                       |       | 1,250                     |       | —                                     |       | 8,750                     |       | 2,991 |   | 5,759 |   |
| ***Daiichi*** |       | —                                      |       | 220                       |       | (220                                       | )          | —                    |       | 2,443 |   | (2,443 | ) |
| *** ***  |       |                                        |       |                      |       |                                       |       |                      |       |   |   |   |   |
| ***Total***   |       | $                                           | 6,127      |                      | $          | 3,282                                      |       | $                         | 2,845      |   | $ | 30,345 |   | $ | 10,506 |   | $ | 19,839 |   |

 

Contract revenues from collaborations for the threeand nine months ended September 30, 2006 and 2005 consisted primarily ofresearch support and amortization of upfront fees and milestone payments fromthe continuation of our current collaborations. The increase in revenues for the three months ended September 30, 2006as compared to the similar period in 2005 was primarily due to the recognitionof Serono’s milestone payment to us of $3.0 million upon the initiation of aPhase 1 study for R763.  The increase inrevenues for the nine months ended September 30, 2006 as compared to thesimilar period in 2005 was primarily due to the recognition of Serono milestonepayments totaling $8.0 million, the amortization of the Serono upfront paymentof $7.5 million and the recognition of the Pfizer milestone payment of $5.0million for the nomination of R343, offset by the termination of the Daiichicollaboration in 2005. We have deferred approximately $958,000 of researchreimbursement revenue from Merck in order to account for the headcount effortexpended by us for the time period invoiced, which covers the period from theinitiation of the collaboration through September 30, 2006. We expect thisamount will be recognized as revenue no later than at the end of the researchphase of the collaboration, which is scheduled to be in May 2007. Weexpect contract revenues from collaborations to be a significant component ofour total revenues for the foreseeable future.

**Research and DevelopmentExpenses**
| ** **                                                                            | ** ** | **Three months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** | **Nine months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|---------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                    | ** ** | **2005**                  | ** ** | **2006 from 2005**               | ** ** | **2006**                  | ** ** | **2005** | ** ** | **2006 from 2005** | ** ** |
| ** **                                                                            | ** ** | **(in thousands)**                     | ** ** | **(in thousands)**   | ** ** |
| ***Research  and development expenses***                                              |       | $                                           | 14,050     |                      | $          | 13,676                                     |       | $                         | 374        |   | $ | 41,966 |   | $ | 38,656 |   | $ | 3,310 |   |
| ***Stock-based compensation expense included in research and development  expenses*** |       | 1,734                                       |       | 570                       |       | 1,164                                      |       | 5,198                     |       | 109 |   | 5,089 |   |
|                                                                                       |            |                                             |            |                           |            |                                            |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

The increase in research and development expenses forthe three months ended September 30, 2006, as compared to the similar period in2005, was primarily attributable to an increase in stock-based compensationexpense upon the adoption of SFAS 123(R) as previously discussed under “CriticalAccounting Policies and the Use of Estimates - Stock-based Compensation,” offsetby a decrease in preclinical and clinical costs. The decrease in preclinicaland clinical costs in the three months ended September 30, 2006, as compared tothe similar period in 2005, was primarily due to the termination of the R112program in 2005 and the transfer of sponsorship relating to R763 to Serono in2006.  The increase in research anddevelopment expenses for the nine months ended September 30, 2006, compared tothe similar period in 2005, was primarily due to an increase in stock-basedcompensation expense upon adoption of SFAS 123(R), offset by a decrease inpreclinical and clinical costs.  Thedecrease in preclinical and clinical costs in the nine months ended September30, 2006, compared to the same period in 2005, was primarily attributable tothe decrease in costs relating to termination of the R112 and R803 programs andthe transfer of R763 to Serono as discussed above, offset by increased costsrelating to our R788 program.  We expectthat our research and development expenses will increase through the remainderof 2006 as we continue our Phase II trial of R788 for RA, commence our Phase IItrial of R788 for ITP and continue to work on programs for other indications.

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The scope and magnitude offuture research and development expenses are difficult to predict at this timegiven the number of studies that we will need to conduct for any of ourpotential products, as well as our limited capital resources. In general,biopharmaceutical development involves a series of steps—beginning with identificationof a potential target and including, among others, proof of concept in animalsand Phase I, II and III clinical studies in humans—each of which istypically more expensive than the previous step. Success in development,therefore, results in increasing expenditures. Our research and developmentexpenditures currently include costs for scientific personnel, supplies,equipment, consultants, sponsored research, allocated facility costs, costsrelated to preclinical and clinical trials, and stock-based compensation.

**Generaland Administrative Expenses**
| ** **                                                                              | ** ** | **Three months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** | **Nine months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|---------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                    | ** ** | **2005**                  | ** ** | **2006 from 2005**               | ** ** | **2006**                  | ** ** | **2005** | ** ** | **2006 from 2005** | ** ** |
| ** **                                                                              | ** ** | **(in thousands)**                     | ** ** | **(in thousands)**   | ** ** |
| ***General  and administrative expenses***                                              |       | $                                           | 4,804      |                      | $          | 3,383                                      |       | $                         | 1,421      |   | $ | 14,532 |   | $ | 9,686 |   | $ | 4,846 |   |
| ***Stock-based compensation expense included in general and administrative  expenses*** |       | 1,715                                       |       | 214                       |       | 1,501                                      |       | 4,939                     |       | 29 |   | 4,910 |   |
|                                                                                         |            |                                             |            |                           |            |                                            |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

The increases in general and administrative expensesfor the three and nine months ended September 30, 2006, as compared to similarperiods in 2005, is primarily attributable to an increase in stock-basedcompensation expense upon the adoption of SFAS 123(R) as previously discussedunder “Critical Accounting Policies and the Use of Estimates - Stock-basedCompensation”.

**InterestIncome**
| ** **                 | ** ** | **Three months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** | **Nine months  ended  September 30,** | ** ** | **Aggregate Change** | ** ** |
|----------------------------|------------|---------------------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **2006**                                    | ** ** | **2005**                  | ** ** | **2006 from 2005**               | ** ** | **2006**                  | ** ** | **2005** | ** ** | **2006 from 2005** | ** ** |
| ** **                 | ** ** | **(in thousands)**                     | ** ** | **(in thousands)**   | ** ** |
| ***Interest******income*** | ** ** | $                                           | 1,447      |                      | $          | 935                                        |       | $                         | 512        |   | $ | 4,287 |   | $ | 1,667 |   | $ | 2,620 | ** ** |
|                            |            |                                             |            |                           |            |                                            |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

Interest income resultsfrom our interest-bearing cash and investment balances. The increase in thethree and nine months ended September 30, 2006, as compared to similar periodsin 2005, is attributable to an increase in our overall investment balances as aresult of the public offering we completed in July 2005 in which we raised$81.6 million in net proceeds, combined with an increase in the rate of interestwe earned on the balances.

**Interest Expense**
| ** **              | ** ** | **Three months ended  September 30,** | ** ** | **Aggregate Change** | ** ** | **Nine months ended  September 30,**  | ** ** | **Aggregate Change** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|---------------------------|------------|------------------------------------------------------|------------|---------------------------|------------|
| ** **              | ** ** | **2006**                                             | ** ** | **2005**                  | ** ** | **  2006 from 2005  ** | ** ** | **2006**                  | ** ** | **2005** | ** ** | **  2006 from 2005  ** | ** ** |
| ** **              | ** ** | **(in thousands)**                              | ** ** | **(in thousands)**   | ** ** |
| ***Interest  expense*** |       | $                                                    | 102        |                      | $          | 64                                                   |       | $                         | 38         |   | $ | 315 |   | $ | 194 |   | $ | 121 |   |
|                         |            |                                                      |            |                           |            |                                                      |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

Interest expense is the resultof our capital lease obligations associated with fixed asset acquisitions.Interest expense increased for the three and nine months ended September 30,2006 and 2005 due to the increase in debt obligations outstanding during thoseperiods.

**Liquidity and CapitalResources**

**Cash Requirements**

We have financed our operations from inceptionprimarily through sales of equity securities, contract

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payments under our collaborationagreements and equipment financing arrangements. We have consumed substantialamounts of capital to date, and operating expenditures are expected to increaseover the next several years as we expand our infrastructure and research anddevelopment activities. We believe that our existing capital resources andanticipated proceeds from current collaborations will be sufficient to supportour current operating plan through at least the next 12 months. Ouroperations will require significant additional funding, in large part due toour research and development expenses, future preclinical and clinical testingcosts and the absence of any meaningful revenues for the foreseeable future.The amount of future funds needed will depend largely on the timing andstructure of potential future collaborations. We do not know whether additionalfinancing will be available when needed, or that, if available, we will obtainfinancing on terms favorable to our stockholders or us.

To the extent we raise additional capital by issuingequity securities, our stockholders could at that time experience substantialdilution. To the extent that we raise additional funds through collaborationand licensing arrangements, we may be required to relinquish some rights to ourtechnologies or product candidates, or grant licenses on terms that are notfavorable to us.

Ourfuture funding requirements will depend upon many factors, including, but notlimited to:

·              the progress andsuccess of clinical trials and preclinical activities (including studies andmanufacture of materials) of our product candidates conducted by us or ourcollaborative partners or licensees;

·              our ability toestablish new collaborations and to maintain our existing collaborationpartnerships;

·              the progress of researchprograms carried out by us;

·              any changes in thebreadth of our research and development programs;

·              our ability to meetthe milestones identified in our collaborative agreements that triggerpayments;

·              the progress of theresearch and development efforts of our collaborative partners;

·              our ability toacquire or license other technologies or compounds that we seek to pursue;

·              our ability tomanage our growth;

·              competingtechnological and market developments;

·              the costs and timingof obtaining, enforcing and defending our patent and intellectual propertyrights;

·              the costs and timingof regulatory approvals and filings by us and our collaborators; and

·              expenses associated with unforeseenlitigation.

Insufficient funds may requireus to delay, scale back or eliminate some or all of our research or developmentprograms, to lose rights under existing licenses or to relinquish greater orall rights to product candidates at an earlier stage of development or on lessfavorable terms than we would otherwise choose or may adversely affect ourability to operate as a going concern.  As of September 30, 2006,we had approximately $115.0 million in cash, cash equivalents andavailable-for-sale securities, as compared to $138.2 million as ofDecember 31, 2005, a decrease of $23.2 million. The decrease wasattributable to operating spending in the period, offset by the receipts of$8.0 million from Serono, $5.0 million from Pfizer and approximately $4.1million from Merck.  We also receivedapproximately $2.0 million from the issuance of common stock resulting fromoption exercises and approximately $1.4 million under our equipment financingarrangements, which was offset by debt service payments of approximately$976,000 relating to the equipment financing arrangements.  We expect that our net cash used inoperations for the remainder of 2006 will increase as we continue our Phase IIclinical trial of R788 for RA, commence our Phase II trial of R788 for ITP andcontinue to work on programs for other indications.  For the three and nine months ended September30, 2006 and 2005, we maintained an investment portfolio primarily in moneymarket funds, federal agency securities and corporate bonds and notes. Cash inexcess of immediate requirements is invested with regard to liquidity andcapital preservation. Wherever possible, we seek to minimize the potentialeffects of concentration and degrees of risk.

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**ContractualObligations**

As of September 30, 2006,we had the following contractual commitments (by fiscal year) associated withdebt and lease obligations:
|                                           | ** ** | **Total**               | ** ** | **2006** | ** ** | **2007-2009** | ** ** | **2010-2012** | ** ** | **2013-2018** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|----------|------------|---------------|------------|---------------|------------|---------------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Debt obligations  (1)                     |       | $                       | 2,768      |     | $          | 267           |       | $             | 2,501      |          | $          | — |   | $ | — |   |
| Facilities  lease, net of sublease (2)(3) |       | 162,008                 |       | 1,469    |       | 39,663        |       | 44,753        |       | 76,123        |       |
|                                      |       |                    |       |     |       |          |       |          |       |          |       |
| Total                                     |       | $                       | 164,776    |     | $          | 1,736         |       | $             | 42,164     |          | $          | 44,753 |   | $ | 76,123 |   |

 

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(1)           As of September 30,2006, we had approximately $2.6 million in debt obligations associatedwith our equipment additions. All existing debt agreements as of September 30,2006 are secured by the equipment financed, bear interest at rates in a rangeof 8.8% to 12.2% and are due in monthly installments through 2009.

(2)           During May 2004,we initiated a sublease of approximately 15,000 square feet of our premises toa tenant for a period of two years. This sublease was amended in September 2005to extend the term for an additional year. The facilities lease obligationsabove are reflective of the new sublease income stream of $496,000.

(3)           These payments reflectthe terms of the recent amendment to our lease.

**Item3.****    Quantitativeand Qualitative Disclosures About Market Risk**

The primary objective of our investment activities isto preserve principal while at the same time maximizing the income we receivefrom our investments without significantly increasing risk. Some of thesecurities in which we invest may have market risk. This means that a change inprevailing interest rates may cause the fair value amount of the investment tofluctuate. For example, if we hold a security that was issued with a fixedinterest rate at the then-prevailing rate and the prevailing interest ratelater rises, the market value amount of our investment will decline. Tominimize this risk in the future, we intend to maintain our portfolio of cashequivalents and available-for-sale securities in a variety of securities,including money market funds and government and non-government debt securities.For the three and nine months ended September 30, 2006 and 2005, we maintainedan investment portfolio primarily in money market funds, federal agencysecurities and corporate bonds and notes. Due to the short-term nature of themajority of these investments, we believe we do not have a material exposure tointerest rate risk arising from our investments. Therefore, no quantitativetabular disclosure is provided.

We have operated primarily in the United States, andall funding activities with our collaborators to date have been made in U.S.dollars. Accordingly, we have had minimal exposure to foreign currency ratefluctuations.

**Item4.**** ****  Controls and Procedures**

*Evaluation of Disclosure Controls and Procedures.*Basedon our management’s evaluation (with the participation of our chief executiveofficer and chief financial officer), our chief executive officer and chieffinancial officer have concluded that our disclosure controls and procedures(as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended), were effective as of September30, 2006.

*Changes in Internal Controls.*Therewere no changes in our internal controls over financial reporting during thequarter ended September 30, 2006 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

*Limitations on the Effectiveness of Controls*.A control system, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the controls aremet. Because of the inherent limitations in all control systems, no evaluationof controls can provide absolute assurance that all control issues, if any,within a company have been detected. Accordingly, our disclosure controls andprocedures are designed to provide reasonable, not absolute, assurance that theobjectives of our disclosure control system are met and, as set forth above,our chief executive officer and chief financial officer have concluded, basedon their

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evaluation as of the end of the period covered by this quarterly reporton Form 10-Q, that our disclosure controls and

procedureswere sufficiently effective to provide reasonable assurance that the objectivesof our disclosure control system were met.

**PART II.OTHER INFORMATION**

**Item 1A. Risk Factors**

*Inevaluating our business, you should carefully consider the following risks, aswell as the other information contained in this quarterly report onForm 10-Q. If any of the following risks actually occurs, our businesscould be harmed. The risks and uncertainties described below are not the onlyones facing us. Additional risks and uncertainties not presently known to us,or that we currently see as immaterial, may also harm our business.*

*We havemarked with an asterisk(*) those risk factors below that reflect materialchanges from the risk factors included in our Annual Report on Form 10-K filedwith the Securities and Exchange Commission on March 8, 2006.*

**We will need additional capital in the futureto sufficiently fund our operations and research.***

We have consumed substantial amounts of capital todate, and operating expenditures are expected to increase over the next severalyears as we expand our infrastructure and research and development activities.We believe that our existing capital resources and anticipated proceeds fromcurrent collaborations will be sufficient to support our current operating planthrough at least the next 12 months. Our operations will requiresignificant additional funding in large part due to our research anddevelopment expenses, future preclinical and clinical-testing costs, and theabsence of any meaningful revenues for the foreseeable future. The amount offuture funds needed will depend largely on the timing and structure ofpotential future collaborations. We do not know whether additional financingwill be available when needed, or that, if available, we will obtain financingon terms favorable to our stockholders or us.

To the extent we raise additional capital by issuingequity securities, our stockholders could at that time experience substantialdilution. To the extent that we raise additional funds through collaborationand licensing arrangements, we may be required to relinquish some rights to ourtechnologies or product candidates, or grant licenses on terms that are notfavorable to us.

**Our future funding requirements will depend on many uncertainfactors**.

Our future funding requirements will depend upon manyfactors, including, but not limited to:

·              the progress andsuccess of clinical trials and preclinical activities (including studies andmanufacture of materials) of our product candidates conducted by us or ourcollaborative partners or licensees;

·              our ability toestablish new collaborations and to maintain our existing collaborationpartnerships;

·              the progress ofresearch programs carried out by us;

·              any changes in thebreadth of our research and development programs;

·              our ability to meetthe milestones identified in our collaborative agreements that triggerpayments;

·              the progress of theresearch and development efforts of our collaborative partners;

·              our ability toacquire or license other technologies or compounds that we seek to pursue;

·              our ability tomanage our growth;

·              competing technologicaland market developments;

·              the costs and timingof obtaining, enforcing and defending our patent and intellectual propertyrights;

·              the costs and timingof regulatory approvals and filings by us and our collaborators; and

·              expenses associated with unforeseenlitigation.

Insufficient funds may require us to delay, scale backor eliminate some or all of our research or development programs, to loserights under existing licenses or to relinquish greater or all rights toproduct candidates at an earlier stage of development or on less favorableterms than we would otherwise choose or may

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adversely affect ourability to operate as a going concern.

**Our success as a company is uncertain due toour history of operating losses and the uncertainty of future profitability.***

Due in large part to the significant research anddevelopment expenditures required to identify and validate new productcandidates and pursue our development efforts, we have not been profitable andhave incurred operating losses since we were incorporated in June 1996.The extent of our future losses and the timing of potential profitability arehighly uncertain, and we may never achieve profitable operations. We incurrednet losses of approximately $22.2 million for the first nine months of2006, $45.3 million in 2005 and $56.3 million in 2004. Currently, our revenuesare generated solely from research payments pursuant to our collaborationagreements and licenses and are insufficient to generate profitable operations.As of September 30, 2006, we had an accumulated deficit of approximately $279.7million. We expect to incur losses for at least the next several years andexpect that these losses could increase as we expand our research anddevelopment activities and incur significant clinical and testing costs.

**There is a high risk that drug discovery anddevelopment efforts might not successfully generate good product candidates.***

At the present time, the majority of our operationsare in various stages of drug identification and development. We currently havetwo product compounds in the clinical testing stage: one is for both RA andITP, which is proprietary to our company and the other is for oncology, whichis subject to a collaboration agreement with Serono. In our industry, it isstatistically unlikely that the limited number of compounds that we haveidentified as potential product candidates will actually lead to successfulproduct development efforts, and we do not expect any drugs resulting from ourresearch to be commercially available for several years, if at all. Our productcompounds in clinic trials and our future leads for potential drug compoundsare subject to the risks and failures inherent in the development ofpharmaceutical products. These risks include, but are not limited to, theinherent difficulty in selecting the right drug and drug target and avoidingunwanted side effects as well as unanticipated problems relating to productdevelopment, testing, regulatory compliance, manufacturing, marketing,competition and costs and expenses that may exceed current estimates. Theresults of preliminary studies do not necessarily predict clinical orcommercial success, and larger later-stage clinical trials may fail to confirmthe results observed in the preliminary studies. With respect to our owncompounds in development, we have established anticipated timelines withrespect to the initiation or completion of clinical studies based on existingknowledge of the compound. However, we cannot provide assurance that we will meetany of these timelines for clinical development.  For example, in December 2005, wecompleted a Phase II clinical trial of R112 for the treatment of allergicrhinitis, which did not achieve the primary endpoint.

Because of the uncertainty of whether the accumulatedpreclinical evidence (pharmacokinetic, pharmacodynamic, safety and/or otherfactors) or early clinical results will be observed in later clinical trials,we can make no assurances regarding the likely results from our future clinicaltrials or the impact of those results on our business.

**We might not be able to commercialize ourproduct candidates successfully if problems arise in the clinical testing andapproval process.***

Commercialization of our product candidates dependsupon successful completion of preclinical studies and clinical trials.Preclinical testing and clinical development are long, expensive and uncertainprocesses. We do not know whether we, or any of our collaborative partners,will be permitted to undertake clinical trials of potential products beyond thetrials already concluded and the trials currently in process. It will take usor our collaborative partners several years to complete any such testing, andfailure can occur at any stage of testing. Interim results of trials do notnecessarily predict final results, and acceptable results in early trials maynot be repeated in later trials. A number of companies in the pharmaceuticalindustry, including biotechnology companies, have suffered significant setbacksin advanced clinical trials, even after achieving promising results in earliertrials. Moreover, we or our collaborative partners or regulators may decide todiscontinue development of any or all of these projects at any time forcommercial, scientific or other reasons.

**Delays in clinical testing could result inincreased costs to us.**

Significant delays in clinical testing couldmaterially impact our product development costs and timing. We do not knowwhether planned clinical trials will begin on time, will need to be halted orrevamped or will be completed on schedule, or at all. Clinical trials can bedelayed for a variety of reasons, including delays in obtaining

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regulatoryapproval to commence a study, delays from scale up delays in reaching agreementon acceptable clinical study agreement terms with prospective clinical sites,delays in obtaining institutional review board approval to conduct a study at aprospective clinical site or delays in recruiting subjects to participate in astudy. Environmental conditions may impact the execution of some clinicaltrials, particularly during the allergy season for our allergic rhinitisprogram.

In addition, we typically rely on third-party clinicalinvestigators to conduct our clinical trials and other third-party organizationsto oversee the operations of such trials and to perform data collection andanalysis. As a result, we may face additional delaying factors outside ourcontrol if these parties do not perform their obligations in a timely fashion.While we have not yet experienced delays that have materially impacted ourclinical trials or product development costs, delays of this sort could occurfor the reasons identified above or other reasons. If we have delays in testingor approvals, our product development costs will increase. For example, we mayneed to make additional payments to third-party investigators and organizationsto retain their services or we may need to pay recruitment incentives. If thedelays are significant, our financial results and the commercial prospects forour product candidates will be harmed, and our ability to become profitablewill be delayed.

**We lack the capability to manufacture compounds fordevelopment and rely on third parties to manufacture our product candidates,and we may be unable to obtain required material in a timely manner, at anacceptable cost or at a quality level required to receive regulatory approval**.

We currently donot have manufacturing capabilities or experience necessary to produce ourproduct candidates, including R788 for clinical trials.  We also rely on a single manufacturer forR788 product for clinical testing. We will rely on manufacturers to delivermaterials on a timely basis and to comply with applicable regulatory requirements,including the U.S. Food and Drug Administration’s, or FDA’s current GoodManufacturing Practices, or GMP. These outsourcing efforts with respect tomanufacturing preclinical and clinical supplies will result in a dependence onour suppliers to timely manufacture and deliver sufficient quantities ofmaterials produced under GMP conditions to enable us to conduct plannedpreclinical studies, clinical trials and, if possible, to bring products tomarket in a timely manner.

Our current and anticipated future dependence uponthese third-party manufacturers may adversely affect our ability to develop andcommercialize product candidates on a timely and competitive basis. Thesemanufacturers may not be able to produce material on a timely basis ormanufacture material at the quality level or in the quantity required to meetour development timelines and applicable regulatory requirements. We may not beable to maintain or renew our existing third-party manufacturing arrangements,or enter into new arrangements, on acceptable terms, or at all. Our third-partymanufacturers could terminate or decline to renew our manufacturingarrangements based on their own business priorities, at a time that is costlyor inconvenient for us. If we are unable to contract for the production ofmaterials in sufficient quantity and of sufficient quality on acceptable terms,our planned clinical trials may be significantly delayed. Manufacturing delayscould postpone the filing of our IND applications and/or the initiation ofclinical trials that we have currently planned.

Our third-party manufacturers may not be able tocomply with the GMP regulations, other applicable FDA regulatory requirementsor similar regulations applicable outside of the United States. Additionally,if we are required to enter into new supply arrangements, we may not be able toobtain approval from the FDA of any alternate supplier in a timely manner, orat all, which could delay or prevent the clinical development andcommercialization of any related product candidates. Failure of our third-partymanufacturers or us to obtain approval from the FDA or to comply withapplicable regulations could result in sanctions being imposed on us, includingfines, civil penalties, delays in or failure to grant marketing approval of ourproduct candidates, injunctions, delays, suspension or withdrawal of approvals,license revocation, seizures or recalls of products and compounds, operatingrestrictions and criminal prosecutions, any of which could significantly andadversely affect our business.

**Because most of our expected future revenuesare contingent upon collaborative and license agreements, we might not meet ourstrategic objectives.**

Our ability to generate revenue in the near termdepends on our ability to enter into additional collaborative agreements withthird parties and to maintain the agreements we currently have in place. Ourability to enter into new collaborations and the revenue, if any, that may berecognized under these collaborations is highly uncertain. If we are unable toenter into new collaborations, our business prospects could be harmed, whichcould have an

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immediateadverse effect on the trading price of our stock.

To date, most of our revenues have been related to theresearch phase of each of our collaborative agreements. Such revenues are forspecified periods, and the impact of such revenues on our results of operationsis partially offset by corresponding research costs. Following the completionof the research phase of each collaborative agreement, additional revenues maycome only from milestone payments and royalties, which may not be paid, if atall, until some time well into the future. The risk is heightened due to thefact that unsuccessful research efforts may preclude us from receiving anymilestone payments under these agreements. Our receipt of revenues fromcollaborative arrangements is also significantly affected by the timing ofefforts expended by us and our collaborators and the timing of lead compoundidentification. In late 2001, we recorded the first revenue from achievement ofmilestones in both the Pfizer and Johnson & Johnson collaborations. Inaddition, we have subsequently received milestone payments from Novartis,Daiichi, Merck, Serono and Pfizer. Under many agreements, however, milestonepayments may not be earned until the collaborator has advanced productcandidates into clinical testing, which may never occur or may not occur untilsome time well into the future. If we are not able to generate revenue underour collaborations when and in accordance with our expectations or theexpectations of industry analysts, this failure could harm our business andhave an immediate adverse effect on the trading price of our stock.

Our business requires us to generate meaningfulrevenue from royalties and licensing agreements. To date, we have not receivedany revenue from royalties for the commercial sale of drugs, and we do not knowwhen we will receive any such revenue, if at all. Likewise, we have notlicensed any lead compounds or drug development candidates to third parties,and we do not know whether any such license will be entered into on acceptableterms in the future, if at all.

**If our current corporate collaborations orlicense agreements are unsuccessful, our research and development efforts couldbe delayed.**

Our strategy depends upon the formation andsustainability of multiple collaborative arrangements and license agreementswith third parties in the future. We rely on these arrangements for not onlyfinancial resources, but also for expertise that we expect to need in thefuture relating to clinical trials, manufacturing, sales and marketing, and forlicenses to technology rights. To date, we have entered into several sucharrangements with corporate collaborators; however, we do not know if suchthird parties will dedicate sufficient resources or if any development orcommercialization efforts by third parties will be successful. Should acollaborative partner fail to develop or commercialize a compound or product towhich it has rights from us for any reason including corporate restructuring,such failure might delay ongoing research and development efforts at Rigel,because we might not receive any future milestone payments, and we would notreceive any royalties associated with such compound or product. In addition,the continuation of some of our partnered drug discovery and developmentprograms may be dependent on the periodic renewal of our corporatecollaborations.

The research phase of our collaboration withJohnson & Johnson ended in 2003, and the research phases conducted atour facilities under our broad collaboration with Novartis ended in 2004.The research phase of our corporate collaboration agreement with Daiichi endedin 2005. In 2004, we signed a new corporate collaboration with Merck and in2005, we signed additional collaborations with Pfizer and Serono. Theseagreements could be terminated by the other party, and we may not be able torenew these collaborations on acceptable terms, if at all, or negotiateadditional corporate collaborations on acceptable terms, if at all. If these collaborationsterminate or are not renewed, any resultant loss of revenues from thesecollaborations or loss of the expertise of our collaborative partners couldadversely affect our business.

Conflicts also might arise with collaborative partnersconcerning proprietary rights to particular compounds. While our existingcollaborative agreements typically provide that we retain milestone paymentsand royalty rights with respect to drugs developed from certain derivativecompounds, any such payments or royalty rights may be at reduced rates, anddisputes may arise over the application of derivative payment provisions tosuch drugs, and we may not be successful in such disputes.

We are also a party to various license agreements thatgive us rights to use specified technologies in our research and developmentprocesses. The agreements pursuant to which we have in-licensed technologypermit our licensors to terminate the agreements under certain circumstances.If we are not able to continue to license these and future technologies oncommercially reasonable terms, our product development and research may bedelayed.

**If conflicts arise between our collaboratorsor advisors and us, any of them may act in their self-interest,**

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**which may be adverse to our stockholders’interests.**

If conflicts arise between us and our corporatecollaborators or scientific advisors, the other party may act in itsself-interest and not in the interest of our stockholders. Some of ourcorporate collaborators are conducting multiple product development effortswithin each disease area that is the subject of the collaboration with us ormay be acquired or merged with a company having a competing program. In some ofour collaborations, we have agreed not to conduct, independently or with anythird party, any research that is competitive with the research conducted underour collaborations. Our collaborators, however, may develop, either alone orwith others, products in related fields that are competitive with the productsor potential products that are the subject of these collaborations. Competingproducts, either developed by our collaborators or to which our collaboratorshave rights, may result in their withdrawal of support for our product candidates.

If any of our corporate collaborators were to breachor terminate its agreement with us or otherwise fail to conduct thecollaborative activities successfully and in a timely manner, the preclinicalor clinical development or commercialization of the affected product candidatesor research programs could be delayed or terminated. We generally do notcontrol the amount and timing of resources that our corporate collaboratorsdevote to our programs or potential products. We do not know whether current orfuture collaborative partners, if any, might pursue alternative technologies ordevelop alternative products either on their own or in collaboration withothers, including our competitors, as a means for developing treatments for thediseases targeted by collaborative arrangements with us.

**Our success is dependent on intellectualproperty rights held by us and third parties, and our interest in such rightsis complex and uncertain.**

Our success will depend to a large part on our own,our licensees’ and our licensors’ ability to obtain and defend patents for eachparty’s respective technologies and the compounds and other products, if any,resulting from the application of such technologies. We have over 200 pendingpatent applications and over 75 issued patents in the United States that areowned or exclusively licensed in our field as well as pending correspondingforeign patent applications. In the future, our patent position might be highlyuncertain and involve complex legal and factual questions. For example, we maybe involved in interferences before the United States Patent and TrademarkOffice. Interferences are complex and expensive legal proceedings and there isno assurance we will be successful in such proceedings. An interference couldresult in our losing our patent rights and/or our freedom to operate and/orrequire us to pay significant royalties. Additional uncertainty may resultbecause no consistent policy regarding the breadth of legal claims allowed inbiotechnology patents has emerged to date. Accordingly, we cannot predict thebreadth of claims allowed in our or other companies’ patents.

Because the degree offuture protection for our proprietary rights is uncertain, we cannot ensurethat:

·              we were the first tomake the inventions covered by each of our pending patent applications;

·              we were the first tofile patent applications for these inventions;

·              others will notindependently develop similar or alternative technologies or duplicate any ofour technologies;

·              any of our pendingpatent applications will result in issued patents;

·              any patents issuedto us or our collaborators will provide a basis for commercially-viableproducts or will provide us with any competitive advantages or will not bechallenged by third parties;

·              we will developadditional proprietary technologies that are patentable; or

·              the patents of others will not have anegative effect on our ability to do business.

We rely on trade secrets to protect technology wherewe believe patent protection is not appropriate or obtainable. However, tradesecrets are difficult to protect. While we require employees, collaborators andconsultants to enter into confidentiality agreements, we may not be able toadequately protect our trade secrets or other proprietary information in theevent of any unauthorized use or disclosure or the lawful development by othersof such information.

We area party to certain in-license agreements that are important to our business,and we generally do not control the prosecution of in-licensed technology.Accordingly, we are unable to exercise the same degree of control over thisintellectual property as we exercise over our internally-developed technology.Moreover, some of our academic institution licensors, research collaboratorsand scientific advisors have rights to publish data and

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information inwhich we have rights. If we cannot maintain the confidentiality of ourtechnology and other confidential information in connection with ourcollaborations, then our ability to receive patent protection or protect ourproprietary information will be impaired. In addition, some of the technologywe have licensed relies on patented inventions developed using U.S. governmentresources. The U.S. government retains certain rights, as defined by law, in suchpatents, and may choose to exercise such rights. Certain of our in-licenses maybe terminated if we fail to meet specified obligations. If we fail to meet suchobligations and any of our licensors exercise their termination rights, wecould lose our rights under those agreements. If we lose any of our rights, itmay adversely affect the way we conduct our business. In addition, becausecertain of our licenses are sublicenses, the actions of our licensors mayaffect our rights under those licenses.

**If a dispute arises regarding theinfringement or misappropriation of the proprietary rights of others, suchdispute could be costly and result in delays in our research and developmentactivities and partnering.**

Our success willalso depend, in part, on our ability to operate without infringing ormisappropriating the proprietary rights of others. There are many issuedpatents and patent applications filed by third parties relating to products orprocesses that are similar or identical to ours or our licensors, and othersmay be filed in the future. There can be no assurance that our activities, orthose of our licensors, will not infringe patents owned by others. We believethat there may be significant litigation in the industry regarding patent andother intellectual property rights, and we do not know if we or ourcollaborators would be successful in any such litigation. Any legal actionagainst our collaborators or us claiming damages or seeking to enjoincommercial activities relating to the affected products, our methods orprocesses could:

·              require ourcollaborators or us to obtain a license to continue to use, manufacture ormarket the affected products, methods or processes, which may not be availableon commercially reasonable terms, if at all;

·              prevent us fromusing the subject matter claimed in the patents held by others;

·              subject us topotential liability for damages;

·              consume asubstantial portion of our managerial and financial resources; and

·              result in litigation or administrativeproceedings that may be costly, whether we win or lose.

**If we are unable to obtain regulatoryapproval to market products in the United States and foreign jurisdictions, wemight not be permitted to commercialize products from our research anddevelopment.**

Due, in part, tothe early stage of our product candidate research and development process, wecannot predict whether regulatory clearance will be obtained for any productthat we, or our collaborative partners, hope to develop. Satisfaction ofregulatory requirements typically takes many years, is dependent upon the typecomplexity and novelty of the product and requires the expenditure ofsubstantial resources. Of particular significance to us are the requirementsrelating to research and development and testing.

Before commencingclinical trials in humans in the United States, we, or our collaborativepartners, will need to submit and receive approval from the FDA of an IND.Clinical trials are subject to oversight by institutional review boards and theFDA and:

·              must be conducted inconformance with the FDA’s good clinical practices and other applicableregulations;

·              must meetrequirements for institutional review board oversight;

·              must meetrequirements for informed consent;

·              are subject tocontinuing FDA oversight;

·              may require largenumbers of test subjects; and

·              may be suspended byus, our collaborators or the FDA at any time if it is believed that thesubjects participating in these trials are being exposed to unacceptable healthrisks or if the FDA finds deficiencies in the IND or the conduct of thesetrials.

While we have stated that we intend to file additionalINDs, this is only a statement of intent, and we may not be able to do sobecause we may not be able to identify potential product candidates. In addition,the FDA may not approve any IND in a timely manner, or at all.

Before receiving FDA approval to market a product, wemust demonstrate that the product is safe and effective in the patientpopulation and the indication that will be treated. Data obtained frompreclinical and clinical activities are susceptible to varying interpretationsthat could delay, limit or prevent regulatory approvals. In

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addition,delays or rejections may be encountered based upon additional governmentregulation from future legislation or administrative action or changes in FDApolicy during the period of product development, clinical trials and FDAregulatory review. Failure to comply with applicable FDA or other applicableregulatory requirements may result in criminal prosecution, civil penalties,recall or seizure of products, total or partial suspension of production orinjunction, as well as other regulatory action against our potential productsor us. Additionally, we have limited experience in conducting and managing theclinical trials necessary to obtain regulatory approval.

If regulatory approval of a product is granted, thisapproval will be limited to those indications or disease states and conditionsfor which the product is demonstrated through clinical trials to be safe andefficacious. We cannot ensure that any compound developed by us, alone or withothers, will prove to be safe and efficacious in clinical trials and will meetall of the applicable regulatory requirements needed to receive marketingapproval.

Outside the United States, our ability, or that of ourcollaborative partners, to market a product is contingent upon receiving amarketing authorization from the appropriate regulatory authorities. Thisforeign regulatory approval process typically includes all of the risksassociated with FDA approval described above and may also include additionalrisks.

**If our competitors develop technologies thatare more effective than ours, our commercial opportunity will be reduced oreliminated.**

The biotechnology and pharmaceutical industries areintensely competitive and subject to rapid and significant technologicalchange. Many of the drugs that we are attempting to discover will be competingwith existing therapies. In addition, a number of companies are pursuing thedevelopment of pharmaceuticals that target the same diseases and conditionsthat we are targeting. We face competition from pharmaceutical andbiotechnology companies both in the United States and abroad.

Our competitors may utilize discovery technologies andtechniques or partner with collaborators in order to develop products morerapidly or successfully than we, or our collaborators, are able to do. Many ofour competitors, particularly large pharmaceutical companies, havesubstantially greater financial, technical and human resources than we do. Inaddition, academic institutions, government agencies and other public andprivate organizations conducting research may seek patent protection withrespect to potentially competitive products or technologies and may establishexclusive collaborative or licensing relationships with our competitors.

We believe that our ability to compete is dependent,in part, upon our ability to create, maintain and licensescientifically-advanced technology and upon our and our collaborators’ abilityto develop and commercialize pharmaceutical products based on this technology,as well as our ability to attract and retain qualified personnel, obtain patentprotection or otherwise develop proprietary technology or processes and securesufficient capital resources for the expected substantial time period betweentechnological conception and commercial sales of products based upon ourtechnology. The failure by us or any of our collaborators in any of those areasmay prevent the successful commercialization of our potential drug targets.

Our competitors might develop technologies and drugsthat are more effective or less costly than any that are being developed by usor that would render our technology and potential drugs obsolete andnoncompetitive. In addition, our competitors may succeed in obtaining theapproval of the FDA or other regulatory agencies for product candidates morerapidly. Companies that complete clinical trials, obtain required regulatoryagency approvals and commence commercial sale of their drugs before theircompetitors may achieve a significant competitive advantage, including certainpatent and FDA marketing exclusivity rights that would delay or prevent ourability to market certain products. Any drugs resulting from our research anddevelopment efforts, or from our joint efforts with our existing or futurecollaborative partners, might not be able to compete successfully withcompetitors’ existing or future products or obtain regulatory approval in theUnited States or elsewhere.

**Our ability to generate revenues will bediminished if our collaborative partners fail to obtain acceptable prices or anadequate level of reimbursement for products from third-party payors orgovernment agencies.**

The drugs we hopeto develop may be rejected by the marketplace due to many factors, includingcost. Our ability to commercially exploit a drug may be limited due to thecontinuing efforts of government and third-party payors to contain or reducethe costs of health care through various means. For example, in some foreignmarkets, pricing and profitability of prescription pharmaceuticals are subjectto government control. In the United States, we expect that there will continueto be a number of federal and state proposals to implement similar government

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control. In addition, increasing emphasis on managedcare in the United States will likely continue to put pressure on the pricingof pharmaceutical products. Cost control initiatives could decrease the pricethat any of our collaborators would receive for any products in the future.Further, cost control initiatives could adversely affect our collaborators’ability to commercialize our products and our ability to realize royalties fromthis commercialization.

Our ability to commercialize pharmaceuticalproducts with collaborators may depend, in part, on the extent to whichreimbursement for the products will be available from:

·              government andhealth administration authorities;

·              private healthinsurers; and

·              other third-party payors.

Significantuncertainty exists as to the reimbursement status of newly-approved healthcareproducts. Third-party payors, including Medicare, are challenging the pricescharged for medical products and services. Government and other third-partypayors increasingly are attempting to contain healthcare costs by limiting bothcoverage and the level of reimbursement for new drugs and by refusing, in somecases, to provide coverage for uses of approved products for diseaseindications for which the FDA has not granted labeling approval. Third-partyinsurance coverage may not be available to patients for any products wediscover and develop, alone or with collaborators. If government and otherthird-party payors do not provide adequate coverage and reimbursement levelsfor our products, the market acceptance of these products may be reduced.

**If product liability lawsuits aresuccessfully brought against us, we may incur substantial liabilities and maybe required to limit commercialization of our products.**

The testing andmarketing of medical products entail an inherent risk of product liability. Ifwe cannot successfully defend ourselves against product liability claims, wemay incur substantial liabilities or be required to limit commercialization ofour products although we are not currently aware of any specific causes forconcern with respect to clinical liability claims. We currently do not haveproduct liability insurance, and our inability to obtain sufficient productliability insurance at an acceptable cost to protect against potential productliability claims could prevent or inhibit the commercialization ofpharmaceutical products we develop, alone or with corporate collaborators. We,or our corporate collaborators, might not be able to obtain insurance at areasonable cost, if at all. While under various circumstances we are entitledto be indemnified against losses by our corporate collaborators,indemnification may not be available or adequate should any claim arise.

**Our research and development efforts will beseriously jeopardized, if we are unable to attract and retain key employees andrelationships.**

As a small companywith only 149 employees as of September 30, 2006, our success depends on thecontinued contributions of our principal management and scientific personneland on our ability to develop and maintain important relationships with leadingacademic institutions, scientists and companies in the face of intensecompetition for such personnel. In particular, our research programs depend onour ability to attract and retain highly skilled chemists, other scientists,and development, regulatory and clinical personnel. If we lose the services ofany of our personnel, our research and development efforts could be seriouslyand adversely affected. Our employees can terminate their employment with us atany time.

**We depend on various scientific consultantsand advisors for the success and continuation of our research and developmentefforts.**

We workextensively with various scientific consultants and advisors. The potentialsuccess of our drug discovery and development programs depends, in part, oncontinued collaborations with certain of these consultants and advisors. We,and various members of our management and research staff, rely on certain ofthese consultants and advisors for expertise in our research, regulatory andclinical efforts. Our scientific advisors are not our employees and may havecommitments to, or consulting or advisory contracts with, other entities thatmay limit their availability to us. We do not know if we will be able tomaintain such consulting agreements or that such scientific advisors will notenter into consulting arrangements, exclusive or otherwise, with competingpharmaceutical or biotechnology companies, any of which would have adetrimental impact on our research objectives and could have a material adverseeffect on our business, financial condition and results of operations.

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**If we use biological and hazardous materialsin a manner that causes injury or violates laws, we may be liable for damages.**

Our research anddevelopment activities involve the controlled use of potentially harmfulbiological materials as well as hazardous materials, chemicals and variousradioactive compounds. We cannot completely eliminate the risk of accidentalcontamination or injury from the use, storage, handling or disposal of thesematerials. In the event of contamination or injury, we could be held liable fordamages that result, and such liability could exceed our resources. We are alsosubject to federal, state and local laws and regulations governing the use,storage, handling and disposal of these materials and specified waste products.The cost of compliance with, or any potential violation of, these laws andregulations could be significant.

**Our facilities are located near knownearthquake fault zones, and the occurrence of an earthquake or othercatastrophic disaster could cause damage to our facilities and equipment, whichcould require us to cease or curtail operations.**

Our facilities are located in the San Francisco BayArea near known earthquake fault zones and are vulnerable to significant damagefrom earthquakes. We are also vulnerable to damage from other types ofdisasters, including fires, floods, power loss, communications failures andsimilar events. If any disaster were to occur, our ability to operate ourbusiness at our facilities would be seriously, or potentially completely,impaired, and our research could be lost or destroyed. In addition, the uniquenature of our research activities and of much of our equipment could make itdifficult for us to recover from a disaster. The insurance we maintain may notbe adequate to cover our losses resulting from disasters or other businessinterruptions.

**Our stock price may be volatile, and ourstockholders’ investment in our stock could decline in value.**

The market pricesfor our securities and those of other biotechnology companies have been highlyvolatile and may continue to be highly volatile in the future. The followingfactors, in addition to other risk factors described in this section, may havea significant impact on the market price of our common stock:

·              the progress andsuccess of clinical trials and preclinical activities (i.e., studies,manufacture of materials) of our product candidates conducted by us or ourcollaborative partners or licensees;

·              the receipt orfailure to receive the additional funding necessary to conduct our business;

·              selling by largestockholders;

·              announcements oftechnological innovations or new commercial products by our competitors or us;

·              developmentsconcerning proprietary rights, including patents;

·              developmentsconcerning our collaborations;

·              publicity regardingactual or potential medical results relating to products under development byour competitors or us;

·              regulatorydevelopments in the United States and foreign countries;

·              litigation;

·              economic and otherexternal factors or other disaster or crisis; and

·              period-to-period fluctuations infinancial results.

**Anti-takeover provisions in our charterdocuments and under Delaware law may make an acquisition of us, which may bebeneficial to our stockholders, more difficult.**

Provisions of our amended and restated certificate ofincorporation and bylaws, as well as provisions of Delaware law, could make itmore difficult for a third party to acquire us, even if doing so would benefitour stockholders. These provisions:

·              establish thatmembers of the board of directors may be removed only for cause upon theaffirmative vote of stockholders owning a majority of our capital stock;

·              authorize theissuance of “blank check” preferred stock that could be issued by our board ofdirectors to increase the number of outstanding shares and thwart a takeoverattempt;

·              limit who may call aspecial meeting of stockholders;

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·              prohibit stockholderaction by written consent, thereby requiring all stockholder actions to betaken at a meeting of our stockholders;

·              establish advancenotice requirements for nominations for election to the board of directors orfor proposing matters that can be acted upon at stockholder meetings;

·              provide for a boardof directors with staggered terms; and

·              provide that theauthorized number of directors may be changed only by a resolution of our boardof directors.

In addition,Section 203 of the Delaware General Corporation Law, which imposes certainrestrictions relating to transactions with major stockholders, may discourage,delay or prevent a third party from acquiring us.

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

In July 2006, weamended our facility lease in order to defer certain rent payments tooriginally occur in 2006 and 2007.  Theamended lease agreement also included a warrant to purchase 100,000 shares ofour common stock at $10.57 per share. The warrant was issued to Kwacker Limited and remains exercisable untilJuly 2013.  The warrant was issued inreliance upon the exemption from the registration requirements under theSecurities Act of 1933, as amended, pursuant to Regulation D  thereunder. Rigel relied upon representationsand covenants of Kwacker in support of the satisfaction of the conditionscontained in Regulation D under the Securities Act.

**Item 6.****    Exhibits**

The exhibits listed onthe accompanying index to exhibits are filed or incorporated by reference (asstated therein) as part of this Quarterly Report on Form 10-Q.

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, as amended, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.
|        | RIGEL  PHARMACEUTICALS, INC. |
|--------|------------------------------|
|   |                         |
|   |                         |
|   | By:                          | /s/ JAMES M.  GOWER |
|   |                         | James M. Gower |
|   |                         | Chief Executive  Officer |
|   |                         |
|   |                         |
|   | Date:                        | November 7, 2006 |
|   |                         |   |
|   |                         |
|   | By:                          | /s/ RYAN D.  MAYNARD |
|   |                         | Ryan D. Maynard |
|   |                         | Vice President  of Finance and Acting Chief  Financial Officer |
|   |                         | (Principal  Financial and Accounting Officer) |
|   |                         |
|   |                         |
|   | Date:                        | November 7, 2006 |

 

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**INDEX TO EXHIBITS**
| Exhibit Number | ** ** | **Description of Document**                                                                                                                                                             |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Amended and Restated Certificate of  Incorporation.(1)                                                                                                                                            |
| 3.2                 |       | Amended and Restated Bylaws.(2)                                                                                                                                                                   |
| 4.6                 |       | Warrant issued to Kwacker Limited for the purchase  of shares of common stock                                                                                                                     |
| 15.1                |       | Letter re: unaudited interim financial information.                                                                                                                                               |
| 31.1                |       | Certification required by  Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.                                                                                              |
| 31.2                |       | Certification required by  Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.                                                                                              |
| 32.1                |       | Certification required by  Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and  Section 1350 of Chapter 63 of Title 18 of the United States Code (18  U.S.C. 1350). |

 

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(1)           Filed as an exhibit to Rigel’s Current Reporton Form 8-K on June 24, 2003 and incorporated herein by reference.

(2)           Filed as an exhibit to Rigel’s RegistrationStatement on Form S-1, as amended, and incorporated herein by reference.

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