**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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** **

**FORM 10-Q**

 
| **ý**                                          | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|-----------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                |       |                                                                                                     |
| **FOR THE  QUARTERLY PERIOD ENDED MARCH 31, 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          .**

 

**Commission File Number 0-29889**

 

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**Rigel Pharmaceuticals, Inc.**

(Exact name of registrant asspecified 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)      |       |                                  |

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days. Yes  ý  No  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act)(Check one):
| Large  accelerated filer o |   | Accelerated  filer ý |   | Non-accelerated  filer o |
|----------------------------|--------|---------------------------|--------|--------------------------|

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes  o  No  ý

 

As of April 28, 2006, there were 24,842,635 shares of the registrant’scommon stock outstanding.

 

 

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**RIGELPHARMACEUTICALS, INC.**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THEQUARTERLY PERIOD ENDED MARCH 31, 2006**

 

**INDEX**

 
| **PART I**  | ** ** | **FINANCIAL INFORMATION**                                                                   |   |
|------------------|------------|---------------------------------------------------------------------------------------------|--------|
| **Item 1.**      |       | Financial Statements (unaudited)                                                            | 3      |
|             |       | Balance  Sheets - March 31, 2006 and December 31, 2005                                 | 3      |
|             |       | Condensed Statements of Operations - three months ended March 31,  2006 and 2005            | 4      |
|             |       | Condensed Statements of Cash Flows - three months ended  March 31, 2006 and 2005       | 5      |
|             |       | Notes to Condensed Financial Statements                                                     | 6      |
|             |       | Report of Independent Registered Public Accounting Firm                                     | 13     |
| **Item 2.**      |       | Management’s Discussion and Analysis of Financial Condition and  Results of Operations | 14     |
| **Item 3.**      |       | Quantitative and Qualitative Disclosures About Market Risk                                  | 20     |
| **Item 4.**      |       | Controls and Procedures                                                                     | 20     |
| **PART II** | ** ** | **OTHER  INFORMATION**                                                                      |   |
| **Item  1A.**    |       | Risk  Factors                                                                               | 21     |
| **Item 6.**      |       | Exhibits                                                                                    | 29     |
|             |       |                                                                                        |   |
| **Signatures**   |       |                                                                                        | 30     |

 

2

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**PART I  FINANCIAL INFORMATION**

** **

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

 

**RIGEL PHARMACEUTICALS, INC.**

**BALANCE SHEETS**

**(in thousands, except share amounts)**

 

 
| ** **                                                                                                                                                                          | ** ** | **March 31,  2006** | ** ** | **December 31,  2005(1)** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | ** **               | ** ** |
| ** **                                                                                                                                                                          | ** ** | **(unaudited)**          | ** ** | ** **                     | ** ** |
| **Assets**                                                                                                                                                                          |       |                     |       |                           |       |
| Current assets:                                                                                                                                                                     |       |                     |       |                           |       |
| Cash and cash equivalents                                                                                                                                                           |       | $                        | 65,286     |                           | $          | 76,779 |   |
| Available-for-sale securities                                                                                                                                                       |       | 63,081                   |       | 61,417                         |       |
| Accounts receivable                                                                                                                                                                 |       | 1,630                    |       | 1,050                          |       |
| Other receivables                                                                                                                                                                   |       | 911                      |       | 777                            |       |
| Prepaid expenses and other current assets                                                                                                                                           |       | 2,491                    |       | 2,573                          |       |
| Total current assets                                                                                                                                                                |       | 133,399                  |       | 142,596                        |       |
|                                                                                                                                                                                |       |                     |       |                           |       |
| Property and equipment, net                                                                                                                                                         |       | 3,477                    |       | 3,457                          |       |
| Other assets                                                                                                                                                                        |       | 1,590                    |       | 1,615                          |       |
|                                                                                                                                                                                |       | $                        | 138,466    |                           | $          | 147,668 |   |
|                                                                                                                                                                                |       |                     |       |                           |       |
| Liabilities and stockholders’ equity                                                                                                                                           |       |                     |       |                           |       |
| Current liabilities:                                                                                                                                                                |       |                     |       |                           |       |
| Accounts payable                                                                                                                                                                    |       | $                        | 2,537      |                           | $          | 2,497 |   |
| Accrued compensation                                                                                                                                                                |       | 1,450                    |       | 2,189                          |       |
| Other accrued liabilities                                                                                                                                                           |       | 1,324                    |       | 2,324                          |       |
| Deferred revenue                                                                                                                                                                    |       | 13,656                   |       | 15,567                         |       |
| Capital lease obligations                                                                                                                                                           |       | 1,218                    |       | 1,070                          |       |
| Total current liabilities                                                                                                                                                           |       | 20,185                   |       | 23,647                         |       |
|                                                                                                                                                                                |       |                     |       |                           |       |
| Long-term portion of capital lease  obligations                                                                                                                                     |       | 1,550                    |       | 1,132                          |       |
| Long-term portion of deferred revenue                                                                                                                                               |       | 1,336                    |       | 2,771                          |       |
| Long-term portion of deferred rent                                                                                                                                                  |       | 11,214                   |       | 11,121                         |       |
| Other long-term liabilities                                                                                                                                                         |       | 397                      |       | 409                            |       |
|                                                                                                                                                                                |       |                     |       |                           |       |
| Commitments                                                                                                                                                                         |       |                     |       |                           |       |
|                                                                                                                                                                                |       |                     |       |                           |       |
| Stockholders’ equity:                                                                                                                                                          |       |                     |       |                           |       |
| Common stock, $0.001 par value; 100,000,000  shares authorized; 24,833,132 and 24,814,671 shares issued and outstanding on  March 31, 2006 and December 31, 2005, respectively |       | 25                       |       | 25                             |       |
| Additional paid-in capital                                                                                                                                                          |       | 369,882                  |       | 366,203                        |       |
| Deferred stock compensation                                                                                                                                                         |       | —                   |       | (26                            | )          |
| Accumulated other comprehensive loss                                                                                                                                                |       | (132                     | )          | (92                            | )          |
| Accumulated deficit                                                                                                                                                                 |       | (265,991                 | )          | (257,522                       | )          |
| Total stockholders’ equity                                                                                                                                                     |       | 103,784                  |       | 108,588                        |       |
|                                                                                                                                                                                |       | $                        | 138,466    |                           | $          | 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 onForm 10-K for the year ended December 31, 2005.

 

See accompanying notes.

 

3

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**RIGELPHARMACEUTICALS, INC.****CONDENSED STATEMENTS OF OPERATIONS(in thousands, except per share amounts)**

**(unaudited)**

** **
| ** **                                                                              | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Contract revenues from collaborations                                                   |       | $                                                    | 9,897      |   | $ | 2,618 |   |
|                                                                                    |       |                                                 |       |   |   |
| Costs and expenses:                                                                     |       |                                                 |       |   |   |
| Research and development                                                                |       | 14,711                                               |       | 11,173 |   |
| General and administrative                                                              |       | 5,003                                                |       | 2,874 |   |
|                                                                                    |       | 19,714                                               |       | 14,047 |   |
|                                                                                    |       |                                                 |       |   |   |
| Loss from operations                                                                    |       | (9,817                                               | )          | (11,429 | ) |
| Interest income                                                                         |       | 1,413                                                |       | 330 |   |
| Interest expense                                                                        |       | (65                                                  | )          | (65 | ) |
| Net loss                                                                                |       | (8,469                                               | )          | (11,164 | ) |
| Net loss per common share, basic and  diluted                                           |       | $                                                    | (0.34      | ) | $ | (0.57 | ) |
| Weighted average shares used in computing  net loss per common share, basic and diluted |       | 24,816                                               |       | 19,713 |   |

 

See accompanying notes.

 

4

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**RIGELPHARMACEUTICALS, INC.****CONDENSED STATEMENTSOF CASH FLOWS****(in thousands)**

**(unaudited**)

 
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| **Operating activities**                                                | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                                                | (8,469     | ) | $ | (11,164 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                |       | 334                                              |       | 305 |   |
| Amortization of deferred stock  compensation, net                            |       | —                                           |       | 6 |   |
| Non-cash stock compensation expense  (recovery)                              |       | 3,561                                            |       | (1,474 | ) |
| Changes in assets and liabilities:                                           |       |                                             |       |   |   |
| Accounts receivable                                                          |       | (580                                             | )          | (1,610 | ) |
| Other receivables                                                            |       | (134                                             | )          | (223 | ) |
| Prepaid expenses and other current assets                                    |       | 82                                               |       | (510 | ) |
| Other assets                                                                 |       | 25                                               |       | 43 |   |
| Accounts payable                                                             |       | 40                                               |       | 378 |   |
| Accrued compensation                                                         |       | (739                                             | )          | (439 | ) |
| Other accrued liabilities                                                    |       | (1,000                                           | )          | (71 | ) |
| Deferred revenue                                                             |       | (3,346                                           | )          | 9,361 |   |
| Deferred rent and other long-term  liabilities                               |       | 81                                               |       | (696 | ) |
| Net cash used in operating activities                                        |       | (10,145                                          | )          | (6,094 | ) |
| **Investing activities**                                                     |       |                                             |       |   |   |
| Purchases of available-for-sale securities                                   |       | (11,154                                          | )          | (16,163 | ) |
| Maturities of available-for-sale securities                                  |       | 9,450                                            |       | 19,505 |   |
| Capital expenditures                                                         |       | (354                                             | )          | (478 | ) |
| Net cash (used in) provided by investing  activities                         |       | (2,058                                           | )          | 2,864 |   |
| **Financing activities**                                                     |       |                                             |       |   |   |
| Proceeds from capital lease financing                                        |       | 882                                              |       | 1,002 |   |
| Payments on capital lease obligations                                        |       | (316                                             | )          | (466 | ) |
| Net proceeds from issuances of common stock  and warrants                    |       | 144                                              |       | 5,109 |   |
| Net cash provided by financing activities                                    |       | 710                                              |       | 5,645 |   |
| Net increase (decrease) in cash and cash  equivalents                        |       | (11,493                                          | )          | 2,415 |   |
| Cash and cash equivalents at beginning of  period                            |       | 76,779                                           |       | 10,495 |   |
| Cash and cash equivalents at end of period                                   |       | $                                                | 65,286     |   | $ | 12,910 |   |

 

See accompanying notes.

 

5

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**RigelPharmaceuticals, Inc.**

**Notes toCondensed Financial Statements**

**(unaudited)**

 

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

 

**1. Nature of Operations**

 

We were incorporated in the state of Delawareon June 14, 1996. We are engaged in the discovery and development ofnovel, small-molecule drugs for the treatment of inflammatory diseases, cancerand viral diseases.

 

**2. Basis of Presentation**

 

Our accompanying unaudited condensedfinancial statements have been prepared in accordance with generally acceptedaccounting principles for interim financial information and pursuant to theinstructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the informationand notes required by generally accepted accounting principles for completefinancial statements. In our opinion, these unaudited condensedfinancial statements include all adjustments, consisting only of normalrecurring adjustments, which we consider necessary to fairly state ourfinancial position 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 generally accepted accounting principles forcomplete financial statements. These unaudited condensed financial statementsand the notes accompanying them should be read in conjunction with our AnnualReport on Form 10-K for the year ended December 31, 2005.

 

The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. Actual results could differ fromthese estimates.

 

Comprehensive net loss did not differmaterially from the net loss as reported.

 

**3. Basic and Diluted Net Loss Per Share**

 

Basic net loss per share was computed basedon the number of weighted average shares outstanding. The calculation ofdiluted net loss per share excluded shares of potential common stock,consisting of stock options and warrants, because their effect would have beenanti-dilutive.

 

**4. Stock Award Plans**

 

We have two stock option plans, the 2000Equity Incentive Plan and 2000 Non-Employee Directors Stock Option Plan, thatprovide for granting to officers, directors, all other employees and other nonemployeesoptions to purchase shares of our common stock. Under the plans, we may issuenon-qualified options or incentive stock options. We also have an employe stockpurchase plan, or ESPP, where eligible employees can purchase shares of ourcommon stock at a price per share equal to 85% of the lower of the fair marketvalue on the first and last day of each six-month purchase period. The benefitsprovided under these plans are share-based payments subject to the provisionsof SFAS 123(R). In December 2004, the Financial Accounting StandardsBoard, or FASB, issued Statement of Financial Accounting Standards No. 123(R), “Share-BasedPayment (Revised 2004)”, or SFAS 123(R), which replaces SFAS No. 123, “Accountingfor Stock-Based Compensation”, or SFAS 123, and supersedes Accounting Principles Board Option No. 25, “Accountingfor Stock Issued to Employees”, or APB 25. In March 2005, the SEC issuedStaff Accounting Bulletin No. 107, or SAB 107, providing supplementalimplementation guidance for SFAS 123(R). In April 2005, the SEC issued “Amendmentto Rule 04-01(a) of Regulation S-X Regarding the Compliance Date forStatement of Financial Accounting Standard No.123(R), ‘Share-Based Payment’”(the “Amendment to Rule 4-01(a)”), changing the effective date for mostpublic companies to adopt SFAS 123(R) to the first interim reportingperiod of a company’s fiscal year that begins on or after June 15, 2005.Under the Amendment to Rule 4-01(a), we were required to adopt SFAS123(R) in our first quarter of fiscal year 2006.

 

Effective January 1, 2006, we adopted the provisions of SFAS 123(R)using the modified prospective application transition method. Under thismethod, the share-based compensation cost recognized beginning January 1, 2006includes compensation cost for (i) all share-based payments granted prior to,but not vested as of January 1, 2006, based on the grant date fair valueoriginally estimated in accordance with the provisions of SFAS 123 andcalculated for pro forma disclosures under SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure”, or SFAS 148, and (ii)all share-based payments granted subsequent to January 1, 2006, based on thegrant date fair value estimated in accordance with the provisions of SFAS123(R). Compensation cost under SFAS 123(R) for awards granted prior to January1, 2006 is recognized using an accelerated method pursuant to the FASBInterpretation No. 28, “Accounting for Stock Appreciation Rights and OtherVariable Stock Option or Award Plans”, or FIN 28. For awards granted afterJanuary 1, 2006, we have adopted the use of the straight-line attributionmethod over the requisite service period

 

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for the entire award. Results of prior periods do not reflect anyrestated amounts, and we had no cumulative effect adjustment upon adoption ofSFAS No. 123(R) under the modified prospective method.

 

***Impact of theAdoption of FAS 123(R)***

 

Total stock-based compensation expense, related to all of the Company’sshare-based awards, recognized for the three months ended March 31, 2006 and2005 was comprised as follows (in thousands, except per share amounts):

 

 
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Research and development                                                 |       | $                                                | 1,921      |   | $ | (1,027 | ) |
| General and administrative                                               |       | 1,640                                            |       | (441 | ) |
| Stock-based compensation expense (recovery)                              |       | $                                                | 3,561      |   | $ | (1,468 | ) |
|                                                                     |       |                                             |       |   |   |
| Stock-based compensation expense (recovery)  per share Basic and diluted |       | $                                                | 0.14       |   | $ | (0.07 | ) |

 

We recorded approximately $3.6 million in stock-based compensationexpense in the three months ended March 31, 2006, of which approximately $3.3million  related to share-based awardsgranted to officers, directors and all other employees from our stock optionplans and ESPP and approximately $277,000 related to options granted toconsultants, which is discussed below. Pursuant to SFAS 123(R), we are requiredto estimate the amount of expected forfeitures when calculating thecompensation costs, instead of accounting for forfeitures as incurred, whichwas our previous method. Our weighted annual average forfeiture rate is 4.7%. Wewill record actual forfeitures as they occur, and we will review our forfeiturerates each quarter and make changes to our estimate.

 

For the three months ended March 31, 2006, werecorded charges of approximately $277,000 associated with options granted toconsultants, reflecting the fair value and periodic fair value remeasurement ofoutstanding consultant options under EITF 96-18, “Accounting for EquityInstruments That are Issued to Other Than Employees for Acquiring, or inConjunction with Selling Goods or Services.”  The valuation is based upon the current market value of our common stockand other assumptions, including the expected future volatility of our stockprice, risk-free interest rate and expected term. For consultant optionsgranted in the first three months of 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 FAS 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 recoveryrelating to our consultant options of $207,000 for the three months ended March31, 2005. We expect to see continued fluctuations in the future as a portion ofthese options are remeasured based on the changes in the current market priceof our common stock.

 

In 2005, we recorded charges associated withthe stock options that were eligible for re-pricing under a tender offerinitiated in June 2003. All replacement options, as well as the eligibleoptions that were not surrendered under the original offer to exchange, weretreated for financial reporting purposes as variable awards. Therefore, for theperiod prior to adoption of FAS 123(R), we recorded a non-cash charge,generally for the intrinsic value of the options as they vested under APB 25,utilizing the accelerated vesting method, reflecting increases and decreases(down to, but not below, the exercise price) in the price of our common stockas compensation expense (recovery) in connection with the replacement optionsand the eligible options that were not exchanged. For the three months endedMarch 31, 2005, we recorded non-cash compensation recovery of $1.3 millionrelated to all employee options eligible for replacement options. The recoveryresulted from the decrease in the market price of our common stock during theperiod. For periods after the adoption of FAS 123(R), we are continuing toaccount for the vested portion of the options repriced prior to the adoption ofSFAS 123(R) in accordance with provisions of SFAS 123.

 

Under FAS 123(R), the fair value of eachoption award is estimated on the date of grant using the Black-Scholes optionpricing model. We have segregated option awards into three homogenous groups(i.e., Officers and Directors, All Other Employees and Non-employees orConsultants) for purposes of determining fair values of options.

 

We determined weighted-average valuationassumptions separately for the groups as follows:

 

•                  Volatility-  We estimated volatility using thehistorical share price performance over the expected life of the option. As ourpublicly listed options are not actively traded, implied volatility was notrepresentative of our current volatility. We also considered other factors suchas our current clinical trials and other company activities that may affectvolatility of our stock in the future but determined that at this time, thehistorical volatility was more indicative of our expected future stockperformance.

 

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•                  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 date to exercise date; (2) cancellation term ofoptions from grant date to cancellation date and excluding unvested optionforfeitures 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 and all other employees) and other factors that mayaffect the expected term of the option. For nonemployee options, we use thecontractual term of the option, which is generally ten years, for the initialvaluation of the option and the remaining contractual term of the option forthe succeeding years.

 

•                  Risk-freeinterest rate - The risk-free interest rate is based on the U.S. Treasury ofconstant maturity rates with similar terms to the expected term of the options foreach option group.

 

•                  Forfeiturerate - We estimated the forfeiture rate using our historical experience withpre-vesting options. Our weighted-average forfeiture rate is approximately4.7%. We review our forfeiture rates each quarter and make changes as factorsaffecting our forfeiture rate calculations and assumptions change.

 

•                  Dividendyield - The expected dividend yield is 0% as we have not and do not expect topay dividends.

 

The following table summarizes theweighted-average assumptions relating to our employee options for the threemonths ended March 31, 2006 and 2005 as permitted under FAS 123(R) for 2006 andFAS 123 for 2005:

 

 
| ** **               | ** ** | **Stock Option Plans  Three Months Ended  March 31,** | ** ** |
|--------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                                       | ** ** | **2005** | ** ** |
| Risk-free interest rate  |       | 4.6                                                                            | %          | 4.2 | % |
| Expected life (in years) |       | 4.5                                                                            |       | 2.1 |   |
| Dividend yield           |       | 0.0                                                                            | %          | 0.0 | % |
| Expected volatility      |       | 99.5                                                                           | %          | 75.0 | % |

 

Option prices are not less than the marketprice of our common stock on the date of grant, become exercisable at varyingdates and generally expire ten years from the date of grant. At March 31, 2006,options to purchase 1,061,590 shares of common stock were available for grantunder our stock option plans.

 

***Employee Stock Purchase Plan***

 

The fair value of each option element of ouremployee stock purchase plan (ESPP) is estimated on the date of grant using theBlack-Scholes option pricing model that uses weighted-average assumptions inthe table below. Our ESPP provides for a twenty-four month offering periodcomprised of four six-month purchase periods with a look-back option. Alook-back option is a provision in an ESPP that establishes the purchase priceas an amount based on the lesser of the stock’s market price at the grant dateor its market price at the exercise or purchase date. The plan also includes areset feature whereby participants reset to a new offering when the marketprice of the stock falls below the market price from the last purchase period. Expectedvolatilities are based on historical volatility of our stock. Expected termrepresents the purchase periods within our offering period. The risk-free ratefor periods within the contractual life of the option is based on the U.S.Treasury of constant maturity rates. Stock-basedcompensation expense relating to our employee stock purchase plan is recognizedaccording to the FASB Technical Bulletin No. 97-1, “Accounting under Statement123 for Certain Employee Stock Purchase Plans with a Look-back Option”, or FTB97-1. As of March 31, 2006, there were approximately 138,000 shares in reservefor future issuance under the plan. The following table summarizes theweighted-average assumptions relating to our employee stock purchase plan forthe three months ended March 31, 2006 and 2005:

 

 
| ** **               | ** ** | **Employee Stock Purchase Plan  Three Months Ended  March 31,** | ** ** |
|--------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                                                      | ** ** | **2005** | ** ** |
| Risk-free interest rate  |       | 4.6                                                                                           | %          | 4.1 | % |
| Expected life (in years) |       | 1.2                                                                                           |       | 0.5 |   |
| Dividend yield           |       | 0.0                                                                                           | %          | 0.0 | % |
| Expected volatility      |       | 110                                                                                           | %          | 75.0 | % |

 

 

8

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***Stock-based Compensation AwardActivity***

 

The following table summarizes activity underour equity incentive and stock option plans for the three months ended March31, 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                                        |       | 654,060    |       | $                                           | 7.62       |                                                 |       |                                |       |   |
| Exercised                                      |       | (18,461    | )          | $                                           | 7.80       |                                                 |       |                                |       |   |
| Forfeited/Expired/Cancelled                    |       | (20,816    | )          | $                                           | 17.66      |                                                 |       |                                |       |   |
| Outstanding at March 31, 2006                  |       | 4,508,002  |       | $                                           | 14.80      |                                                 | 8.00       |                                | $          | 8,342,780 |   |
| Vested and expected to vest at March 31,  2006 |       | 4,386,595  |       | $                                           | 14.72      |                                                 |       |                                | $          | 8,208,366 |   |
| Exercisable at March 31, 2006                  |       | 2,091,287  |       | $                                           | 13.35      |                                                 | 7.07       |                                | $          | 4,481,572 |   |

 

The aggregate intrinsic value is calculated as the difference betweenthe exercise price of the underlying awards and the quoted price of our commonstock for the options to acquire 2.3 million shares that were in-the-money atMarch 31, 2006. During the three months ended March 31, 2006 and 2005, theaggregate intrinsic values of options exercised under our stock option planswere approximately $53,000 and $153,000, respectively, determined as of thedate of option exercise. As of March 31, 2006, there were approximately $15.1million of total unrecognized compensation cost, net of forfeitures, related tounvested share-based compensation arrangements granted under our stock optionplans and $1.2 million of total unamortized compensation cost related to ourESPP. That cost is expected to be recognized over a weighted-average period of1.16 years. We also had approximately 2.4 million of unvested stock options atMarch 31, 2006. Future option grants and their valuation will increase ourcompensation cost in the future as the options are granted, valued and expensedratably according to their vesting periods. The weighted average grant-datefair values of options granted in the three months ended March 31, 2006 and2005 were $5.61 and $9.51, respectively.

 

***Pro Forma Information under FAS123 for Periods Prior to Fiscal 2006***

* *

Prior to adopting SFAS 123(R) on January 1,2006, we accounted for equity-based employee compensation costs under therecognition and measurement principles of APB 25. Under APB 25, the intrinsic value method of accounting, no compensationexpense is recognized, because the exercise price of our employee stock optionsequals the market price of the underlying stock on the date of grant. Pro formainformation regarding net loss and net loss per share was determined as if wehad accounted for our employee stock options and employee stock purchase planunder the fair value method prescribed by FAS 123, as amended byFAS No. 148. The fair value for these options was estimated at thedate of grant using the Black-Scholes model. See the weighted-averageassumptions discussed above.

 

9

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For purposes of pro forma disclosures, the estimated fair value of theoptions was amortized to expense over the vesting period of the options priorto adopting SFAS 123(R). Our pro forma information was as follows (inthousands, except per share amounts):

 

 
| ** **                                                                                                                                            | ** ** | **Three Months Ended,  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                            | ** ** | **2005**                                          | ** ** |
| Net loss—as reported:                                                                                                                            |       | $                                                 | (11,164    | ) |
| Add (Deduct): Total stock-based employee  compensation (recovery)     determined under APB 25                                     |       | (1,261                                            | )          |
| Add: Total stock-based employee  compensation expense determined under      under the  fair value based method of all awards |       | 1,814                                             |       |
| Pro forma net loss                                                                                                                                    |       | $                                                 | (14,239    | ) |
| Basic and diluted net loss per common  share:                                                                                                         |       |                                              |       |
| As reported                                                                                                                                           |       | $                                                 | (0.57      | ) |
| Pro forma                                                                                                                                             |       | (0.72                                             | )          |

 

**5. Revenue Recognition**

 

We recognize revenue from our contract arrangements. Our revenuearrangements with multiple elements are evaluated under Emerging Issues TaskForce No. 00-21, *“Revenue Arrangementswith Multiple 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 are 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.

 

Revenues related to collaborative researchwith our corporate collaborators are recognized as research services areperformed over the related development funding periods for each contract. Underthese agreements, we are required to perform research and developmentactivities as specified in each respective agreement. The payments received arenot refundable and are generally based on a contractual cost per full-timeequivalent employee working on the project. Research and development expensesunder the collaborative research agreements, except for the Merck collaborationsigned in November 2004 related to ubiquitin ligases, approximate orexceed the revenue recognized under such agreements over the term of therespective agreements. For the Merck collaboration, we are recognizing apro-rata portion of the invoiced amounts for funding of our research scientistsbased on the headcount dedicated to the project. It is our policy to recognizerevenue based on our level of effort expended, however, revenue recognized willnot exceed amounts billable under the arrangement which corresponds to cashreceipts.

 

Milestones are recognized pursuant tocollaborative agreements upon the achievement of these at risk milestones.

 

Royalties will be recognized as earned inaccordance with the contract terms when the third party results are reliablymeasurable and collectibility is reasonably assured.

 

10

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**6. Cash, Cash Equivalents andAvailable-For-Sale Securities**

 

Cash, cash equivalents and available-for-salesecurities consist of the following (in thousands):

 
| ** **                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Checking account              |       | $                  | 710        |                  | $          | 742 |   |
| Money market funds            |       | 8,952              |       | 3,421                 |       |
| Federal agency securities     |       | 20,371             |       | 21,067                |       |
| Corporate bonds and notes     |       | 98,334             |       | 112,966               |       |
|                          |       |               |       |                  |       |
|                          |       | $                  | 128,367    |                  | $          | 138,196 |   |
| Reported as:                  |       |               |       |                  |       |
| Cash and cash equivalents     |       | $                  | 65,286     |                  | $          | 76,779 |   |
| Available-for-sale securities |       | 63,081             |       | 61,417                |       |
|                          |       |               |       |                  |       |
|                          |       | $                  | 128,367    |                  | $          | 138,196 |   |

 
| **March 31, 2006** | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| Federal agency securities    |       | $                   | 20,419     |                         | $          | —                        |       | $                   | (48        | ) | $ | 20,371 |   |
| Corporate bonds and note     |       | 42,794              |       | 1                            |       | (85                           | )          | 42,710              |       |
|                         |       |                |       |                         |       |                          |       |                |       |
| Total                        |       | $                   | 63,213     |                         | $          | 1                             |       | $                   | (133       | ) | $ | 63,081 |   |

 
| **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 March 31, 2006, the above debt securitieshad a weighted average maturity of approximately 155 days with one federalagency security with a fair market value of $3.0 million having a maturitygreater than 360 days.

 

The following table shows the grossunrealized losses and fair values of our investments in individual securitiesthat are in an unrealized loss position aggregated by investment category, (inthousands):

 
| **March 31, 2006** | ** ** | **Fair Value** | ** ** | **Unrealized  (Losses)/gains** | ** ** |
|------------------------------|------------|---------------------|------------|--------------------------------|------------|
| Federal agency securities    |       | $                   | 19,124     |                           | $          | (48 | ) |
| Corporate bonds and notes    |       | 41,479              |       | (85                            | )          |
| Total                        |       | $                   | 60,603     |                           | $          | (133 | ) |

 
| **December 31, 2005** | ** ** | **Fair Value** | ** ** | **Unrealized  (Losses****)****/gains** | ** ** |
|---------------------------------|------------|---------------------|------------|----------------------------------------|------------|
| Federal agency securities       |       | $                   | 12,879     |                                   | $          | (17 | ) |
| Corporate bonds and notes       |       | 40,615              |       | (75                                    | )          |
| Total                           |       | $                   | 53,494     |                                   | $          | (92 | ) |

 

11

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At March 31, 2006, we had investments in twocorporate bond securities with a combined fair market value of approximately$2.5 million that have been in a continuous unrealized loss position for morethan twelve months. As of March 31, 2006, this unrealized loss position wasapproximately $1,000. We have not recorded an impairment charge as of  March 31, 2006, since we have the ability andintent to hold these investments to maturity at which time no gain or losswould be recognized. Both of these investments will mature by April 30, 2006. Duringthe periods presented, there were no recorded realized gains or losses oninvestments.

 

As of March 31, 2006, a total of 36 individual securities were in an unrealized loss position for lessthan twelve months and deemed to be temporary. As of December 31, 2005, 34individual securities were in an unrealized loss position for less than twelvemonths and deemed to be 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. Eventhough the agreement includes a basket of compounds within the Aurora kinaseinhibitor program, the collaboration and our efforts under the agreement arefocused on R763. We are responsible for all costs associated with the preparationand filing of an IND for R763, which we filed in December 2005, while Serono isresponsible for all development of R763 following regulatory acceptance of theIND and will bear all costs thereafter. In connection with this collaboration,Serono paid us $10.0 million upfront and paid $15.0 million to purchase ourcommon stock at a premium. We are amortizing the upfront amount into revenueover the nine months from the initiation of the collaboration inOctober 2005. This is the period of time that we estimate it will take toperform our deliverables such as assisting Serono with certain studies andactivities leading up to the initiation of the first clinical trial to be runby Serono.

 

DuringFebruary 2006, we received a payment of $5.0 million triggered by theregulatory acceptance of the R763 IND in January 2006. Serono will befiling an amended IND to take over sponsorship of the clinical trial. We haveamortized the payment on a straight-line basis thru April 2006 when ourinvolvement with the amended IND was completed. We will be eligible to receivemilestone payments, under certain conditions, upon commencement of a Phase Iclinical trial for R763, other clinical events, marketing approval androyalties on any future product sales.

 

**8. Equipment Lease Line**

 

In July 2005, our equipment credit line underan original master agreement was extended to create a total borrowing limit of$1.5 million. We have the ability to draw down on this line throughJune 2006. The repayment period will be for three years beginning on thefirst draw down with the interest rate on the line fixed at each drawdown. Eachline has a bargain purchase buyout provision of $101. During the three monthsended March 31, 2006, we drew down $882,000 on this line, which is included incapital lease obligation on the balance sheet. Approximately $153,000 remainedavailable under the line as of  March 31,2006.

 

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## **Report of Independent Registered PublicAccounting Firm**

##  

TheBoard of Directors

RigelPharmaceuticals, Inc.

 

Wehave reviewed the balance sheet of Rigel Pharmaceuticals, Inc. as of  March 31, 2006, and the related condensedstatements of operations and cash flows for the three-month periods ended March31, 2006 and 2005. These interim financial statements are the responsibility ofthe Company’s management.

 

Weconducted our review in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). A review of interim financialinformation consists principally of applying analytical procedures and makinginquiries of persons responsible for financial and accounting matters. It issubstantially less in scope than an audit conducted in accordance with thestandards of the Public Company Accounting Oversight Board, the objective ofwhich is the expression of an opinion regarding the financial statements takenas a whole. Accordingly, we do not express such an opinion.

 

Basedon our review, we are not aware of any material modifications that should be madeto the condensed interim financial statements referred to above for them to bein conformity with U.S. generally accepted accounting principles.

 

Wehave previously audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the balance sheet of RigelPharmaceuticals, Inc. as of December 31, 2005, and the relatedstatements of operations, shareholders’ equity, and cash flows for the yearthen ended (not presented herein), and in our report dated March 3, 2006,we expressed an unqualified opinion on those financial statements. In ouropinion, the information set forth in the accompanying balance sheet as ofDecember 31, 2005, is fairly stated, in all material respects, in relationto the balance sheet from which it has been derived.

 
|                  | /s/ Ernst & Young LLP |
|-----------------------|--------------------------------|
| Palo Alto, California |                           |
| April 24, 2006        |                           |

 

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**Item 2.****           Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*This discussion and analysis should be readin conjunction 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 ended December 31,2005. Operating results for the three months ended March 31, 2006 are notnecessarily indicative of results that may occur in future periods.*

 

*Weusually use words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,”“believe,” “estimate,” “predict,” “future,” “intend,” “potential” or “continue”or the negative of these 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 company that discovers anddevelops novel, small-molecule drugs for the treatment of inflammatorydiseases, cancer and viral diseases. Our goal is to move one new productcandidate for a significant indication into the clinic each year. We haveachieved this goal each year beginning in 2002. Our research focuses onintracellular signaling pathways and related targets that are critical todisease mechanisms. Our productivity has resulted in strategic collaborationswith large pharmaceutical partners to discover, 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*.*

 

Since 2004, we have matured into a clinical stage drug developmentcompany with multiple product candidates in development as 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 have recently completedR788 studies to evaluate its safety and pharmacokinetics in combination withmethotrexate, a commonly prescribed treatment for RA. Results of this trialsuggest no adverse interaction. We expect to commence Phase II clinicaltrials of R788 for RA in the second half of 2006.

 

•                  *R788**—*ProductCandidate for Immune Thombocytopenia Purpura (ITP).* *Plateletdestruction from ITP is mediated by IgG signaling. R788 is a potent inhibitorof IgG signaling. In preclinical studies, Rigel has shown R788 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 patientsin the second half of 2006.

 

•                  *R763—Product Candidate for Oncology. *InJuly 2004, we identified R763 as a lead compound in our Aurora kinaseinhibition program, targeting cancer cell proliferation. R763 is a potent,highly-selective, small-molecule inhibitor of Aurora kinase. InOctober 2005, we signed a licensing agreement with Serono that grants toSerono an exclusive license to develop and commercialize R763, in addition toother product candidates arising from our Aurora kinase inhibitor program.Under the agreement, we were responsible for filing an IND for R763 whileSerono will be responsible for the further development and commercialization ofR763. We filed the IND for R763 with the Food and Drug Administration, or FDA,in December 2005, and were allowed to proceed under the IND inJanuary 2006. During February 2006, we received a payment of $5.0million from Serono triggered by the regulatory acceptance. We anticipate thatSerono will initiate clinical trials for R763 in the second half of 2006.

 

In the first quarter of2005, we announced that we entered into a collaborative research and licenseagreement with Pfizer for the development of inhaled products for the treatmentof allergic asthma and other respiratory diseases, such as chronic obstructivepulmonary disease, or COPD. The collaboration is focused on our preclinicalsmall molecule compounds, which inhibit IgE receptor signaling in respiratorytract mast cells by blocking the signaling enzyme Syk, or spleen tyrosinekinase, a novel drug target for respiratory diseases. Mast cells play importantroles in both early and late phase allergic reactions, and Syk inhibitors couldprevent

 

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both phases. We expectPfizer to advance a compound to the clinic combining their dry powder inhaler,their drug development capabilities and our novel small molecules. The firstsignificant milestone under this collaboration is Pfizer’s selection of aspecific molecule to take into drug development, which we expect to occur inthe second half of 2006.

 

In addition to the above mentioned productcandidates, we have ongoing research programs involving back-up candidates forthe product candidates above as well as drug discovery efforts in ourimmunology/inflammation, virology, and oncology programs. For example, we arepursuing JAK3 in immunology for potential applications in transplant rejectionand Axl in oncology.

 

**Corporate Collaborations**

 

We carry on research and development programsin connection with our corporate collaborations. As of March 31, 2006, we hadcollaborations with six major pharmaceutical/biotech companies comprised of:one with Janssen Pharmaceutica N.V., a division of Johnson & Johnson,relating to oncology therapeutics and diagnostics, two with Pfizer Inc.,one initiated in 1999 and the other in the first quarter of 2005, relating tointrapulmonary asthma and allergy therapeutics, one with Novartis Pharma AGwith respect to four different programs relating to immunology, oncology andchronic bronchitis, one with Daiichi Pharmaceuticals Co., Ltd. in the areaof oncology, one with Merck, in the area of oncology, and one with Serono inthe area of oncology. All of these collaborations, excluding the recent Pfizerand the Serono collaborations, have a research phase during which we receive orreceived funding based on the level of headcount allocated to a program. In allof these collaborations if certain conditions are met, we are entitled toreceive future 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 and potentialcollaborators. Our earliest partnerships focused on the early stages of drugdiscovery, specifically on target discovery and validation. Our collaborationswith Daiichi and recently with Merck are both later stage, focusing on drugdiscovery and development. Our 2005 collaboration with Pfizer covers compoundsat the preclinical and lead designation stages while our 2005 collaborationwith Serono covers a compound for which an IND was filed in December 2005and obtained FDA approval in January 2006. We currently anticipate that inorder to support our current research programs we will need to self-fund ourown research programs, which involve an increased rate of spending on laterstages of development prior to partnering with collaborative partners.Therefore, it is expected that future collaborations may have an expanded focusand could include high throughput screening, combinatorial and medicinalchemistry, 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.

 

**Critical Accounting Policies and the Use ofEstimates**

 

Our discussion and analysis of our financialcondition and results of operations are based upon our financial statements,which have been prepared in accordance with U.S generally accepted accountingprinciples. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. On an on-going basis, we evaluate our estimates, includingthose related to terms of the research collaborations, investments, stockcompensation, impairment issues, the estimated useful life of assets andcontingencies. We base our estimates on historical experience and on variousother assumptions 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.Actual results 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 nosignificant changes in our critical accounting policies during the period endedMarch 31, 2006 as compared to those previously disclosed in our Annual Reporton Form 10-K for the year ended December 31, 2005 except for theadoption of SFAS 123(R) for equity-based compensation costs.

 

***Revenue Recognition***

* *

We recognize revenue from our contract arrangements. Our revenuearrangements with multiple elements are evaluated under Emerging Issues TaskForce No. 00-21, *“Revenue Arrangementswith Multiple Deliverables,”* 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 are 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.

 

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Revenues related to collaborative researchwith our corporate collaborators are recognized as research services areperformed over the related development funding periods for each contract. Underthese agreements, we are required to perform research and developmentactivities as specified in each respective agreement. The payments received arenot refundable and are generally based on a contractual cost per full-timeequivalent employee working on the project. Research and development expensesunder the collaborative research agreements, except for the Merck collaborationsigned in November 2004 related to ubiquitin ligases, approximate orexceed the revenue recognized under such agreements over the term of therespective agreements. For the Merck collaboration, we are recognizing a pro-rataportion of the invoiced amounts for funding of our research scientists based onthe headcount dedicated to the project. It is our policy to recognize revenuebased on our level of effort expended; however, revenue recognized will notexceed amounts billable under the arrangement which corresponds to cashreceipts.

 

Milestones are recognized pursuant tocollaborative agreements upon the achievement of these at risk milestones.

 

Royalties will be recognized as earned inaccordance with the contract terms when the third party results are reliablymeasurable and collectibility is reasonably assured.

 

***Stock-basedCompensatio**n***

 

 
| ** **                                             | ** ** | **Three months ended  March 31,** | ** ** | **Aggregate Change  2006 from 2005** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                         | ** ** | **2005**                                            |
| ** **                                             | ** ** | **(in thousands)**                          | ** ** |
| **Stock-based compensation expense (recovery)  from:** |       |                                             |       |                                                |       |   |   |
| ***Officer, director and employee options***           |       | $                                                | 3,284      |                                                | $          | (1,266 | ) | $ | 4,550 |   |
| ***Consultant options***                               |       | 277                                              |       | (207                                                | )          | 484 |   |
| ***Other employee options***                           |       | —                                           |       | 5                                                   |       | (5 | ) |
| *** ***                                           |       |                                             |       |                                                |       |   |   |
| ***Total***                                            |       | $                                                | 3,561      |                                                | $          | (1,468 | ) | $ | 5,029 |   |
|                                                        |            |                                                  |            |                                                     |            |  |  |  |  |  |  |

 

We grant options to purchase our common stock to our employees,directors and consultants under our stock option plans. Eligible employees canalso purchase shares of our common stock at 85% of the lower of the fair marketvalue on the first and last day of each six-month purchase period under ouremployee stock purchase plan. 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 and calculated for pro formadisclosures under SFAS No. 148, and (ii) all share-based 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 FASB Interpretation No. 28, “Accounting forStock Appreciation Rights and Other Variable Stock Option or Award Plans”, orFIN 28. For awards granted after January 1, 2006, we have adopted the use ofthe straight-line attribution method over the requisite service period for theentire award. Results of prior periods do not reflect any restated amounts, andthe cumulative effect of a change in accounting principle was insignificantupon adoption of SFAS No. 123(R) under the modified prospective method. Inaddition pursuant to SFAS 123(R), we are required to estimate the amount ofexpected forfeitures when calculating the compensation costs, instead ofaccounting for forfeitures as incurred, which was our previous method. We willrecord actual forfeitures as they occur, and we will review our forfeiturerates each quarter and make any necessary changes our estimates.

 

Prior to adopting SFAS 123(R) on January 1,2006, we accounted for equity-based employee compensation costs under therecognition and measurement principles of APB 25. Under APB 25, the intrinsic value method of accounting, nocompensation expense is recognized, because the exercise price of our employeestock options equals the market price of the underlying stock on the date ofgrant. Pro forma information regarding net loss and net loss per share wasdetermined as if we had accounted for our employee stock options and employeestock purchase plan under the fair value method prescribed by FAS 123, asamended by FAS 148. The fair value for these options was estimated at the dateof grant using the Black-Scholes model.

 

In 2005, we recorded charges associated with the stock options thatwere eligible for re-pricing under a tender offer initiated in June 2003.All replacement options, as well as the eligible options that were notsurrendered under the original offer to exchange, were treated for financialreporting purposes as variable awards. Therefore, for the period prior toadoption of FAS 123(R), we recorded a non-cash charge, generally for theintrinsic value of the options as they vested, utilizing the acceleratedvesting method, reflecting increases and decreases (down to, but not below, theexercise price) in the price of our common stock as compensation expense(recovery) in connection with the replacement options and the eligible optionsthat were not exchanged. For the three months ended March 31, 2005, we recordednon-cash compensation recovery of $1.3 million related to all employeeoptions eligible for

 

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replacement options. The recovery resulted from the decrease in themarket price of our common stock during the period. For periods after theadoption of SFAS 123(R), we are continuing to account for the options repricedprior to the adopton of SFAS 123(R) in accordance with provisions of SFAS 123.

 

We also record charges associated withoptions granted to consultants reflecting the fair value valuation and periodicfair value remeasurement of outstanding consultant options under EITF 96-18, “Accountingfor Equity Instruments That are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling Goods or Services.”   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 expected term.For consultant options granted in the first three months of 2006, we amortizedstock-based compensation using a straight-line attribution method consistentwith the method used for employees and with the attribution election we madeupon adoption of FAS 123(R). For options granted prior to January 1, 2006, weused the accelerated method for expensing stock-based compensation, which wasthe method we used prior to adoption. We expect to see continued fluctuationsin the future as a portion of these options are remeasured based on the changesin the current market price of our common stock.

 

Thedetermination of the fair value of share-based payment awards on the date ofgrant using an option-pricing model is affected by our stock price as well asassumptions regarding a number of complex and subjective variables. Thesevariables include, but are not limited to, our expected stock price volatilityover the term of the awards, actual and projected employee stock optionexercise behaviors, risk-free interest rate and expected dividends.

 

Iffactors change and we employ different assumptions in the application of SFAS123(R) in future periods, the compensation expense that we record under SFAS123(R) may differ significantly from what we have recorded in the currentperiod. Therefore, we believe it is important to be aware of the high degree ofsubjectivity involved when using option pricing models to estimate share-basedcompensation under SFAS 123(R).

 

Theguidance in SFAS 123(R) and SAB 107 is relatively new, and best practices arenot well established. The application of these principles may be subject tofurther interpretation and refinement over time. There are significantdifferences among valuation models, and there is a possibility that we mayadopt different valuation models in the future. This may result in a lack ofconsistency in future periods and materially affect the fair value estimate ofshare-based payments. It may also result in a lack of comparability with othercompanies that use different models, methods and assumptions.

 

**Three Months Ended March 31, 2006 and 2005**

 

**Revenues**

 
| ** **                                  | ** ** | **Three months ended  March 31,** | ** ** | **Aggregate Change  2006 from 2005** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                         | ** ** | **2005**                                            |
| ** **                                  | ** ** | **(in thousands)**                          | ** ** |
| ***Contract revenues from collaborations*** |       | $                                                | 9,897      |                                                | $          | 2,618 |   | $ | 7,279 |   |
|                                             |            |                                                  |            |                                                     |            |  |  |  |  |  |

 

Revenues by collaborator were:

 
| ** **    | ** ** | **Three months ended  March 31,** | ** ** | **Aggregate Change  2006 from 2005** | ** ** |
|---------------|------------|--------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                         | ** ** | **2005**                                            | ** ** | ** ** |
| ** **    | ** ** | **(in thousands)**                          | ** ** |
| ***Serono***  |       | $                                                | 6,834      |                                                | $          | — |   | $ | 6,834 |   |
| ***Merck***   |       | 1,813                                            |       | 1,465                                               |       | 348 |   |
| ***Pfizer***  |       | 1,250                                            |       | 491                                                 |       | 759 |   |
| ***Daiichi*** |       | —                                           |       | 662                                                 |       | (662 | ) |
| ***Total***   |       | $                                                | 9,897      |                                                | $          | 2,618 |   | $ | 7,279 |   |

 

Contract revenues from collaborations for thethree months ended March 31, 2006 and 2005 consisted primarily of researchsupport and amortization of upfront fees and milestone payments from the continuationof our collaborations above. The increase in revenues for the three monthsended March 31, 2006 compared to the similar period in 2005 was primarily dueto the initiation of the Serono collaboration in November 2005 and theamortization of the Serono payment that we received in February 2006 upon theregulatory acceptance of the IND in January 2006. Research support under theDaiichi collaboration ended in August 2005. We have deferred approximately$887,000 of research reimbursement revenue from Merck in order to only accountfor the headcount effort expended by us for the time period invoiced, whichcovers the period from the initiation of the collaboration through March 31,2006. We expect this amount will be recognized as revenue no later than at theend of the research phase of the collaboration, which will be May 2007. Weexpect contract revenues from collaborations to be a significant component ofour total revenues for the foreseeable future.

 

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**Research and Development Expenses**

 
| ** **                                                                                        | ** ** | **Three months ended  March 31,** | ** **                                          | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|-----------------------------------------------------|------------|------------|
| ** **                                                                                        | ** ** | ** **                                       | **Aggregate Change  2006 from 2005** | ** ** |
| ** **                                                                                        | ** ** | **2006**                                         | ** **                                          | **2005**   | ** ** | ** ** |
| ** **                                                                                        | ** ** | **(in thousands)**                          | ** **                                          |
| ***Research and development expenses***                                                           |       | $                                                | 14,711                                              |       | $          | 11,173 |   | $ | 3,538 |   |
| ***Stock-based compensation expense  (recovery) included in research  and development expenses*** |       | 1,921                                            |                                                | (1,027     | )          | 2,948 |   |
|                                                                                                   |            |                                                  |                                                     |            |            |  |  |  |  |  |

 

The increase in research and developmentexpenses of $3.5 million for the three months ended March 31, 2006 wasprimarily attributable to an increase in stock-based compensation expense uponthe adoption of SFAS 123(R) as previously discussed under “Stock-basedCompensation” in the “Critical Accounting Policies and the Use of Estimates”section and an increase in preclinical and clinical costs and personnel costs.The increase in our preclinical and clinical costs for the three months endedMarch 31, 2006 compared to the similar period in 2005 was attributable to costsassociated with our R788 program. The costs attributable to R788 were relatedto our ongoing clinical trials as well as costs related to manufacturingmaterials for our upcoming Phase II trial. We expect that research anddevelopment expenses will increase through the remainder of 2006.

 

The scope and magnitudeof future research and development expenses are difficult to predict at thistime given 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.

 

**General and Administrative Expenses**

 
| ** **                                                                                          | ** ** | **Three months ended  March 31,** | ** ** | **Aggregate Change  2006 from 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                                         | ** ** | **2005**                                            | ** ** | ** ** |
| ** **                                                                                          | ** ** | **(in thousands)**                          | ** ** |
| ***General and administrative expenses***                                                           |       | $                                                | 5,003      |                                                | $          | 2,874 |   | $ | 2,129 |   |
| ***Stock-based compensation expense  (recovery) included in general  and administrative expenses*** |       | 1,640                                            |       | (441                                                | )          | 2,081 |   |
|                                                                                                     |            |                                                  |            |                                                     |            |  |  |  |  |  |

 

The increase in general and administrativeexpenses of $2.1 million for the three months ended March 31, 2006 compared tothe similar period in 2005 was primarily attributable to an increase instock-based compensation expense upon the adoption of SFAS 123(R) as previously discussed under “Stock-basedCompensation” in the “Critical Accounting Policies and the Use of Estimates”section.

 

**Interest Income**

 
| ** **            | ** ** | **Three months ended  March 31,** | ** ** | **Aggregate Change**

**2006 from 2005** | ** ** |
|-----------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **            | ** ** | **2006**                                         | ** ** | **2005**                                                | ** ** | ** ** |
| ** **            | ** ** | **(in thousands)**                          | ** ** |
| ***Interest income*** |       | $                                                | 1,413      |                                                    | $          | 330 |   | $ | 1,083 |   |
|                       |            |                                                  |            |                                                         |            |  |  |  |  |  |

 

Interest income results from ourinterest-bearing cash and investment balances. The increase in the three monthsended March 31, 2006 compared to the similar period in 2005 is attributable toan increase in our overall investment balances as a result of the publicoffering we completed in July 2005 in which we raised $81.6 million in netproceeds, combined with an increase in the rate of interest we earned on thebalances.

 

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**Interest Expense**

 
| ** **             | ** ** | **Three months ended  March 31,** | ** **                                              | ** ** | ** ** |
|------------------------|------------|--------------------------------------------------|---------------------------------------------------------|------------|------------|
| ** **             | ** ** | ** **                                       | **Aggregate Change**

**2006 from 2005** | ** ** |
| ** **             | ** ** | **2006**                                         | ** **                                              | **2005**   | ** ** | ** ** |
| ** **             | ** ** | **(in thousands)**                          | ** **                                              |
| ***Interest expense*** |       | $                                                | 65                                                      |       | $          | 65 |   | $ | — |   |
|                        |            |                                                  |                                                         |            |            |  |  |  |  |  |

 

Interest expense is the result of our capital leaseobligations associated with fixed asset acquisitions. Interest expense wasconsistent for the three months ended March 31, 2006 and 2005 due to comparabledebt obligations outstanding during those periods.

 

**Liquidity and Capital Resources**

 

**Cash Requirements**

 

We have financed our operations from inception primarily through salesof equity securities, contract payments under our collaboration agreements andequipment financing arrangements. We have consumed substantial amounts ofcapital to date, and operating expenditures are expected to increase over thenext several years as we expand our insfrastructure and research anddevelopment activities. We believe that our existing capital resources and anticipatedproceeds from current collaborations will be sufficient to support our currentoperating plan through at least the next 12 months. Our operations willrequire significant 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 issuing equity securities,our stockholders could at that time experience substantial dilution. To theextent that we raise additional funds through collaboration and licensingarrangements, we may be required to relinquish some rights to our technologiesor product candidates, or grant licenses on terms that are not favorable to us.

 

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

 

•                                          theprogress and success of preclinical activities (including studies andmanufacture of materials) and clinical trials of our product candidatesconducted by us or our collaborative partners or licensees;

•                                          ourability to establish new collaborations and to maintain our existingcollaboration partnerships;

•                                          theprogress of research programs carried out by us;

•                                          anychanges in the breadth of our research and development programs;

•                                          ourability to meet the milestones identified in our collaborative agreements thattrigger payments;

•                                          theprogress of the research and development efforts of our collaborative partners;

•                                          ourability to acquire or license other technologies or compounds that we seek topursue;

•                                          ourability to manage our growth;

•                                          competingtechnological and market developments;

•                                          thecosts and timing of obtaining, enforcing and defending our patent andintellectual property rights;

•                                          thecosts and timing of regulatory approvals and filings by us and ourcollaborators; and

•                                          expensesassociated with unforeseen litigation.

 

Insufficient funds mayrequire us to delay, scale back or eliminate some or all of our research ordevelopment programs, to lose rights under existing licenses or to relinquishgreater or all rights to product candidates at an earlier stage of developmentor on less favorable terms than we would otherwise choose or may adverselyaffect our ability to operate as a going concern.

As of March 31, 2006, we had $128.4 million in cash, cashequivalents and available-for-sale securities, as compared to$138.2 million as of December 31, 2005, a decrease of$9.8 million. The decrease was attributable to operating spending in thequarter, offset by the receipt of $5.0 million from Serono. We also receivedapproximately $882,000 under our equipment financing arrangements, which wasoffset by debt service payments of approximately $300,000 relating to theequipment financing arrangements. For the three months ended March 31,2006, we maintained an investment portfolio primarily in money market funds,federal agency securities and corporate bonds and notes. Cash in excess ofimmediate requirements is invested with regard to liquidity and capitalpreservation. Wherever possible, we seek to minimize the potential effects ofconcentration and degrees of risk.

 

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**Contractual Obligations**

 

The following are our contractual commitments(by fiscal year) as of March 31, 2006 associated with debt obligations,contracted research obligations, and lease obligations:

 
| ** **                               | ** ** | **Total**               | ** ** | **2006** | ** ** | **2007-2009** | ** ** | **2010-2012** | ** ** | **2013-2018** | ** ** |
|------------------------------------------|------------|-------------------------|------------|----------|------------|---------------|------------|---------------|------------|---------------|------------|
| ** **                               | ** ** | **(in thousands)** | ** ** |
| Debt obligations (1)                     |       | $                       | 3,039      |     | $          | 1,018         |       | $             | 2,021      |          | $          | — |   | $ | — |   |
| Contracted research                      |       | 300                     |       | 300      |       | —        |       | —        |       | —        |       |
| Facilities lease, net of sublease (2)(3) |       | 164,485                 |       | 8,274    |       | 41,581        |       | 38,507        |       | 76,123        |       |
|                                     |       |                    |       |     |       |          |       |          |       |          |       |
| Total                                    |       | $                       | 167,824    |     | $          | 9,592         |       | $             | 43,602     |          | $          | 38,507 |   | $ | 76,123 |   |

 

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(1)                                  Asof March 31, 2006, we had $2.8 million in debt obligations associated withour equipment additions. All existing debt agreements as of March 31, 2006 aresecured by the equipment financed, bear interest at rates in a range of 8.8% to12.2%  and are due in monthlyinstallments through 2009.

 

(2)                                  DuringMay 2004, we initiated a sublease of approximately 15,000 square feet ofour premises to a tenant for a period of two years. This sublease was amendedin September 2005 to extend the term for an additional year. The facilitieslease obligations above are reflective of the new sublease income stream of$757,000.

 

(3)                                  Thepayments above reflect the remaining approximately twelve years of the leaseterm.

 

**Item 3.****           Quantitative and Qualitative DisclosuresAbout Market Risk**

 

The primary objective of our investmentactivities is to preserve principal while at the same time maximizing theincome we receive from our investments without significantly increasing risk.Some of the securities in which we invest may have market risk. This means thata change in prevailing interest rates may cause the fair value amount of theinvestment to fluctuate. For example, if we hold a security that was issuedwith a fixed interest rate at the then-prevailing rate and the prevailinginterest rate later rises, the market value amount of our investment willdecline. To minimize this risk in the future, we intend to maintain ourportfolio of cash equivalents and available-for-sale securities in a variety ofsecurities, including money market funds and government and non-government debtsecurities. For the three months ended March 31, 2006, we maintained aninvestment portfolio primarily in money market funds, federal agency securitiesand corporate bonds and notes. Due to the short-term nature of the majority ofthese investments, we believe we do not have a material exposure to interestrate risk arising from our investments. Therefore, no quantitative tabulardisclosure is provided.

 

We have operated primarily in the UnitedStates, and all funding activities with our collaborators to date have beenmade in U.S. dollars. Accordingly, we have had minimal exposure to foreigncurrency rate fluctuations.

 

**Item 4.****           Controls and Procedures**

 

*Evaluation of Disclosure Controls andProcedures.*Based on our management’s evaluation (withthe participation of our chief executive officer and chief financial officer),our chief executive officer and chief financial officer have concluded that ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended), wereeffective as of March 31, 2006.

 

*Changes in Internal Controls.*Therewere no changes in our internal controls over financial reporting during thequarter ended March 31, 2006 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

*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 evaluation as of the end of the period covered by this quarterlyreport on Form 10-Q, that our disclosure controls and

 

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procedures were sufficiently effective to provide reasonable assurancethat the objectives of our disclosure control system were met.

 

**PART II. OTHER INFORMATION**

 

**Item1A. Risk Factors**

 

*In evaluating our business, you shouldcarefully consider the following risks, as well as the other informationcontained in this quarterly report on Form 10-Q. If any of the followingrisks actually occurs, our business could be harmed. The risks anduncertainties described below are not the only ones facing us. Additional risksand uncertainties not presently known to us, or that we currently see as immaterial,may also harm our business.*

 

**Wewill need additional capital in the future to sufficiently fund our operationsand research.**

** **

We have consumed substantial amounts of capital to date, and operatingexpenditures are expected to increase over the next several years as we expandour infrastructure and research and development activities. We believe that ourexisting capital resources and anticipated proceeds from current collaborationswill be sufficient to support our current operating plan through at least thenext 12 months. Our operations will require significant additional fundingin large part due to our research and development expenses, future preclinicaland clinical-testing costs, and the absence of any meaningful revenues for theforeseeable future. The amount of future funds needed will depend largely onthe timing and structure of potential future collaborations. We do not knowwhether additional financing will be available when needed, or that, ifavailable, we will obtain financing on terms favorable to our stockholders orus.

 

To the extent we raise additional capital by issuing equity securities,our stockholders could at that time experience substantial dilution. To theextent that we raise additional funds through collaboration and licensingarrangements, we may be required to relinquish some rights to our technologiesor product candidates, or grant licenses on terms that are not favorable to us.

 

**Our future funding requirements will dependon many uncertain factors**.

 

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

 

•                                          theprogress and success of preclinical studies (including studies and manufactureof materials) and clinical trials of our product candidates conducted by us orour collaborative partners or licensees;

•                                          ourability to establish new collaborations and to maintain our existingcollaboration partnerships;

•                                          theprogress of research programs carried out by us;

•                                          anychanges in the breadth of our research and development programs;

•                                          ourability to meet the milestones identified in our collaborative agreements thattrigger payments;

•                                          theprogress of the research and development efforts of our collaborative partners;

•                                          ourability to acquire or license other technologies or compounds that we seek topursue;

•                                          ourability to manage our growth;

•                                          competingtechnological and market developments;

•                                          thecosts and timing of obtaining, enforcing and defending our patent andintellectual property rights;

•                                          thecosts and timing of regulatory approvals and filings by us and ourcollaborators; and

•                                          expensesassociated with unforeseen litigation.

 

Insufficient funds may require us to delay, scale back or eliminatesome or all of our research or development programs, to lose rights underexisting licenses or to relinquish greater or all rights to product candidatesat an earlier stage of development or on less favorable terms than we wouldotherwise choose or may adversely affect our ability to operate as a goingconcern.

 

**Oursuccess as a company is uncertain due to our history of operating losses andthe uncertainty of future profitability.**

** **

Due in large part to the significant research and developmentexpenditures required to identify and validate new product candidates andpursue our development efforts, we have not been profitable and have incurredoperating losses since we were incorporated in June 1996. The extent ofour future losses and the timing of potential profitability are highlyuncertain, and we may never achieve profitable operations. We incurred netlosses of $8.5 million for the first three months of 2006, $45.3 millionin 2005 and $56.3 million in 2004. Currently, our revenues are generated solelyfrom research payments pursuant to our collaboration agreements and licensesand are insufficient to generate profitable operations. As of March 31, 2006,we had an accumulated deficit of approximately $266.0 million. We expectto incur losses for at least the next several years and expect that theselosses could increase as we expand our research and development activities andincur significant clinical and testing costs.

 

**Thereis a high risk that drug discovery and development efforts might notsuccessfully generate good product candidates.**

** **

At the present time, the majority of our operations are in variousstages of drug identification and development. We currently have two productcompounds in the clinical testing stage: one is for both RA and ITP, which isproprietary to our company and the

 

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other is for oncology, which is partnered with Serono. In our industry,it is statistically 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 the clinic and our future leads for potential drug compounds aresubject to the risks and failures inherent in the development of pharmaceuticalproducts. These risks include, but are not limited to, the inherent difficultyin selecting the right drug and drug target and avoiding unwanted side effectsas well as unanticipated problems relating to product development, testing,regulatory compliance, manufacturing, marketing, competition and costs andexpenses that may exceed current estimates. The results of preliminary studiesdo not necessarily predict clinical or commercial success, and largerlater-stage clinical trials may fail to confirm the results observed in thepreliminary studies. With respect to our own compounds in development, we haveestablished anticipated timelines for clinical development based on existingknowledge of the compound. However, we cannot provide assurance that we willmeet any of these timelines with respect to the initiation or completion ofclinical studies. For example, in December 2005, we completed a Phase IItrial of R112 for the treatment of allergic rhinitis, which did not achieve theprimary endpoint.

 

In addition, we expect Serono to initiate clinical trials of R763 inthe second half of 2006. 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 assurance regarding the likely results from our future clinicaltrials or the impact of those results on our business.

 

**Wemight not be able to commercialize our product candidates successfully ifproblems arise in the clinical testing and approval process.**

 

Commercialization of our product candidates depends upon successfulcompletion of preclinical studies and clinical trials. Preclinical testing andclinical development are long, expensive and uncertain processes. We do notknow whether we, or any of our collaborative partners, will be permitted toundertake clinical trials of potential products beyond the trials alreadyconcluded and the trials currently in process. It will take us or ourcollaborative partners several years to complete any such testing, and failurecan occur at any stage of testing. Interim results of trials do not necessarilypredict final results, and acceptable results in early trials may not be repeatedin later trials. A number of companies in the pharmaceutical industry,including biotechnology companies, have suffered significant setbacks inadvanced 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.

 

**Delaysin clinical testing could result in increased costs to us.**

 

Significant delays in clinical testing could materially impact ourproduct development costs and timing. We do not know whether planned clinicaltrials will begin on time, will need to be halted or revamped or will becompleted on schedule, or at all. Clinical trials can be delayed for a varietyof reasons, including delays in obtaining regulatory approval to commence astudy, delays from scale up delays in reaching agreement on acceptable clinicalstudy agreement terms with prospective clinical sites, delays in obtaininginstitutional review board approval to conduct a study at a prospectiveclinical site or delays in recruiting subjects to participate in a study.Environmental conditions may impact the execution of some clinical trials,particularly during the allergy season for our allergic rhinitis program.

 

In addition, we typically rely on third-party clinical investigators toconduct our clinical trials and other third-party organizations to oversee theoperations of such trials and to perform data collection and analysis. As aresult, we may face additional delaying factors outside our control if theseparties do not perform their obligations in a timely fashion. While we have notyet experienced delays that have materially impacted our clinical trials orproduct development costs, delays of this sort could occur for the reasonsidentified above or other reasons. If we have delays in testing or approvals,our product development costs will increase. For example, we may need to makeadditional payments to third-party investigators and organizations to retaintheir services or we may need to pay recruitment incentives. If the delays aresignificant, our financial results and the commercial prospects for our productcandidates will be harmed, and our ability to become profitable will bedelayed.

 

**We lack the capability to manufacturecompounds for development and rely on third parties to manufacture our productcandidates, and we may be unable to obtain required material in a timelymanner, at an acceptable cost or at a quality level required to receiveregulatory approval**.

 

We currently do not have manufacturingcapabilities or experience necessary to produce our product candidates,including R788 for preclinical testing and clinical trials. We relied on asingle third-party contractor to produce R763. We also rely on a singlemanufacturer for R788 product for preclinical and clinical testing. We willrely on manufacturers to deliver materials on a timely basis and to comply withapplicable regulatory requirements, including the U.S. Food and DrugAdministration’s, or FDA’s current Good Manufacturing Practices, or GMP. Theseoutsourcing efforts with respect to manufacturing preclinical and clinicalsupplies will result in a dependence on our suppliers to timely manufacture anddeliver sufficient quantities of materials produced under GMP conditions toenable us to conduct planned preclinical studies, clinical trials and, ifpossible, to bring products to market in a timely manner.

 

Our current and anticipated future dependence upon these third-partymanufacturers may adversely affect our ability to develop and commercializeproduct candidates on a timely and competitive basis. These manufacturers maynot be able to produce

 

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material on a timely basis or manufacture material at the quality levelor in the quantity required to meet our development timelines and applicableregulatory requirements. We may not be able to maintain or renew our existingthird-party manufacturing arrangements, or enter into new arrangements, onacceptable terms, or at all. Our third-party manufacturers could terminate ordecline to renew our manufacturing arrangements based on their own businesspriorities, at a time that is costly or inconvenient for us. If we are unableto contract for the production of materials in sufficient quantity and ofsufficient quality on acceptable terms, our planned clinical trials may besignificantly delayed. Manufacturing delays could postpone the filing of ourIND applications and/or the initiation of clinical trials that we havecurrently planned.

 

Our third-party manufacturers may not be able to comply with the GMPregulations, other applicable FDA regulatory requirements or similarregulations applicable outside of the United States. Additionally, if we arerequired to enter into new supply arrangements, we may not be able to obtainapproval from the FDA of any alternate supplier in a timely manner, or at all,which could delay or prevent the clinical development and commercialization ofany related product candidates. Failure of our third-party manufacturers or usto obtain approval from the FDA or to comply with applicable regulations couldresult in sanctions being imposed on us, including fines, civil penalties,delays in or failure to grant marketing approval of our product candidates,injunctions, delays, suspension or withdrawal of approvals, license revocation,seizures or recalls of products and compounds, operating restrictions andcriminal prosecutions, any of which could significantly and adversely affectour business.

 

**Becausemost of our expected future revenues are contingent upon collaborative andlicense agreements, we might not meet our strategic objectives.**

 

Our ability to generate revenue in the near term depends on our abilityto enter into additional collaborative agreements with third parties and tomaintain the agreements we currently have in place. Our ability to enter intonew collaborations and the revenue, if any, that may be recognized under thesecollaborations is highly uncertain. If we are unable to enter into newcollaborations, our business prospects could be harmed, which could have animmediate adverse effect on the trading price of our stock.

 

To date, most of our revenues have been related to the research phaseof each of our collaborative agreements. Such revenues are for specifiedperiods, and the impact of such revenues on our results of operations ispartially offset by corresponding research costs. Following the completion ofthe 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 and Serono. Under many agreements, however, milestone paymentsmay not be earned until the collaborator has advanced product candidates intoclinical testing, which may never occur or may not occur until some time wellinto the future. If we are not able to generate revenue under ourcollaborations when and in accordance with our expectations or the expectationsof industry analysts, this failure could harm our business and have animmediate adverse effect on the trading price of our stock.

 

Our business requires us to generate meaningful revenue from royaltiesand licensing agreements. To date, we have not received any revenue fromroyalties for the commercial sale of drugs, and we do not know when we willreceive any such revenue, if at all. Likewise, we have not licensed any leadcompounds or drug development candidates to third parties, and we do not knowwhether any such license will be entered into on acceptable terms in thefuture, if at all.

 

**Ifour current corporate collaborations or license agreements are unsuccessful,our research and development efforts could be delayed.**

 

Our strategy depends upon the formation and sustainability of multiplecollaborative arrangements and license agreements with third parties in thefuture. We rely on these arrangements for not only financial resources, butalso for expertise that we expect to need in the future relating to clinicaltrials, manufacturing, sales and marketing, and for licenses to technologyrights. To date, we have entered into several such arrangements with corporatecollaborators; however, we do not know if such third parties will dedicatesufficient resources or if any development or commercialization efforts bythird parties will be successful. Should a collaborative partner fail todevelop or commercialize a compound or product to which it has rights from usfor any reason including corporate restructuring, such failure might delayongoing research and development efforts at Rigel, because we might not receiveany future milestone payments, and we would not receive any royaltiesassociated with such compound or product. In addition, the continuation of someof our partnered drug discovery and development programs may be dependent onthe periodic renewal of our corporate collaborations.

 

The research phase of our collaboration with Johnson & Johnsonended in 2003, and the research phases conducted at our facilities under ourbroad collaboration with Novartis ended in 2004. The research phase of ourcorporate collaboration agreement with Daiichi ended in 2005. In 2004, wesigned a new corporate collaboration with Merck and in 2005, we signedadditional collaborations with Pfizer and Serono. These agreements could beterminated by the other party, and we may not be able to renew thesecollaborations on acceptable terms, if at all, or negotiate additionalcorporate collaborations on acceptable terms, if at all. If these

 

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collaborations terminate or are not renewed, any resultant loss ofrevenues from these collaborations or loss of the expertise of ourcollaborative partners could adversely affect our business.

 

Conflicts also might arise with collaborative partners concerningproprietary rights to particular compounds. While our existing collaborativeagreements typically provide that we retain milestone payments and royaltyrights with respect to drugs developed from certain derivative compounds, anysuch payments or royalty rights may be at reduced rates, and disputes may ariseover the application of derivative payment provisions to such drugs, and we maynot be successful in such disputes.

 

We are also a party to various license agreements that give us rightsto use specified technologies in our research and development processes. Theagreements pursuant to which we have in-licensed technology permit ourlicensors to terminate the agreements under certain circumstances. If we arenot able to continue to license these and future technologies on commerciallyreasonable terms, our product development and research may be delayed.

 

**Ifconflicts arise between our collaborators or advisors and us, any of them mayact in their self-interest, which may be adverse to our stockholders’interests.**

 

If conflicts arise between us and our corporate collaborators orscientific advisors, the other party may act in its self-interest and not inthe interest of our stockholders. Some of our corporate collaborators areconducting multiple product development efforts within each disease area thatis the subject of the collaboration with us or may be acquired or merged with acompany having a competing program. In some of our collaborations, we haveagreed not to conduct, independently or with any third party, any research thatis competitive with the research conducted under our collaborations. Ourcollaborators, however, may develop, either alone or with others, products inrelated fields that are competitive with the products or potential productsthat are the subject of these collaborations. Competing products, eitherdeveloped by our collaborators or to which our collaborators have rights, mayresult in their withdrawal of support for our product candidates.

 

If any of our corporate collaborators were to breach or terminate itsagreement with us or otherwise fail to conduct the collaborative activitiessuccessfully and in a timely manner, the preclinical or clinical development orcommercialization of the affected product candidates or research programs couldbe delayed or terminated. We generally do not control the amount and timing of resourcesthat our corporate collaborators devote to our programs or potential products.We do not know whether current or future collaborative partners, if any, mightpursue alternative technologies or develop alternative products either on theirown or in collaboration with others, including our competitors, as a means fordeveloping treatments for the diseases targeted by collaborative arrangementswith us.

 

**Oursuccess is dependent on intellectual property rights held by us and thirdparties, and our interest in such rights is complex and uncertain.**

 

Our success will depend to a large part on our own, our licensees’ andour licensors’ ability to obtain and defend patents for each party’s respectivetechnologies and the compounds and other products, if any, resulting from theapplication of such technologies. We have over 150 pending patent applicationsand over 50 issued patents in the United States that are owned or exclusivelylicensed in our field as well as pending corresponding foreign patent applications.In the future, our patent position might be highly uncertain and involvecomplex legal and factual questions. For example, we may be involved ininterferences before the United States Patent and Trademark Office.Interferences are complex and expensive legal proceedings and there is noassurance 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 of future protection for our proprietary rights isuncertain, we cannot ensure that:

 

•                                          wewere the first to make the inventions covered by each of our pending patentapplications;

•                                          wewere the first to file patent applications for these inventions;

•                                          otherswill not independently develop similar or alternative technologies or duplicateany of our technologies;

•                                          anyof our pending patent applications will result in issued patents;

•                                          anypatents issued to us or our collaborators will provide a basis forcommercially-viable products or will provide us with any competitive advantagesor will not be challenged by third parties;

•                                          wewill develop additional proprietary technologies that are patentable; or

•                                          thepatents of others will not have a negative effect on our ability to dobusiness.

 

We rely on trade secrets to protect technology where we believe patentprotection is not appropriate or obtainable. However, trade secrets aredifficult to protect. While we require employees, collaborators and consultantsto enter into confidentiality agreements, we may not be able to adequatelyprotect our trade secrets or other proprietary information in the event of anyunauthorized use or disclosure or the lawful development by others of suchinformation.

 

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We are a party to certain in-license agreements that are important toour business, and we generally do not control the prosecution of in-licensedtechnology. Accordingly, we are unable to exercise the same degree of controlover this intellectual property as we exercise over our internally-developedtechnology. Moreover, some of our academic institution licensors, researchcollaborators and scientific advisors have rights to publish data andinformation in which we have rights. If we cannot maintain the confidentialityof our technology 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, insuch patents, and may choose to exercise such rights. Certain of ourin-licenses may be terminated if we fail to meet specified obligations. If wefail to meet such obligations and any of our licensors exercise theirtermination rights, we could lose our rights under those agreements. If we loseany of our rights, it may adversely affect the way we conduct our business. Inaddition, because certain of our licenses are sublicenses, the actions of ourlicensors may affect our rights under those licenses.

 

**Ifa dispute arises regarding the infringement or misappropriation of theproprietary rights of others, such dispute could be costly and result in delaysin our research and development activities and partnering.**

 

Our success will also depend, in part, on ourability to operate without infringing or misappropriating the proprietaryrights of others. There are many issued patents and patent applications filedby third parties relating to products or processes that are similar oridentical to ours or our licensors, and others may be filed in the future.There can be no assurance that our activities, or those of our licensors, willnot infringe patents owned by others. We believe that there may be significantlitigation in the industry regarding patent and other intellectual propertyrights, and we do not know if we or our collaborators would be successful inany such litigation. Any legal action against our collaborators or us claimingdamages or seeking to enjoin commercial activities relating to the affectedproducts, our methods or processes could:

 

•                                          requireour collaborators 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;

•                                          preventus from using the subject matter claimed in the patents held by others;

•                                          subjectus to potential liability for damages;

•                                          consumea substantial portion of our managerial and financial resources; and

•                                          resultin litigation or administrative proceedings that may be costly, whether we winor lose.

 

**Ifwe are unable to obtain regulatory approval to market products in the UnitedStates and foreign jurisdictions, we might not be permitted to commercializeproducts from our research and development.**

 

Due, in part, to the early stage of ourproduct candidate research and development process, we cannot predict whetherregulatory clearance will be obtained for any product that we, or ourcollaborative partners, hope to develop. Satisfaction of regulatoryrequirements typically takes many years, is dependent upon the type complexityand novelty of the product and requires the expenditure of substantialresources. Of particular significance to us are the requirements relating toresearch and development and testing.

 

Before commencing clinical trials in humansin the United States, we, or our collaborative partners, will need to submitand receive approval from the FDA of an IND. Clinical trials are subject tooversight by institutional review boards and the FDA and:

 

•                                          mustbe conducted in conformance with the FDA’s good clinical practices and otherapplicable regulations;

•                                          mustmeet requirements for institutional review board oversight;

•                                          mustmeet requirements for informed consent;

•                                          aresubject to continuing FDA oversight;

•                                          mayrequire large numbers of test subjects; and

•                                          maybe suspended by us, our collaborators or the FDA at any time if it is believedthat the subjects participating in these trials are being exposed tounacceptable health risks or if the FDA finds deficiencies in the IND or theconduct of these trials.

 

While we have stated that we intend to file additional INDs, this isonly a statement of intent, and we may not be able to do so because we may notbe able to identify potential product candidates. In addition, the FDA may notapprove any IND in a timely manner, or at all.

 

Before receiving FDA approval to market a product, we must demonstratethat the product is safe and effective in the patient population and theindication that will be treated. Data obtained from preclinical and clinicalactivities are susceptible to varying interpretations that could delay, limitor prevent regulatory approvals. In addition, delays or rejections may beencountered based upon additional government regulation from future legislationor administrative action or changes in FDA policy during the period of productdevelopment, clinical trials and FDA regulatory review. Failure to comply withapplicable FDA or other applicable regulatory requirements may result incriminal prosecution, civil penalties, recall or seizure of products, total orpartial suspension of production or injunction, as well as other regulatoryaction against our potential products or us. Additionally, we have limitedexperience in conducting and managing the clinical trials necessary to obtainregulatory approval.

 

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If regulatory approval of a product is granted, this approval will belimited to those indications or disease states and conditions for which theproduct is demonstrated through clinical trials to be safe and efficacious. Wecannot ensure that any compound developed by us, alone or with others, willprove to be safe and efficacious in clinical trials and will meet all of theapplicable regulatory requirements needed to receive marketing approval.

 

Outside the United States, our ability, or that of our collaborativepartners, to market a product is contingent upon receiving a marketingauthorization from the appropriate regulatory authorities. This foreignregulatory approval process typically includes all of the risks associated withFDA approval described above and may also include additional risks.

 

**Ifour competitors develop technologies that are more effective than ours, ourcommercial opportunity will be reduced or eliminated.**

 

The biotechnology and pharmaceutical industries are intenselycompetitive and subject to rapid and significant technological change. Many ofthe drugs that we are attempting to discover will be competing with existingtherapies. In addition, a number of companies are pursuing the development ofpharmaceuticals that target the same diseases and conditions that we aretargeting. We face competition from pharmaceutical and biotechnology companiesboth in the United States and abroad.

 

Our competitors may utilize discovery technologies and techniques orpartner with collaborators in order to develop products more rapidly orsuccessfully than we, or our collaborators, are able to do. Many of ourcompetitors, particularly large pharmaceutical companies, have substantiallygreater financial, technical and human resources than we do. In addition,academic institutions, government agencies and other public and privateorganizations conducting research may seek patent protection with respect topotentially competitive products or technologies and may establish exclusivecollaborative or licensing relationships with our competitors.

 

We believe that our ability to compete is dependent, in part, upon ourability to create, maintain and license scientifically-advanced technology andupon our and our collaborators’ ability to develop and commercializepharmaceutical products based on this technology, as well as our ability toattract and retain qualified personnel, obtain patent protection or otherwisedevelop proprietary technology or processes and secure sufficient capitalresources for the expected substantial time period between technologicalconception and commercial sales of products based upon our technology. Thefailure by us or any of our collaborators in any of those areas may prevent thesuccessful commercialization of our potential drug targets.

 

Our competitors might develop technologies and drugs that are moreeffective or less costly than any that are being developed by us or that wouldrender our technology and potential drugs obsolete and noncompetitive. Inaddition, our competitors may succeed in obtaining the approval of the FDA orother regulatory agencies for product candidates more rapidly. Companies thatcomplete clinical trials, obtain required regulatory agency approvals andcommence commercial sale of their drugs before their competitors may achieve asignificant competitive advantage, including certain patent and FDA marketingexclusivity rights that would delay or prevent our ability to market certainproducts. Any drugs resulting from our research and development efforts, orfrom our joint efforts with our existing or future collaborative partners,might not be able to compete successfully with competitors’ existing or futureproducts or obtain regulatory approval in the United States or elsewhere.

 

**Ourability to generate revenues will be diminished if our collaborative partnersfail to obtain acceptable prices or an adequate level of reimbursement forproducts from third-party payors or government agencies.**

 

The drugs we hope to develop may be rejectedby the marketplace due to many factors, including cost. Our ability tocommercially exploit a drug may be limited due to the continuing efforts ofgovernment and third-party payors to contain or reduce the costs of health carethrough various means. For example, in some foreign markets, pricing andprofitability of prescription pharmaceuticals are subject to governmentcontrol. In the United States, we expect that there will continue to be anumber of federal and state proposals to implement similar government control.In addition, increasing emphasis on managed care in the United States willlikely continue to put pressure on the pricing of pharmaceutical products. Costcontrol initiatives could decrease the price that any of our collaboratorswould receive for any products in the future. Further, cost control initiativescould adversely affect our collaborators’ ability to commercialize our productsand our ability to realize royalties from this commercialization.

 

Our ability to commercializepharmaceutical products with collaborators may depend, in part, on the extentto which reimbursement for the products will be available from:

 

•                                          governmentand health administration authorities;

•                                          privatehealth insurers; and

•                                          otherthird-party payors.

 

Significant uncertainty exists as to the reimbursement status ofnewly-approved healthcare products. Third-party payors, including Medicare, arechallenging the prices charged for medical products and services. Governmentand other third-party payors increasingly are attempting to contain healthcarecosts by limiting both coverage and the level of reimbursement for new drugsand by refusing, in some cases, to provide coverage for uses of approvedproducts for disease indications for which the FDA has not granted

 

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labeling approval. Third-party insurance coverage may not be availableto patients for any products we discover and develop, alone or withcollaborators. If government and other third-party payors do not provideadequate coverage and reimbursement levels for our products, the marketacceptance of these products may be reduced.

 

**Ifproduct liability lawsuits are successfully brought against us, we may incursubstantial liabilities and may be required to limit commercialization of ourproducts.**

 

The testing and marketing of medical products entail an inherent riskof product liability. If we cannot successfully defend ourselves againstproduct liability claims, we may incur substantial liabilities or be requiredto limit commercialization of our products although we are not currently awareof any specific causes for concern with respect to clinical liability claims.We currently do not have product liability insurance, and our inability toobtain sufficient product liability insurance at an acceptable cost to protectagainst potential product liability claims could prevent or inhibit thecommercialization of pharmaceutical products we develop, alone or withcorporate collaborators. We, or our corporate collaborators, might not be ableto obtain insurance at a reasonable cost, if at all. While under variouscircumstances we are entitled to be indemnified against losses by our corporatecollaborators, indemnification may not be available or adequate should anyclaim arise.

 

**Ourresearch and development efforts will be seriously jeopardized, if we areunable to attract and retain key employees and relationships.**

 

As a small company with only 155 employees asof March 31, 2006, our success depends on the continued contributions of ourprincipal management and scientific personnel and on our ability to develop andmaintain important relationships with leading academic institutions, scientistsand companies in the face of intense competition for such personnel. Inparticular, our research programs depend on our ability to attract and retainhighly skilled chemists, other scientists, and development, regulatory andclinical personnel. If we lose the services of any of our personnel, ourresearch and development efforts could be seriously and adversely affected. Ouremployees can terminate their employment with us at any time.

 

**Wedepend on various scientific consultants and advisors for the success andcontinuation of our research and development efforts.**

 

We work extensively with various scientificconsultants and advisors. The potential success of our drug discovery anddevelopment programs depends, in part, on continued collaborations with certainof these consultants and advisors. We, and various members of our managementand research staff, rely on certain of these consultants and advisors forexpertise in our research, regulatory and clinical efforts. Our scientificadvisors are not our employees and may have commitments to, or consulting oradvisory contracts with, other entities that may limit their availability tous. We do not know if we will be able to maintain such consulting agreements orthat such scientific advisors will not enter into consulting arrangements,exclusive or otherwise, with competing pharmaceutical or biotechnologycompanies, any of which would have a detrimental impact on our researchobjectives and could have a material adverse effect on our business, financialcondition and results of operations.

 

**Ifwe use biological and hazardous materials in a manner that causes injury orviolates laws, we may be liable for damages.**

 

Our research and development activitiesinvolve the controlled use of potentially harmful biological materials as wellas hazardous materials, chemicals and various radioactive compounds. We cannotcompletely eliminate the risk of accidental contamination or injury from theuse, storage, handling or disposal of these materials. In the event ofcontamination or injury, we could be held liable for damages that result, andsuch liability could exceed our resources. We are also subject to federal,state and local laws and regulations governing the use, storage, handling anddisposal of these materials and specified waste products. The cost ofcompliance with, or any potential violation of, these laws and regulationscould be significant.

 

**Ourfacilities are located near known earthquake fault zones, and the occurrence ofan earthquake or other catastrophic disaster could cause damage to ourfacilities and equipment, which could require us to cease or curtailoperations.**

 

Our facilities are located in the San Francisco Bay Area near knownearthquake fault zones and are vulnerable to significant damage fromearthquakes. We are also vulnerable to damage from other types of disasters,including fires, floods, power loss, communications failures and similarevents. If any disaster were to occur, our ability to operate our business atour facilities would be seriously, or potentially completely, impaired, and ourresearch could be lost or destroyed. In addition, the unique nature of ourresearch activities and of much of our equipment could make it difficult for usto recover from a disaster. The insurance we maintain may not be adequate tocover our losses resulting from disasters or other business interruptions.

 

**Ourstock price may be volatile, and our stockholders’ investment in our stockcould decline in value.**

 

The market prices for our securities andthose of other biotechnology companies have been highly volatile and may continueto be highly volatile in the future. The following factors, in addition toother risk factors described in this section, may have a significant impact onthe market price of our common stock:

 

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•                                          theprogress and success of preclinical activities (i.e., studies, manufacture ofmaterials) and clinical trials of our product candidates conducted by us or ourcollaborative partners or licensees;

•                                          thereceipt or failure to receive the additional funding necessary to conduct ourbusiness;

•                                          sellingby large stockholders;

•                                          announcementsof technological innovations or new commercial products by our competitors orus;

•                                          developmentsconcerning proprietary rights, including patents;

•                                          developmentsconcerning our collaborations;

•                                          publicityregarding actual or potential medical results relating to products underdevelopment by our competitors or us;

•                                          regulatorydevelopments in the United States and foreign countries;

•                                          litigation;

•                                          economicand other external factors or other disaster or crisis; and

•                                          period-to-periodfluctuations in financial results.

 

**Anti-takeoverprovisions in our charter documents and under Delaware law may make anacquisition of us, which may be beneficial to our stockholders, more difficult.**

 

Provisions of our amended and restated certificate of incorporation andbylaws, as well as provisions of Delaware law, could make it more difficult fora third party to acquire us, even if doing so would benefit our stockholders.These provisions:

 

•                                          establishthat members of the board of directors may be removed only for cause upon theaffirmative vote of stockholders owning a majority of our capital stock;

•                                          authorizethe issuance of “blank check” preferred stock that could be issued by our boardof directors to increase the number of outstanding shares and thwart a takeoverattempt;

•                                          limitwho may call a special meeting of stockholders;

•                                          prohibitstockholder action by written consent, thereby requiring all stockholderactions to be taken at a meeting of our stockholders;

•                                          establishadvance notice requirements for nominations for election to the board ofdirectors or for proposing matters that can be acted upon at stockholdermeetings;

•                                          providefor a board of directors with staggered terms; and

•                                          providethat the authorized number of directors may be changed only by a resolution ofour board of directors.

 

In addition, Section 203 of the DelawareGeneral Corporation Law, which imposes certain restrictions relating totransactions with major stockholders, may discourage, delay or prevent a thirdparty from acquiring us.

 

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

 

The exhibitslisted on the accompanying index to exhibits are filed or incorporated byreference (as stated therein) as part of this Quarterly Report onForm 10-Q.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, as amended, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|   | RIGEL PHARMACEUTICALS, INC. |
|--------|-----------------------------|
|   |                        |
|   |                        |
|   | By:                         | /s/ JAMES M. GOWER |
|   |                        | James M. Gower |
|   |                        | Chief Executive Officer |
|   |                        |
|   |                        |
|   | Date:                       | May 3, 2006 |
|   |                        |   |
|   |                        |
|   | By:                         | /s/ JAMES H. WELCH |
|   |                        | James H. Welch |
|   |                        | Vice President, Chief Financial Officer and  Corporate |
|   |                        | Secretary |
|   |                        | (Principal Financial and Accounting  Officer) |
|   |                        |
|   |                        |
|   | Date:                       | May 3, 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)                                                                                                                                                                   |
| 4.1                     |       | Specimen Common Stock Certificate.(1)                                                                                                                                                             |
| 4.3                     |       | Form of warrant to purchase shares of  common stock.(2)                                                                                                                                      |
| 4.7                     |       | Amended and Restated Warrant issued to  Kwacker Limited for the purchase of shares of common stock.(3)                                                                                            |
| 4.8                     |       | Warrant issued to TBCC Funding Trust II for  the purchase of shares of common stock.(4)                                                                                                           |
| 4.10                    |       | Warrant issued to Kwacker Limited for the  purchase of shares of common stock.(3)                                                                                                                 |
| 4.23                    |       | Second Investor Rights Agreement between  Rigel and certain investors, dated June 26, 2003.(5)                                                                                               |
| 10.33                   |       | 2006 Base Salaries for Named Executive Officers.(6)                                                                                                                                               |
| 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.

(3)                                 Filedas an exhibit to Rigel’s Annual Report on Form 10-K for the fiscal yearended December 31, 2002 and incorporated herein by reference.

(4)                                  Filedas an exhibit to Rigel’s Quarterly Report on Form 10-Q for the quarterended March 31, 2002 and incorporated herein by reference.

(5)                                  Filedas an exhibit to Rigel’s Annual Report on Form 10-K for the fiscal yearended December 31, 2003 and incorporated herein by reference.

(6)                                  Filedas an exhibit to Rigel’s Current Report on Form 8-K on January 30, 2006 andincorporated herein by reference.

 

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