Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010**

 

**OR**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**FOR THE TRANSITION PERIODFROM        TO        **

 

**CommissionFile Number 0-29889**

 

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**Rigel Pharmaceuticals, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                     | ** ** | **94-3248524**                       |
|--------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or |       | (I.R.S. Employer Identification No.) |
| organization)                                    |       |                                 |

 

| **1180 Veterans Blvd.  South San Francisco, CA** | ** ** | **94080**  |
|--------------------------------------------------|------------|------------|
| (Address of principal executive offices)         |       | (Zip Code) |

 

**(650)624-1100**

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of thischapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” inRule 12b-2 of the Exchange Act.

 

| Large accelerated filer o                     |   | Accelerated filer x         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filer o                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                        |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

 

As of July 29, 2010,there were 52,127,035 shares of the registrant’s Common Stock outstanding.

 

 

 

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**RIGELPHARMACEUTICALS, INC.QUARTERLY REPORT ON FORM 10-QFOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010**

 

**INDEX**

 
| ** **       | ** **                                                                                                    | **Page** |
|------------------|---------------------------------------------------------------------------------------------------------------|----------|
| **PART I**  | **FINANCIAL INFORMATION**                                                                                     | 3        |
| **Item 1.**      | Condensed Financial  Statements                                                                               | 3        |
|             | Condensed  Balance Sheets — June 30, 2010 (Unaudited) and December 31, 2009                    | 3        |
|             | Condensed  Statements of Operations (Unaudited) —three and six months ended  June 30, 2010 and 2009 | 4        |
|             | Condensed  Statements of Cash Flows (Unaudited) —six months ended June 30, 2010 and  2009           | 5        |
|             | Notes to  Condensed Financial Statements (Unaudited)                                                          | 6        |
| **Item 2.**      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                   | 13       |
| **Item 3.**      | Quantitative  and Qualitative Disclosures About Market Risk                                                   | 26       |
| **Item 4.**      | Controls and  Procedures                                                                                      | 26       |
| **PART II** | **OTHER INFORMATION**                                                                                         | 26       |
| **Item 1.**      | Legal Proceedings                                                                                             | 26       |
| **Item 1A.**     | Risk Factors                                                                                                  | 27       |
| **Item 6.**      | Exhibits                                                                                                      | 38       |
|             |                                                                                                          |     |
| **Signatures**   |                                                                                                          | 39       |

 

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.    Condensed FinancialStatements**

 

**RIGEL PHARMACEUTICALS, INC.**

**CONDENSEDBALANCE SHEETS**

**(In thousands, except share and per share amounts)**

 
| ** **                                                                                                                                                                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **2010**          | ** ** | **2009 (1)**          | ** ** |
| ** **                                                                                                                                                                                 | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                 | ** ** | ** **        |       |                  |       |
| Current assets:                                                                                                                                                                            |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                  |       | $                 | 32,229     |                  | $          | 14,717 |   |
| Available-for-sale securities                                                                                                                                                              |       | 155,229           |       | 118,601               |       |
| Prepaid expenses and other current assets                                                                                                                                                  |       | 2,653             |       | 2,650                 |       |
| Total current assets                                                                                                                                                                       |       | 190,111           |       | 135,968               |       |
| Property and equipment, net                                                                                                                                                                |       | 3,429             |       | 2,291                 |       |
| Other assets                                                                                                                                                                               |       | 2,370             |       | 2,485                 |       |
|                                                                                                                                                                                       |       | $                 | 195,910    |                  | $          | 140,744 |   |
|                                                                                                                                                                                       |       |              |       |                  |       |
| **Liabilities and stockholders’  equity**                                                                                                                                             |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                       |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                           |       | $                 | 3,049      |                  | $          | 3,154 |   |
| Accrued compensation                                                                                                                                                                       |       | 3,033             |       | 6,840                 |       |
| Other accrued liabilities                                                                                                                                                                  |       | 7,996             |       | 6,718                 |       |
| Deferred revenue                                                                                                                                                                           |       | 47,283            |       | —                |       |
| Capital lease obligations                                                                                                                                                                  |       | 941               |       | 1,061                 |       |
| Total current liabilities                                                                                                                                                                  |       | 62,302            |       | 17,773                |       |
|                                                                                                                                                                                       |       |              |       |                  |       |
| Long-term portion of capital lease obligations                                                                                                                                             |       | 393               |       | 883                   |       |
| Long-term portion of deferred rent                                                                                                                                                         |       | 8,635             |       | 12,064                |       |
| Other long-term liabilities                                                                                                                                                                |       | 147               |       | 157                   |       |
|                                                                                                                                                                                       |       |              |       |                  |       |
| Commitments and contingencies                                                                                                                                                              |       |              |       |                  |       |
|                                                                                                                                                                                       |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                 |       |              |       |                  |       |
| Preferred stock, $0.001 par value; 10,000,000  shares authorized; none issued and outstanding as of June 30, 2010 and  December 31, 2009                                         |       | —            |       | —                |       |
| Common stock, $0.001 par value; 100,000,000 shares  authorized; 52,110,360 and 51,956,140 shares issued and outstanding as of  June 30, 2010 and December 31, 2009, respectively |       | 52                |       | 52                    |       |
| Additional paid-in capital                                                                                                                                                                 |       | 732,977           |       | 723,151               |       |
| Accumulated other comprehensive income (loss)                                                                                                                                              |       | 32                |       | (12                   | )          |
| Accumulated deficit                                                                                                                                                                        |       | (608,628          | )          | (613,324              | )          |
| Total stockholders’ equity                                                                                                                                                            |       | 124,433           |       | 109,867               |       |
|                                                                                                                                                                                       |       | $                 | 195,910    |                  | $          | 140,744 |   |

 

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(1)  Thebalance sheet at December 31, 2009 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, 2009.

 

See Accompanying Notes.

 

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**RIGEL PHARMACEUTICALS, INC.**

**CONDENSEDSTATEMENTS OF OPERATIONS**

**(In thousands, except per share amounts)**

**(unaudited)**

 
| ** **                                                              | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Contract revenues                                                       |       | $                                    | 49,457     |                               | $          | — |   | $ | 52,718 |   | $ | — |   |
| Costs and expenses:                                                     |       |                                 |       |                               |       |   |   |   |   |
| Research and development                                                |       | 16,815                               |       | 24,948                             |       | 34,240 |   | 49,486 |   |
| General and administrative                                              |       | 5,664                                |       | 5,050                              |       | 13,850 |   | 9,653 |   |
| Restructuring charges                                                   |       | —                               |       | —                             |       | — |   | 1,141 |   |
| Total costs and expenses                                                |       | 22,479                               |       | 29,998                             |       | 48,090 |   | 60,280 |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Income (loss) from operations                                           |       | 26,978                               |       | (29,998                            | )          | 4,628 |   | (60,280 | ) |
| Interest income                                                         |       | 76                                   |       | 159                                |       | 123 |   | 506 |   |
| Interest expense                                                        |       | (25                                  | )          | (69                                | )          | (55 | ) | (122 | ) |
| Income (loss) before income taxes                                       |       | 27,029                               |       | (29,908                            | )          | 4,696 |   | (59,896 | ) |
| Income tax benefit                                                      |       | —                               |       | 27                                 |       | — |   | 93 |   |
| Net income (loss)                                                       |       | $                                    | 27,029     |                               | $          | (29,881 | ) | $ | 4,696 |   | $ | (59,803 | ) |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Net income (loss) per share:                                            |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                   |       | $                                    | 0.52       |                               | $          | (0.81 | ) | $ | 0.09 |   | $ | (1.63 | ) |
| Diluted                                                                 |       | $                                    | 0.51       |                               | $          | (0.81 | ) | $ | 0.09 |   | $ | (1.63 | ) |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Weighted-average shares used in computing net  income (loss) per share: |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                   |       | 51,974                               |       | 36,704                             |       | 51,969 |   | 36,701 |   |
| Diluted                                                                 |       | 52,511                               |       | 36,704                             |       | 52,480 |   | 36,701 |   |

 

See Accompanying Notes.

 

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**RIGEL PHARMACEUTICALS, INC.**

**CONDENSEDSTATEMENTS OF CASH FLOWS**

**(In thousands)**

**(unaudited)**

 
| ** **                                                                            | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                            | ** ** | **June 30,**    | ** ** |
| ** **                                                                            | ** ** | **2010**             | ** ** | **2009** | ** ** |
| **Operating activities**                                                              |       |                 |       |   |   |
| Net income (loss)                                                                     |       | $                    | 4,696      |   | $ | (59,803 | ) |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                 |       |   |   |
| Depreciation and amortization                                                         |       | 597                  |       | 692 |   |
| Stock-based compensation expense                                                      |       | 8,868                |       | 6,125 |   |
| Changes in assets and liabilities:                                                    |       |                 |       |   |   |
| Prepaid expenses and other current assets                                             |       | (3                   | )          | 976 |   |
| Other assets                                                                          |       | 115                  |       | 122 |   |
| Accounts payable                                                                      |       | (105                 | )          | (1,486 | ) |
| Accrued compensation                                                                  |       | (3,807               | )          | 684 |   |
| Other accrued liabilities                                                             |       | 1,278                |       | (1,065 | ) |
| Deferred revenue                                                                      |       | 47,283               |       | — |   |
| Deferred rent and other long-term liabilities                                         |       | (3,439               | )          | (364 | ) |
| Net cash provided by (used in) operating  activities                                  |       | 55,483               |       | (54,119 | ) |
| ** **                                                                            |       |                 |       |   |   |
| **Investing activities**                                                              |       |                 |       |   |   |
| Purchases of available-for-sale securities                                            |       | (114,849             | )          | (60,376 | ) |
| Maturities and sale of available-for-sale  securities                                 |       | 78,265               |       | 92,132 |   |
| Capital expenditures                                                                  |       | (1,735               | )          | (71 | ) |
| Net cash (used in) provided by investing  activities                                  |       | (38,319              | )          | 31,685 |   |
| ** **                                                                            |       |                 |       |   |   |
| **Financing activities**                                                              |       |                 |       |   |   |
| Payments on capital lease obligations                                                 |       | (610                 | )          | (794 | ) |
| Net proceeds from issuances of common stock                                           |       | 958                  |       | 802 |   |
| Net cash provided by financing activities                                             |       | 348                  |       | 8 |   |
|                                                                                  |       |                 |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                 |       | 17,512               |       | (22,426 | ) |
| Cash and cash equivalents at beginning of period                                      |       | 14,717               |       | 46,005 |   |
| Cash and cash equivalents at end of period                                            |       | $                    | 32,229     |   | $ | 23,579 |   |
|                                                                                  |       |                 |       |   |   |
| **Supplemental disclosure of cash  flow information**                                 |       |                 |       |   |   |
| Interest paid                                                                         |       | $                    | 52         |   | $ | 102 |   |
|                                                                                  |       |                 |       |   |   |
| **Schedule of non cash transactions**                                                 |       |                 |       |   |   |
| Issuance of warrant with lease amendment                                              |       | $                    | —     |   | $ | 616 |   |

 

See Accompanying Notes.

 

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**Rigel Pharmaceuticals, Inc.**

**Notes to Condensed FinancialStatements**

**(unaudited)**

 

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

 

**1.****             ****Nature of Operations**

 

Wewere incorporated in the state of Delaware on June 14, 1996. We areengaged in the discovery and development of novel, small-molecule drugs for thetreatment of inflammatory/autoimmune, muscle and metabolic diseases.

 

**2.****             ****Basis of Presentation**

 

Ouraccompanying unaudited condensed financial statements have been prepared inaccordance with U.S. generally accepted accounting principles, or GAAP, forinterim financial information and pursuant to the instructions toForm 10-Q and Article 10 of Regulation S-X. Accordingly, they do notinclude all of the information and notes required by U.S. GAAP for completefinancial statements. These unaudited condensed financial statements includeall normal and recurring adjustments that we believe are necessary to fairlystate our financial position and the results of our operations and cash flows.Interim-period results are not necessarily indicative of results of operationsor cash flows for a full-year. The balance sheet at December 31, 2009 hasbeen derived from audited financial statements at that date, but does notinclude all disclosures required by U.S. GAAP for complete financialstatements. Because all of the disclosures required by U.S. GAAP for completefinancial statements are not included herein, these interim unaudited condensedfinancial statements and the notes accompanying them should be read inconjunction with our audited financial statements and the notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2009.

 

The preparation of financialstatements in conformity with U.S. GAAP requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes. We base our estimates on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances. Actual results could differ from these estimates.

 

**3.****             ****Recent Accounting Pronouncements**

 

In April 2010, theFinancial Accounting Standards Board (FASB) issued Accounting Standards Update,or ASU, No. 2010-17 thereby amending Accounting Standards Codification(ASC) 605 for revenue recognition related to the milestone method of revenuerecognition. ASU No. 2010-17 provides guidance on defining a milestone anddetermining when it may be appropriate to apply the milestone method of revenuerecognition for research or development arrangements. A company may make anaccounting policy election to use the milestone method of revenue recognitionfor transactions within the scope of the amendments.  The amendments will be effective in fiscalyears beginning on or after June 15, 2010, and early adoption ispermitted. We evaluated the impact of adopting ASU No. 2010-17 and believeit will have no material effect on our financial statements.

 

**4.****             ****Basic and Diluted Net Income(Loss) Per Share**

 

Basicearnings per share, or EPS, is computed by dividing net income (loss) by theweighted-average number of shares of common stock outstanding during theperiod. Diluted earnings per share is computed by dividing net income (loss) bythe weighted-average number of shares of common stock outstanding during theperiod and the number of additional shares of common stock that would have beenoutstanding if potentially dilutive securities had been issued.  Potentially dilutive securities include stock options and warrants. The dilutive effect ofpotentially dilutive securities is reflected in diluted earnings per share byapplication of the treasury stock method. Under the treasury stock method, anincrease in the fair market value of our common stock can result in a greaterdilutive effect from potentially dilutive securities.

 

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Thefollowing table sets forth the computation of basic and diluted earnings pershare (in thousands except per share amounts):

 
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                               | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                               | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| EPS Numerator:                                                           | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                        |       | $                      | 27,029     |                 | $          | (29,881 | ) | $ | 4,696 |   | $ | (59,803 | ) |
|                                                                     |       |                   |       |                 |       |   |   |   |   |
| EPS Denominator - Basic:                                                 |       |                   |       |                 |       |   |   |   |   |
| Weighted-average common shares outstanding                               |       | 51,974                 |       | 36,704               |       | 51,969 |   | 36,701 |   |
|                                                                     |       |                   |       |                 |       |   |   |   |   |
| EPS Denominator - Diluted:                                               |       |                   |       |                 |       |   |   |   |   |
| Weighted-average common shares outstanding                               |       | 51,974                 |       | 36,704               |       | 51,969 |   | 36,701 |   |
| Dilutive effect of stock options, shares under  ESPP and warrant         |       | 537                    |       | —               |       | 512 |   | — |   |
| Weighted-average common shares outstanding and  common share equivalents |       | 52,511                 |       | 36,704               |       | 52,480 |   | 36,701 |   |
|                                                                     |       |                   |       |                 |       |   |   |   |   |
| Net income (loss) per common share:                                      |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                    |       | $                      | 0.52       |                 | $          | (0.81 | ) | $ | 0.09 |   | $ | (1.63 | ) |
| Diluted                                                                  |       | $                      | 0.51       |                 | $          | (0.81 | ) | $ | 0.09 |   | $ | (1.63 | ) |

 

Forthe three and six months ended June 30, 2010, the calculation of dilutedearnings per share excluded stock options to purchase 7,323,664 and 6,936,678shares, respectively, that had exercise prices greater than the average marketprice, because their effect would have been anti-dilutive.  For the three and six months ended June 30,2009, the calculation of diluted net loss per share excluded shares ofpotential common stock, consisting of stock options, shares under our 2000Employee Stock Purchase Plan, or ESPP, and warrants because their effect wouldhave been anti-dilutive.

 

**5.****             ****Stock Award Plans**

 

Totalstock-based compensation expense related to all of our stock-based awards thatwe recognized was as follows (in thousands):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                             | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                             | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| Research and development               |       | $                      | 1,917      |                 | $          | 2,528 |   | $ | 5,000 |   | $ | 3,953 |   |
| General and administrative             |       | 1,784                  |       | 1,331                |       | 3,868 |   | 2,050 |   |
| Restructuring charges                  |       | —                 |       | —               |       | — |   | 122 |   |
| Total stock-based compensation expense |       | $                      | 3,701      |                 | $          | 3,859 |   | $ | 8,868 |   | $ | 6,125 |   |

 

The fair value of each option award is estimated on the date of grantusing the Black-Scholes option pricing model. We have segregated option awardsinto three homogenous groups for purposes of determining fair values ofoptions: officers and directors, all other employees, and consultants.

 

We determined weighted-average valuation assumptions separately foreach of these groups as follows:

 

·                  Volatility—We estimatedvolatility using the historical share price performance over the expected lifeof the option up to the point where we have historical market data. We alsoconsidered other factors, such as implied volatility, our current clinical trialsand other company activities that may affect the volatility of our stock in thefuture. We determined that at this time historical volatility is moreindicative of our expected future stock performance than implied volatility.

 

·                  Expected term—For optionsgranted to consultants, we use the contractual term of the option, which istypically ten years, for the initial valuation of the option and the remainingcontractual term of the option for succeeding periods. We worked with varioushistorical data to determine the applicable expected term for each of the otheroption groups. This data included: (1) for exercised options, the term ofthe options from option grant date to exercise date; (2) for cancelledoptions, the term of the options from option grant date to cancellation date,excluding unvested option forfeitures; and (3) for options that remainedoutstanding at the balance sheet date, the term of the options from optiongrant date to the end of the reporting period and the estimated remaining termof the options. The consideration and calculation of the above data gave usreasonable estimates of the expected term for each employee group. We alsoconsidered the vesting schedules of the options granted and factors surroundingexercise behavior of the option groups, our current market price and companyactivity that may affect our market price. In addition, we considered theoptionee type (i.e., officers and directors or all other employees) andother factors that may affect the expected term of the option.

 

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·                  Risk-free interest rate—Therisk-free interest rate is based on U.S. Treasury constant maturity rates withsimilar terms to the expected term of the options for each option group.

 

·                  Forfeiture rate—We estimatedthe forfeiture rate using our historical experience with pre-vesting options.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 paid and do not expectto pay dividends.

 

The following table summarizes theweighted-average assumptions relating to options granted pursuant to our equityincentive plans for the three and six months ended June 30, 2010 and 2009:

 
| ** **               | ** ** | **Equity Incentive Plans** | ** ** | **Equity Incentive Plans** | ** ** |
|--------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **               | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended**       | ** ** |
| ** **               | ** ** | **June 30,**          | ** ** | **June 30,**          | ** ** |
| ** **               | ** ** | **2010**                   | ** ** | **2009**                   | ** ** | **2010** | ** ** | **2009** | ** ** |
| Risk-free interest rate  |       | 2.3                        | %          | 2.2                        | %          | 2.4 | % | 1.8 | % |
| Expected term (in years) |       | 5.4                        |       | 5.0                        |       | 5.4 |   | 4.4 |   |
| Dividend yield           |       | 0.0                        | %          | 0.0                        | %          | 0.0 | % | 0.0 | % |
| Expected volatility      |       | 90.1                       | %          | 95.2                       | %          | 90.1 | % | 98.3 | % |

 

Optionsare priced at the market price of our common stock on the date immediatelypreceding the date of grant, become exercisable at varying dates and generallyexpire ten years from the date of grant. Wegranted options to purchase 1,894,400 shares of common stock during the sixmonths ended June 30, 2010, with a grant-date weighted-average fair valueof $6.17 per share. We granted options to purchase 2,052,473 shares of common stock during the six months ended June 30,2009, with a grant-date weighted-average fair value of $4.64 per share.  As of June 30,2010, there was approximately $11.6 million of total unrecognized stock-basedcompensation cost, net of estimated forfeitures, related to unvested optionsgranted under our equity incentive plans. At June 30, 2010, 2,565,093shares of common stock were available for future grant under our equityincentive plans and options to purchase 38,139 shares were exercised during thesix months ended June 30, 2010.

 

***Employee Stock PurchasePlan (ESPP)***

 

The fair value of awards grantedunder our ESPP is estimated on the date of grant using the Black-Scholes optionpricing model, which uses weighted-average assumptions. Our ESPP provides for atwenty-four month offering period comprised of four six-month purchase periodswith a look-back option. A look-back option is a provision in our ESPP underwhich eligible employees can purchase shares of our common stock at a price pershare equal to the lesser of 85% of the fair market value on the first day ofthe offering period or 85% of the fair market value on the purchase date. Our ESPP alsoincludes a feature that provides for a new offering period to begin when thefair market value of our common stock on any purchase date during an offeringperiod falls below the fair market value of our common stock on the first dayof such offering period. This feature is called a “reset.” Participants areautomatically enrolled in the new offering period. We had a “reset” onJuly 1, 2010 because the fair market value of our stock on June 30,2010 was lower than the fair market value of our stock on January 2, 2009,the first day of the offering period. We applied modification accounting inaccordance with ASC Topic No. 718, *Stock Compensation*, todetermine the incremental fair value associated with this ESPP “reset” andrecognized the related stock-based compensation expense according to the FASBASC Subtopic No. 718-50, *Employee Share PurchasePlan*.  The total incrementalfair value for this ESPP “reset” was approximately $1.4 million, and will berecognized from July 1, 2010 to June 30, 2012.

 

As of June 30, 2010, therewere approximately 1,097,812 shares reserved for future issuance under the ESPPand 116,081 shares were purchased under the ESPP during the six months ended June 30,2010. The following table summarizes the weighted-average assumptions relatedto our ESPP for the six months ended June 30, 2010 and 2009. Expectedvolatilities for our ESPP are based on the historical volatility of our stock.Expected term represents the weighted-average of the purchase periods withinthe offering period. The risk-free interest rate for periods within theexpected term is based on U.S. Treasury constant maturity rates.

 
| ** **               | ** ** | **Employee Stock Purchase Plan** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **Six Months Ended**             | ** ** |
| ** **               | ** ** | **June 30,**                | ** ** |
| ** **               | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| Risk-free interest rate  |       | 0.3                              | %          | 1.1 | % |
| Expected term (in years) |       | 0.7                              |       | 1.3 |   |
| Dividend yield           |       | 0.0                              | %          | 0.0 | % |
| Expected volatility      |       | 82.6                             | %          | 112.0 | % |

 

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**6.****             ****Revenue Recognition**

 

We present revenue from our collaboration arrangements under FASB ASC808, *Collaboration Arrangements*.Our revenue arrangements with multiple elements are evaluated under FASBASC 605-25, *Multiple-ElementArrangements*, and are divided into separate units of accounting ifcertain criteria are met, including whether the delivered element hasstand-alone value to the customer and whether there is objective and reliableevidence of the fair value of any undelivered items. The consideration wereceive 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 in connection with researchand development collaboration agreements, including technology access fees, aredeferred and recognized on a straight-line basis over the relevant periods ofcontinuing involvement, generally the research term. When a research term isnot specified, we estimate the time it will take us to complete ourdeliverables under the contract and recognize the upfront fee using thestraight-line method over that time period. We review our estimates everyquarter for reasonableness.

 

Revenues related to collaborative research with our corporatecollaborators are recognized as research services are performed over therelated development periods for each agreement. Under these agreements, we arerequired to perform research and development activities as specified in eachrespective agreement. The payments received are not refundable and are generallybased on a contractual cost per full-time equivalent employee working on theproject. Our research and development expenses under the collaborative researchagreements approximate the revenue recognized under such agreements over theterm of the respective agreements. It is our policy to recognize revenue basedon our level of effort expended, however, revenue recognized will not exceedamounts billable under the agreement.

 

Revenuesassociated with substantive, at-risk milestones pursuant to collaborativeagreements are recognized upon achievement of the milestones.

 

**7.***             ***Research and Development Accruals**

 

Wehave various contracts with third parties related to our research anddevelopment activities. Costs that are incurred but not billed to us as of theend of the period are accrued. We make estimates of the amounts incurred ineach period based on the information available to us and our knowledge of thenature of the contractual activities generating such costs. Clinical trialcontract expenses are accrued based on units of activity reported by thirdparties. Expenses related to other research and development contracts, such asresearch contracts, toxicology study contracts and manufacturing contracts areestimated to be incurred generally on a straight-line basis over the durationof the contracts. Raw materials and study materials purchased by third partiesare expensed at the time of purchase.

 

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

 

Cash,cash equivalents and available-for-sale securities consisted of the following(in thousands): 

 
| ** **                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Checking account                           |       | $                 | 1,514      |                  | $          | 158 |   |
| Money market funds                         |       | 10,263            |       | 8,859                 |       |
| U. S. treasury bills                       |       | 17,603            |       | 44,483                |       |
| Government-sponsored enterprise securities |       | 90,517            |       | 39,167                |       |
| Corporate bonds and commercial paper       |       | 67,561            |       | 40,651                |       |
|                                       |       | $                 | 187,458    |                  | $          | 133,318 |   |
| Reported as:                               |       |              |       |                  |       |
| Cash and cash equivalents                  |       | $                 | 32,229     |                  | $          | 14,717 |   |
| Available-for-sale securities              |       | 155,229           |       | 118,601               |       |
|                                       |       | $                 | 187,458    |                  | $          | 133,318 |   |

 

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Cash equivalents andavailable-for-sale securities include the following securities with unrealizedgains and losses (in thousands):

 
| ** **                                 | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** **     | ** ** |
|--------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **                                 | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **     | ** ** |
| **June 30, 2010**                     | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| U. S. treasury bills                       |       | $             | 17,598     |           | $          | 5              |       | $              | —     |   | $ | 17,603 |   |
| Government-sponsored enterprise securities |       | 90,490        |       | 27             |       | —         |       | 90,517         |       |
| Corporate bonds and commercial paper       |       | 67,561        |       | 20             |       | (20            | )          | 67,561         |       |
| Total                                      |       | $             | 175,649    |           | $          | 52             |       | $              | (20        | ) | $ | 175,681 |   |

 
| ** **                                 | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** **          | ** ** |
|--------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------------|------------|
| ** **                                 | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **          | ** ** |
| **December 31, 2009**            | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| U. S. treasury bills                       |       | $             | 44,489     |           | $          | 3              |       | $                   | (9         | ) | $ | 44,483 |   |
| Government-sponsored enterprise securities |       | 39,184        |       | 7              |       | (24            | )          | 39,167              |       |
| Corporate bonds and commercial paper       |       | 40,640        |       | 12             |       | (1             | )          | 40,651              |       |
| Total                                      |       | $             | 124,313    |           | $          | 22             |       | $                   | (34        | ) | $ | 124,301 |   |

 

As of June 30,2010, the contractual maturities of our cash equivalents and available-for-salesecurities were (in thousands):

 
| ** **                                 | ** ** | **Years to Maturity** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | ** **            | ** ** | **After One Year** | ** ** |
| ** **                                 | ** ** | **Within One**        | ** ** | **Through** | ** ** |
| ** **                                 | ** ** | **Year**              | ** ** | **Five Years** | ** ** |
| Money market funds                         |       | $                     | 10,263     | ** ** | **$** | **—** | ** ** |
| U. S. treasury bills                       |       | 17,603                |       | — |   |
| Government-sponsored enterprise securities |       | 90,517                |       | — |   |
| Corporate bonds and commercial paper       |       | 67,561                |       | — |   |
|                                       |       | $                     | 185,944    |   | $ | — |   |

 

As of June 30,2010, our cash equivalents andavailable-for-sale securities had a weighted-average time to maturity ofapproximately 106 days. We view our available-for-sale portfolio as availablefor use in current operations.  We havethe ability to hold all investments as of June 30, 2010 to maturity. At June 30,2010 and December 31, 2009, we had no investments that had been in acontinuous unrealized loss position for more than twelve months.  As of June 30, 2010, a total of 10individual securities were in an unrealized loss position for twelve months orless and the losses were deemed to be temporary.

 

Thefollowing table shows the fair value and gross unrealized losses of ourinvestments in individual securities that are in an unrealized loss position,aggregated by investment category (in thousands):

 
| ** **                           | ** ** | ** **     | ** ** | **Gross Unrealized** | ** ** |
|--------------------------------------|------------|----------------|------------|----------------------|------------|
| **June 30, 2010**               | ** ** | **Fair Value** | ** ** | **Losses**           | ** ** |
| Corporate bonds and commercial paper |       | $              | 14,531     |                 | $          | (20 | ) |
|                                      |            |                |            |                      |            |  |  |

 

**9.****             ****Fair Value**

 

Under FASB ASC 820, *Fair ValueMeasurements and Disclosures*, fair value is defined as the price atwhich an asset could be exchanged or a liability transferred in a transactionbetween knowledgeable, willing parties in the principal or most advantageousmarket for the asset or liability. Where available, fair value is based onobservable market prices or parameters or derived from such prices orparameters. Where observable prices or parameters are not available, valuationmodels are applied.

 

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Assets and liabilities recorded at fair value in our financialstatements are categorized based upon the level of judgment associated with theinputs used to measure their fair value. Hierarchical levels directly relatedto the amount of subjectivity associated with the inputs to fair valuation ofthese assets and liabilities, are as follows:

 

Level 1—Inputs are unadjusted, quoted prices in active markets foridentical assets at the reporting date. Active markets are those in whichtransactions for the asset or liability occur in sufficient frequency andvolume to provide pricing information on an ongoing basis.

 

The fair valued assets we hold that are generally included under thisLevel 1 are money market securities where fair value is based on publiclyquoted prices.

 

Level 2—Are inputs, other than quoted prices included inLevel 1, that are either directly or indirectly observable for the assetor liability through correlation with market data at the reporting date and forthe duration of the instrument’s anticipated life.

 

The fair valued assets we hold that are generally assessed underLevel 2 included government-sponsored enterprise securities, U. S.Treasury bills and corporate bonds and commercial paper where fair value isbased on valuation methodologies such as models using observable market inputs,including benchmark yields, reported trades, broker/dealer quotes, bids, offersand other reference data.

 

Level 3—Unobservable inputs that are supported by little or nomarket activity and that are significant to the fair value of the assets orliabilities and which reflect management’s best estimate of what marketparticipants would use in pricing the asset or liability at the reporting date.Consideration is given to the risk inherent in the valuation technique and therisk inherent in the inputs to the model.

 

***Fair Value on a Recurring Basis***

 

Financialassets measured at fair value on a recurring basis are categorized in thetables below based upon the lowest level of significant input to the valuations(in thousands):

 
| ** **                                 | ** ** | **Assets at Fair Value as of June 30, 2010** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                 | ** ** | **Level 1**                                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Money market funds                         |       | $                                                 | 10,263     |   | $ | — |   | $ | — |   | $ | 10,263 |   |
| U. S. treasury bills                       |       | —                                            |       | 17,603 |   | — |   | 17,603 |   |
| Government-sponsored enterprise securities |       | —                                            |       | 90,517 |   | — |   | 90,517 |   |
| Corporate bonds and commercial paper       |       | —                                            |       | 67,561 |   | — |   | 67,561 |   |
| Total                                      |       | $                                                 | 10,263     |   | $ | 175,681 |   | $ | — |   | $ | 185,944 |   |

 
| ** **                                 | ** ** | **Assets at Fair Value as of December 31, 2009** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                 | ** ** | **Level 1**                                           | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Money market funds                         |       | $                                                     | 8,859      |   | $ | — |   | $ | — |   | $ | 8,859 |   |
| U. S. treasury bills                       |       | —                                                |       | 44,483 |   | — |   | 44,483 |   |
| Government-sponsored enterprise securities |       | —                                                |       | 39,167 |   | — |   | 39,167 |   |
| Corporate bonds and commercial paper       |       | —                                                |       | 40,651 |   | — |   | 40,651 |   |
| Total                                      |       | $                                                     | 8,859      |   | $ | 124,301 |   | $ | — |   | $ | 133,160 |   |

 

**10.****      ****AstraZeneca Collaboration**

 

In February 2010, we entered into an exclusive worldwide licenseagreement with AstraZeneca AB (AZ) for the global development andcommercialization of our oral syk inhibitors for the treatment of humandiseases other than those primarily involving respiratory or pulmonarydysfunction. The agreement includes a license of rights to fostamatinibdisodium (FosD, previously referred to as R788), our late-stage investigationalproduct candidate for the treatment of RA and other indications. After alimited transition 

 

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period,AZ will be responsible for conducting and funding all development, regulatoryfilings, manufacturing and global commercialization of products containing oralsyk inhibitors. We are responsible for conducting, at our expense, an on-goingopen label extension study of FosD during the limited transition period.

 

The agreement became effective on March 26, 2010 and, inconnection with the effectiveness of the agreement, we received an upfrontpayment of $100.0 million in April 2010 from AZ.  We are recognizing the upfront paymentratably over the transition period from the effective date until alldeliverables are completed, which we estimate to be September 25,2010.  As of June 30, 2010, $52.7 million of the upfront payment hasbeen recognized as revenue and $47.3 million has been deferred.  AZ is required to pay us up to an additional$345.0 million if specified development, regulatory and launch milestonesare achieved for FosD. We will also be eligible to receive up to an additional$800.0 million if specified sales performance milestones are achieved forFosD, as well as significant stepped double-digit royalties on net worldwidesales.

 

**11.****      ****Amendment to the Build-to-SuitLease Agreement**

 

OnMarch 31, 2009, we amended our build-to-suit lease agreement with ourlandlord, HCP BTC, LLC (formerly known as Slough BTC, LLC), to defercertain rental obligations in the aggregate amount of $6.9 million for aperiod of up to seventeen months. Under the terms of this amendment, we wereobligated to repay the deferred rental amounts, including interest accruing at12% during the deferral period, based on a timeline that could vary dependingupon the occurrence of certain financing or collaborative transactions. OnSeptember 22, 2009, we completed an underwritten public offering and receivednet proceeds of approximately $101.5 million after deducting underwritingdiscounts and commissions and offering expenses. As a result of this financing,we paid our landlord $3.7 million, or 50% of the deferred rental amounts,plus interest at 12%, in November 2009. In February 2010, we entered into a worldwide license agreementwith AZ in which we received an upfront payment of $100.0 million inApril 2010.  As a result of thisadditional cash received, we paid our landlord $3.9 million, or the remaining50% of the deferred rental amounts, plus interest at 12%, in April 2010.

 

**12.****      ****Contingencies**

 

On February 6, 2009, a purported securities class action lawsuitwas commenced in the United States District Court for the Northern District ofCalifornia, naming as defendants us and certain of our officers, directors andunderwriters for our February 2008 stock offering. An additional purportedsecurities class action lawsuit containing similar allegations was subsequentlyfiled in the United States District Court for the Northern District ofCalifornia on February 20, 2009. By order of the Court datedMarch 19, 2009, the two lawsuits were consolidated into a single action.On June 9, 2009, the Court issued an order naming the Inter-Local PensionFund GCC/IBT as lead plaintiff and Robbins Geller Rudman & Dowd LLP(formerly Coughlin Stoia) as lead counsel. The lead plaintiff filed aconsolidated complaint on July 24, 2009. We filed a motion to dismiss onSeptember 8, 2009. On December 21, 2009, the Court granted our motionand dismissed the consolidated complaint with leave to amend. Plaintiff filedits consolidated amended complaint on January 27, 2010. The lawsuitalleges violations of the Securities Act of 1933 and the Securities ExchangeAct of 1934 in connection with allegedly false and misleading statements madeby us related to the results of the Phase 2a clinical trial of our productcandidate FosD. The plaintiffs seek damages, including rescission or rescissorydamages for purchasers in the stock offering, an award of their costs andinjunctive and/or equitable relief for purchasers of our common stock duringthe period between December 13, 2007 and February 9, 2009, includingpurchasers in the stock offering. We filed a motion to dismiss the consolidatedamended complaint on February 16, 2010. Briefing on the motion to dismissis complete and we are awaiting a ruling on that motion from the Court. It ispossible that additional suits will be filed with respect to these same mattersand also naming us and/or our officers and directors as defendants. If any suchadditional suits are filed in the same court, we believe that they would beconsolidated into the consolidated action.

 

Thislawsuit and any other related lawsuits are subject to inherent uncertaintiesand the actual costs to be incurred relating to the lawsuit will depend uponmany unknown factors. The outcome of the litigation is necessarily uncertainand we could be forced to expend significant resources in the defense of thissuit, and we may not prevail. We are not currently able to estimate thepossible cost to us from this matter, and we cannot ascertain how long it maytake to resolve this matter. We have not established any reserve for anypotential liability relating to this lawsuit. We believe that we havemeritorious defenses and intend to defend this lawsuit vigorously.

 

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**Item 2.    Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

*This discussion and analysisshould be read in conjunction with our financial statements and theaccompanying notes included in this report and the audited financial statementsand accompanying notes included in our Annual Report on Form 10-K for theyear ended December 31, 2009. Operating results for the six months ended June 30,2010 are not necessarily indicative of results that may occur in futureperiods.*

 

*This Quarterly Report on Form 10-Qcontains statements indicating expectations about future performance and otherforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, that involve risks and uncertainties.**We usually use words such as “may,”“will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,”“predict,” “intend,” or the negative of these terms or similar expressions toidentify these forward-looking statements. These statements appear throughoutthis Quarterly Report on Form 10-Q and are statements regarding ourcurrent expectation, belief or intent, primarily with respect to our operationsand related industry developments. Examples of these statements include, butare not limited to, statements regarding the following: our business andscientific strategies; the progress of our product development programs,including clinical testing, and the timing of results thereof; our corporate collaborationsand revenues that may be received from our collaborations; our drug discoverytechnologies; our research and development expenses; protection of ourintellectual property; sufficiency of our cash resources; and our operationsand legal risks. You should not place undue reliance on these forward-lookingstatements. Our actual results could differ materially from those anticipatedin these forward-looking statements for many reasons, including as a result ofthe risks and uncertainties discussed under the heading “Risk Factors” in Item1A 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**

 

We are a clinical-stage drug development company that discovers anddevelops novel, small-molecule drugs for the treatment ofinflammatory/autoimmune, muscle and metabolic diseases. Our pioneering researchfocuses on intracellular signaling pathways and related targets that arecritical to disease mechanisms. Our productivity has resulted in strategiccollaborations with large pharmaceutical partners to develop and market ourproduct candidates. Current product development programs include fostamatinibdisodium (FosD, previously referred to as R788), an oral syk inhibitor that isexpected to enter Phase 3 clinical trials for rheumatoid arthritis (RA) in2010, and R343, an inhaled syk inhibitor that is in clinical trials for asthma.In February 2010, we entered into an exclusive worldwide license agreementwith AstraZeneca AB (AZ) for the global development and commercialization ofour oral syk inhibitors for the treatment of human diseases other than thoseprimarily involving respiratory or pulmonary dysfunction. The agreementincludes a license of rights to FosD, our late-stage investigational productcandidate for the treatment of RA and other indications. We completed acomprehensive Phase 2 clinical trial of FosD, which is at the mostadvanced stage of development of the oral syk inhibitors being evaluated for anRA indication. FosD reversibly blocks signaling in multiple cell types involvedin inflammation and tissue degradation in RA. After a limited transitionperiod, AZ will be responsible for conducting and funding all development,regulatory filings, manufacturing and global commercialization of productscontaining oral syk inhibitors. The agreement became effective onMarch 26, 2010 and, in connection with the effectiveness of the agreement,we received an upfront payment of $100.0 million in April 2010 from AZ. AZis required to pay us up to an additional $345.0 million if specifieddevelopment, regulatory and launch milestones are achieved for FosD. We willalso be eligible to receive up to an additional $800.0 million if specifiedsales performance milestones are achieved for FosD, as well as significantstepped double-digit royalties on net sales worldwide.

 

Since inception, we have financed our operations primarily through thesale of equity securities, contract payments under our collaboration agreementsand equipment financing arrangements. Our research and development activities,including preclinical studies and clinical trials, consume substantial amountsof capital. As of June 30, 2010, we had approximately$187.5 million in cash, cash equivalents and available-for-salesecurities. We believe that our existing capital resources will be sufficientto support our current and projected funding requirements through at least thenext twelve months. Until we are able to generate sufficient amounts of productrevenues and royalty revenues, we expect to finance future cash needs throughcollaboration and licensing arrangements or public and/or private equity ordebt offerings, as well as through interest income earned on the investment ofour cash balances and short-term investments.

 

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**ProductDevelopment Programs**

 

Ourproduct development portfolio features multiple novel, small molecule drugcandidates whose specialized mechanisms of action are intended to providetherapeutic benefit for a range of inflammatory/autoimmune, muscle andmetabolic diseases.

 

**Partnered Clinical Programs**

 

***FosD (previously referred to as R788)***

 

In February 2010, we entered into an exclusive worldwide licenseagreement with AZ for the global development and commercialization of our oralsyk inhibitors for the treatment of human diseases other than those primarilyinvolving respiratory or pulmonary dysfunction. The agreement includes alicense of rights to FosD, our late-stage investigational product candidate forthe treatment of RA and other indications. We completed a comprehensivePhase 2 clinical trial of FosD, which is at the most advanced stage ofdevelopment of the oral syk inhibitors being evaluated for an RA indication.FosD reversibly blocks signaling in multiple cell types involved ininflammation and tissue degradation in RA. For further discussion on thecollaboration, see “AstraZeneca” under “Corporate Collaborations” below.

 

The agreement became effective on March 26, 2010 and, inconnection with the effectiveness of the agreement, we received an upfrontpayment of $100.0 million in April 2010 from AZ. AZ is required to pay usup to an additional $345.0 million if specified development, regulatoryand launch milestones are achieved for FosD. We will also be eligible toreceive up to an additional $800.0 million if specified sales performancemilestones are achieved for FosD, as well as significant stepped double-digitroyalties on net sales worldwide of FosD. After a limited transition period, AZwill be responsible for conducting and funding all development, regulatoryfilings, manufacturing and global commercialization of products containing oralsyk inhibitors. We are responsible for conducting, at our expense, the on-goingopen label extension study in FosD during the limited transition period.

 

Under the agreement, AZ is expected to design a global Phase 3clinical trial of FosD for the treatment of RA, anticipated to begin in 2010,with the goal of filing new drug applications with the U.S. Food and DrugAdministration (FDA) and the European Medicines Agency (EMEA) in 2013. Underthe terms of the agreement, AZ also received exclusive rights to our portfolioof oral syk inhibitors, including FosD (R788), for all indications includingRA.

 

**RheumatoidArthritis**

 

*Disease background.*  RA is a systemic autoimmune inflammatorydisease that causes damage to the joints and other organs, affectingapproximately 1 in 100 people. It is a major cause of disability and is alsoassociated with reduced life expectancy, especially if it is not adequatelytreated. Despite current treatment options, many patients still experience significantdisease activity, including continued joint destruction leading to pain anddisability, so new treatment options are needed.

 

The current treatment options for RA have significant potential sideeffects and other shortfalls, including gastrointestinal complications andkidney damage. RA patients receive multiple drugs depending on the extent andaggressiveness of their disease. Most RA patients eventually require some formof disease modifying anti-rheumatic drug (DMARD). This category of drugs includesmethotrexate, and/or a variety of intravenously-delivered immunomodulatoryagents (tumor necrosis factor, or TNF, inhibitors and co-stimulationinhibitors).

 

*Orally-available syk inhibitor program.*  FosD is an orally bio-available sykinhibitor. It has a novel mechanism of action for the treatment of RA in whichit reversibly blocks signaling in multiple cell types involved in inflammationand tissue degradation in RA (e.g., macrophages, osteoclasts, mast cells and Bcells). RA is an autoimmune disease characterized by chronic inflammation thataffects multiple tissues, but typically produces its most pronounced symptomsin the joints.

 

*TASKi2*

 

In July 2009, we announced that FosD produced significant clinicalimprovement in RA patients in the *TASKi2*Phase 2b clinical trial in which 457 RA patients were treated for up tosix months. *TASKi2* was a multi-center, randomized, double blind, placebo controlled, parallel dose clinicaltrial involving RA patients in the U.S., Latin America and Europe who had failedto respond to methotrexate alone. Patients received either 100 mg of FosDb.i.d. (twice a day), 150 mg q.d. (once a day) or placebo.

 

Efficacy assessments for each participant were based on the AmericanCollege of Rheumatology (ACR) criteria, which denotes at least 20% (ACR 20), atleast 50% (ACR 50), or at least 70% (ACR 70) improvement, in addition toimprovement denoted in the Disease Activity Score (DAS28), from each patient’sbaseline assessment at the end of the six month treatment period. The 

 

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groupstreated with 100 mg of FosD b.i.d. and 150 mg q.d. reported higher responserates than the placebo group in all aforementioned criteria levels. Theefficacy results for the two dosing groups were comparable, although theresponse rates for the 100 mg b.i.d. group was uniformly greater.

 

Consistent with the previous Phase 2a clinical trial *(TASKi1)*, the onset effect of FosDoccurred within one week after the initiation of therapy and was maintained.The most frequent adverse events were expected based on *TASKi1* and appear to be manageable. Themost common clinically meaningful drug-related adverse events noted in *TASKi2* were diarrhea and hypertension.Dose reduction options were pre-specified in the trial protocol and, in caseswhere doses were reduced, patients generally completed the clinical trial withminimal safety issues. The mean increase in blood pressure from baseline at sixmonths, using a last observation carry forward methodology, was less than 0.5mmHg for the 150 mg q.d. dose group and approximately 1 mmHg for the 100mgb.i.d. dose group. In patients that had a history of high blood pressure, an elevatedblood pressure level at screening or baseline, or were on blood pressuremedication, approximately 29% and 39% of these patients in the 150 mg q.d. doseand the 100 mg b.i.d. dose groups, respectively, had blood pressure medicationadjusted or initiated during the course of the study, compared with 12% ofthese patients from the placebo group. In patients that did not have a historyof high blood pressure, were not on blood pressure medication or did not havean elevated blood pressure level at screening or baseline, approximately 4% and9% of these patients from the 150 mg q.d. dose and the 100 mg b.i.d. dosegroups, respectively, had blood pressure medication initiated during the courseof the study, compared with 3% of these patients from the placebo group. Forthose patients who had their dose of blood pressure medications adjusted orinitiated, their blood pressure was successfully reduced and was generally wellcontrolled throughout the remainder of the trial. The blood pressuremedications were standard doses of common blood pressure medication such asangiotensin-converting enzyme (ACE) inhibitors or diuretics.

 

The most common adverse events in the trial overall were related toinfections, though these were generally evenly distributed among the placeboand FosD groups.

 

*TASKi3*

 

In July 2009, we also announced results for the *TASKi3* Phase 2b clinical trialinvolving 219 RA patients who had failed to respond to at least one biologictreatment. In the *TASKi3* clinicaltrial, patients received either 100 mg of FosD b.i.d. or placebo b.i.d. for upto three months. The group treated with FosD did not report significantlyhigher ACR 20, ACR 50, ACR 70 and DAS28 response rates than the placebo groupat three months, and therefore, the trial failed to meet its efficacyendpoints. The objective components (C-Reactive Protein and ErythrocyteSedimentation Rate) of these ACR scores did show a statistically significantdifference; however, the subjective reported response rate components did notas compared to placebo. Although the ACR scores for the FosD group were withinthe expected range in this patient population, the reported placebo responserates were considerably higher than seen in any other previous study of RAbiologic failure patients and rose unaccountably between week six (at whichpoint the reported response rates between FosD and placebo were significantlydifferent) and month three (when such reported response rates were no longersignificantly different).

 

*TASKi3* was the first clinicaltrial for FosD in which anatomical changes in the patients’ wrists and handswere evaluated using Magnetic Resonance Imaging and scored using the RAMRIS(Rheumatoid Arthritis Magnetic Resonance Imaging Scoring) system. Those resultsshowed improvements in the treated group versus the placebo group in theSynovitis and Osteitis scores, while the Erosion scores, known to be theslowest to change, showed no significant effect at three months.

 

Similar to *TASKi2*, themost common clinically meaningful drug-related adverse events noted in *TASKi3* were diarrhea and hypertension.Dose reduction options were pre-specified in the trial protocol and, in caseswhere doses were reduced, patients generally completed the clinical trial withminimal safety issues. The mean increase in blood pressure from baseline atthree months, using a last observation carry forward methodology, was3.2 - 3.6 mmHg for the FosD group. In *TASKi3*, patients that had a history of high blood pressure,had an elevated blood pressure level at screening or baseline, or were on bloodpressure medication, approximately 26% of these patients had blood pressuremedication adjusted or initiated during the course of the study, compared with14% of these patients from the placebo group. In patients that did not have ahistory of high blood pressure, were not on blood pressure medication or didnot have an elevated blood pressure level at screening or baseline,approximately 5% of these patients had blood pressure medication initiatedduring the course of the study, compared with 3% of these patients from theplacebo group. For those patients who had their dose of blood pressuremedications adjusted or initiated, their blood pressure was successfullyreduced and was generally well controlled throughout the remainder of thetrial. The blood pressure medications were standard doses of common bloodpressure medications such as ACE inhibitors or diuretics.

 

The most common adverse events in the trial overall were related toinfections, though these were generally evenly distributed among the placeboand FosD groups.

 

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**OtherIndications**

 

In addition to RA, FosD is currently being administered to patients inclinical trials for other immune indications and oncology. Under ourcollaboration with AZ, AZ has sole responsibility for all development decisionsfor all indications under its license except for one of the oncology studies, asolid tumor study announced in June 2009, which is funded, designed andimplemented by NCI. Any decisions regarding this study are the responsibilityof NCI.

 

***R343—Asthma***

 

*Disease background.*  Allergic asthma is a chronic inflammatorydisorder of the airways. Asthma affects the lower respiratory tract and ismarked by episodic flare-ups, or attacks, that can be life threatening. In somepatients, allergens, such as pollen, trigger the production of immunoglobulin Eantibodies, or IgE antibodies, which then bind to mast cells and cause anintracellular signal that results in the release of various chemical mediators.When this process occurs repeatedly over time, it creates persistentinflammation of the airway passages, resulting in the chronic congestion and airwayobstruction associated with allergic rhinitis and asthma, respectively.

 

*Inhaled syk inhibitor program.*  R343 is a potent syk inhibitor that blocksIgE receptor signaling. Allergic asthma is a potentially life-threateningchronic inflammatory disorder of the airways which, in some patients, ismediated by allergen-induced IgE antibodies that trigger intracellularsignaling in mast cells via IgE receptors. Mast cells play important roles inboth early and late phase allergic reactions, and syk inhibitors couldpotentially prevent both phases.

 

In the first quarter of 2005, we announced a collaborative research andlicense agreement with Pfizer, Inc., or Pfizer, for the development ofinhaled products for the treatment of allergic asthma and other respiratorydiseases, such as chronic obstructive pulmonary disease. The collaboration wasfocused on our pre-clinical small molecule compounds which inhibit syk. Thecollaboration is now centered on the development of R343. Pfizer has completedthe Phase 1a clinical trial of an inhaled formulation of R343, whichcommenced in December 2007, resulting in a milestone payment of$5.0 million to us. Pfizer initiated a Phase 1b allergen challengeclinical trial in the second quarter of 2009. We expect that Pfizer willinitiate a Phase 2 clinical trial in late 2010 or early 2011.

 

**Research/Preclinical Programs**

 

We are conducting proprietary research in three broad disease areas:inflammation/immunology, metabolism and muscle wasting. Within each diseasearea, our researchers are investigating mechanisms of action as well asscreening compounds against potential novel targets and optimizing those leadsthat appear to have the greatest potential.

 

We are in the process of selecting lead candidates for two of our moreadvanced preclinical programs, both of which grew out of significant researchin the area of immunology/inflammation. We have selected a lead candidate inour oral JAK3 inhibitor program and expect to begin clinical studies by the endof 2010. This program is focused on the treatment of transplant rejection, butcould also extend to indications including RA and psoriasis. Additionally, weexpect to select a compound for preclinical development by the end of 2010 fromour protein kinase C, or PKC, theta program initially focusing on multiplesclerosis and graft vs. host disorders.

 

In the area of metabolism, we are investigating adiponectin mimeticsfor the treatment of type 2 diabetes mellitus and other potentialindications. Type 2 diabetes is the most common form of diabetes,affecting more than 23 million people in the United States. In thisdisease, the body either produces low amounts of insulin or does not respond tothe insulin it makes. Insulin is a hormone that helps the body regulatemetabolism by causing cells to take up glucose from the blood. Adiponectin is aless-well characterized hormone that has insulin-sensitizing and anti-diabeticproperties. We have identified several classes of compounds with adiponectinmimetic activity and are currently performing structure-activity relationshipstudies, as well as mechanism of action studies on these classes of compounds.We expect to nominate a lead development candidate in 2011 - 2012.

 

In the muscle atrophyprogram, we are focusing on several signaling pathways important for musclehomeostasis. Muscle atrophy, or the loss of muscle mass, is associated withseveral disease states and excessive loss of muscle in the context of illnesscan contribute significantly to both morbidity and mortality rates. Many conditionsthat have associated muscle loss, including cancer, chronic heart failure,chronic kidney disease, mechanical ventilation and aging (sarcopenia) havesignificant patient populations that may benefit from therapeutics that countersuch muscle loss. One of our core programs in this area is focused on myostatinsignaling. Myostatin is a cytokine that signals via the type II activinreceptors (ACVR2A and ACVR2B) and has been shown to inhibit muscle growth. Weare currently performing structure activity relationship studies on several hitmolecules from initial ACVR2A/2B screens, and are developing new screens andmodels for this program. We expect to nominate a lead development candidate in2011 - 2012.

 

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**Corporate Collaborations**

 

We conduct research and development programs independently and inconnection with our corporate collaborators. We currently have the followingactive collaborations with three major pharmaceutical/biotechnology companies:AstraZeneca AB, relating to FosD for the treatment of RA and other indications,Pfizer, Inc., relating to intrapulmonary asthma and allergy therapeuticsand associated with the clinical compound R343, and Daiichi Sankyo Co., Ltd.,relating to oncology. None of these collaborations currently provide us withregular research reimbursement. In all of these collaborations, if certainconditions are met, we are entitled to receive future milestone payments androyalties. We cannot guarantee that these conditions will be met or thatresearch and development efforts will be successful. As a result, we may notreceive any further milestone payments or royalties under these agreements.

 

In February 2010, Merck Serono informed us that they expect towind down the various clinical trials associated with our aurora kinaseinhibitor program licensed to them in October 2005 and plan to return theprogram back to us. As a result, our collaboration with Merck Serono is nolonger active. Consequently, we havedecided not to move forward ourselves with this oncology program.

 

***AstraZeneca***

 

In February 2010, we entered into an exclusive worldwide licenseagreement with AZ for the global development and commercialization of our oralsyk inhibitors for the treatment of human diseases other than those primarilyinvolving respiratory or pulmonary dysfunction. The agreement includes alicense of rights to FosD, our late-stage investigational product candidate forthe treatment of RA and other indications. After a limited transition period,AZ will be responsible for conducting and funding all development, regulatoryfilings, manufacturing and global commercialization of products containing oralsyk inhibitors. We are responsible for conducting, at our expense, the on-goingopen label extension study in FosD during the limited transition period.

 

The agreement became effective on March 26, 2010 and, inconnection with the effectiveness of the agreement, we received an upfrontpayment of $100.0 million in April 2010 from AZ. AZ is required to pay usup to an additional $345.0 million if specified development, regulatoryand launch milestones are achieved for FosD. We will also be eligible toreceive up to an additional $800.0 million if specified sales performancemilestones are achieved for FosD, as well as significant stepped double-digitroyalties on net sales worldwide. AZ remains obligated to pay us variousmilestones and royalties in the future if certain conditions are met.

 

Either party may terminate the agreement if the other party materiallybreaches the agreement and such breach remains uncured within sixty days fromthe date of notice, or in the event of insolvency of the other party. We may alsoterminate the agreement in its entirety if AZ challenges the validity,enforceability or scope of any of our patents licensed to AZ by us under theagreement. AZ may also terminate the agreement either without cause upon onehundred eighty-days’ written notice, or in the event of any change of controlof Rigel upon thirty days’ written notice. If neither party terminates theagreement, then the agreement will remain in effect until the cessation of allcommercial sales of all products subject to the agreement, including FosD.

 

***Pfizer***

 

In January 2005, we entered into a research collaboration withPfizer that has a license component. The collaboration is for the developmentof inhaled products for the treatment of allergic asthma and other respiratorydiseases such as chronic obstructive pulmonary disease. The collaboration wasprimarily focused on our preclinical small molecule compounds, which inhibitIgE receptor signaling in respiratory tract mast cells by blocking thesignaling enzyme syk. A goal of the collaboration was for Pfizer to nominate alicensed compound to commence advanced preclinical development. Pfizer isresponsible for the manufacture of all preclinical and clinical materials foreach compound/product and all costs associated with development andcommercialization. We did not have any further obligations to Pfizer after theresearch phase of the collaboration ended in February 2007.

 

In connection with this collaboration, Pfizer paid us upfront fees of$10.0 million and purchased $5.0 million of our common stock at apremium in 2005. We have earned and will earn milestone payments in connectionwith certain clinical events, should they occur, as well as royalties fromsales of the resulting products upon marketing approval. Under the terms of thecollaboration agreement, the aggregate of potential milestone amounts payableto us is $175.0 million and mid-single-digit to low double-digit royaltieson sales. In May 2006, we achieved the first milestone upon selection ofthe licensed compound and received a $5.0 million milestone payment whenPfizer nominated R343 to commence advanced preclinical development in allergicasthma. In December 2007, we received the second milestone payment of$5.0 million when Pfizer initiated a Phase 1 clinical trial on R343.No milestone payments were received in either 2008 or 2009 as no furthermilestones were achieved. We expect Pfizer to initiate a Phase 2 clinicaltrial in late 2010 or early 2011 as a result of which we will be entitled toreceive a milestone payment of $5.0 million. Pfizer remains obligated topay us various milestones and royalties in the future if certain conditions areachieved.

 

Pfizer may terminate the collaboration agreement for any reason uponprior written notice to us, or for cause if we materially breach the agreementand such breach remains uncured, or if we become insolvent. We may terminatethe collaboration agreement for cause if Pfizer fails to meet certain diligenceefforts, materially breaches the agreement and such breach remains uncured, orbecomes 

 

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insolvent.If neither party exercises its option to terminate the collaboration agreement,then the agreement automatically terminates on the later of: 1) the lastvalid claim to expire covering a licensed product and 2) after a specifiedperiod from the launch of a licensed product.

 

***Daiichi Sankyo***

 

In August 2002, we signed an agreement for a collaboration withDaiichi Sankyo, or Daiichi, to pursue research related to a specific targetfrom a novel class of drug targets called ligases that control cancer cellproliferation through protein degradation. Daiichi paid us $0.9 million atthe time we entered into the agreement. Under the terms of the collaborationagreement, the aggregate of potential milestone amounts payable to us is$33.9 million and low to mid-single-digit royalties on sales. We haveearned to date milestone payments totaling $5.7 million and may earnmilestone payments in connection with certain clinical events. The researchphase of this three-year collaboration expired in August 2005. Inaddition, we are entitled to receive royalties on any commercialized productsto emerge from the collaboration at low to mid-single-digit royalties on sales.Under the terms of the agreement, we retain the rights to co-develop andco-promote certain products resulting from this collaboration in North America,while Daiichi retains co-development and promotion rights in the remainder ofthe world. In December 2009, we received a milestone payment of $750,000for the first designation of a rational design lead compound. Daiichi maybecome obligated to pay us certain other milestone payments, and we are alsoentitled to receive royalties on any commercialized products to emerge from thecollaboration.

 

Either party may terminate the collaboration agreement if the otherparty materially breaches the agreement and such breach remains uncured, orafter a specified period from the end of a designated research period if no productis commercialized (unless the parties agree to extend the collaboration). Thecollaboration agreement can also be terminated by mutual written consent of theparties. If neither party exercises its option to terminate the collaborationagreement, then the agreement automatically terminates on the later of:1) the expiration of the last patent with a claim that covers thecomposition of matter of a product (or manufacture or use of a product undercertain circumstances) and 2) after a specified period from the initialcommercialization of a licensed product.

 

**Research and Development Expenses**

 

Our research and development expenditures include costs related topreclinical and clinical trials, scientific personnel, supplies, equipment,consultants, sponsored research, stock-based compensation, and allocatedfacility costs.

 

We do not track fully burdened research and development costsseparately for each of our drug candidates. We review our research anddevelopment expenses by focusing on three categories: research; development;and other. Our research team is focused on creating a portfolio of productcandidates that can be developed into small molecule therapeutics in our ownproprietary programs or with potential collaborative partners and utilizes our robustdiscovery engine to rapidly discover and validate new product candidates in ourfocused range of therapeutic indications. “Research” expenses relate primarilyto personnel expenses, lab supplies, fees to third party research consultants,and compounds. Our development group leads the implementation of our clinicaland regulatory strategies and prioritizes disease indications in which ourcompounds may be studied in clinical trials. “Development” expenses relateprimarily to clinical trials, personnel expenses, lab supplies, and fees tothird party research consultants. “Other” expenses primarily include allocatedstock-based compensation expense relating to personnel in research anddevelopment groups and allocated facilities costs.

 

In addition to reviewing the three categories of research anddevelopment expenses described in the preceding paragraph, we principallyconsider qualitative factors in making decisions regarding our research anddevelopment programs, which include enrollment in clinical trials and theresults thereof, the clinical and commercial potential for our drug candidatesand competitive dynamics. We also make our research and development decisionsin the context of our overall business strategy, which includes the evaluationof potential collaborations for the development of our drug candidates.

 

The following table presents our total research and developmentexpenses by category.

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|------------------------|------------|----------------------|------------|
| ** **              | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **              | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Expense Categories:** |       |                   |       |                 |       |   |   |   |   |   |   |   |   |
| Research                |       | $                      | 5,568      |                 | $          | 4,728 |   | $ | 9,995 |   | $ | 9,189 |   |
| Development             |       | 5,350                  |       | 13,423               |       | 11,062 |   | 27,996 |   |
| Other                   |       | 5,897                  |       | 6,797                |       | 13,183 |   | 12,301 |   |
|                    |       |                   |       |                 |       |   |   |   |   |
|                    |       | $                      | 16,815     |                 | $          | 24,948 |   | $ | 34,240 |   | $ | 49,486 |   |

 

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“Other” expenses mainly represent allocated stock-based compensationexpenses of approximately $1.9 million and $2.5 million for the three monthsended June 30, 2010 and 2009, respectively, and allocated facilities costsof approximately $4.0 million and $4.3 million for the three months endedJune 30, 2010 and 2009, respectively.  For the six months ended June 30,2010 and 2009, allocated stock-based compensation expenses were approximately$5.0 million and $4.0 million, respectively, and allocated facilities costswere approximately $8.2 million and $8.3 million, respectively. For the periodfrom January 1, 2007 to June 30, 2010, accumulated research and developmentcosts by category are $76.2 million, $138.7 million, and $90.1 million,for research, development, and other, respectively.

 

For the three and six months ended June 30, 2010, a major portionof our research and development expenses was associated with our extensiontrials in RA patients. For the three and six months ended June 30, 2009, amajor portion of our research and development expenses was associated with ourtwo Phase 2b clinical trials (*TASKi2* and *TASKi3*), as well as the related extension trials in RApatients. The expenses for these programs are included in “Development”expenses in the table above.

 

We licensed the rights to FosD to AZ in February 2010. Phase 2clinical trials of FosD in RA were completed in 2009. We expect AZ to initiatea Phase 3 clinical trial in RA in 2010. AZ will be responsible for conductingand funding all development, regulatory filings, manufacturing and globalcommercialization of products containing oral syk inhibitors.

 

The scope and magnitude of future research and development expenses aredifficult to predict given the number of clinical trials that we will need toconduct for any of our potential products, as well as our limited capitalresources. Preclinical testing and clinical development are long, expensive anduncertain processes. In general, biopharmaceutical development involves aseries of steps, beginning with identification of a potential target andincluding, among others, proof of concept in animals and Phase 1, 2 and 3clinical trials in humans. Each of these steps is typically more expensive thanthe previous step. Success in early stages of development often results inincreasing expenditures for a given product candidate. Significant delays inclinical testing could materially impact our product development costs andtiming of completion of the clinical trials. We do not know whether plannedclinical trials will begin on time, will need to be halted or revamped or willbe completed on schedule, or at all. Clinical trials can be delayed for a varietyof reasons, including delays in obtaining regulatory approval to commence atrial, delays from scale up, delays in reaching agreement on acceptableclinical trial agreement terms with prospective clinical sites, delays inobtaining institutional review board approval to conduct a trial at aprospective clinical site or delays in recruiting subjects to participate in astudy.

 

We currently do not have reliable estimates of total costs for aparticular drug candidate to reach the market. Our potential products aresubject to a lengthy and uncertain regulatory process that may involveunanticipated additional clinical trials and may not result in receipt of thenecessary regulatory approvals. Failure to receive the necessary regulatoryapprovals would prevent us from commercializing the product candidatesaffected. In addition, clinical trials of our potential products may fail todemonstrate safety and efficacy, which could prevent or significantly delayregulatory approval. We do not have a reasonable basis to determine when or ifmaterial net cash inflows from the commercialization and sale of our drugcandidates will occur. Commercialization of our product candidates depends uponsuccessful completion of extensive preclinical studies and clinical trials todemonstrate their safety and efficacy for humans. We do not know whether we, orany of our current or potential future collaborative partners, will undertakeclinical trials of potential products beyond the trials already concluded andthe trials currently in process. It will take us, or our current or potentialfuture collaborative partners, several years to complete any such testing, andfailure can occur at any stage of testing. Interim results of trials do notnecessarily predict final results, and acceptable results in early trials maynot be repeated in later trials. Moreover, we or our current or potentialfuture collaborative partners may decide to discontinue development of anyproject at any time for regulatory, commercial, scientific or other reasons. Todate, we have not commercialized any of our drug candidates, and we may neverdo so.

 

For a discussion of the risks and uncertainties associated with thetiming and costs of completing the development of our drug candidates, see “Item 1A.Risk Factors,” including in particular the following risks:

 

·                  “If our corporatecollaborations or license agreements are unsuccessful, our research anddevelopment efforts could be delayed.”

 

·                  “If conflicts arise betweenour collaborators or advisors and us, any of them may act in theirself-interest, which may be adverse to our stockholders’ interests.”

 

·                  “We might not be able tocommercialize our product candidates successfully if problems arise in theclinical testing and approval process.”

 

·                  “There is a high risk thatdrug discovery and development efforts might not successfully generate goodproduct candidates.”

 

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·                  “Our future fundingrequirements will depend on many uncertain factors.”

 

·                  “Because we expect to bedependent upon collaborative and license agreements, we might not meet ourstrategic objectives.”

 

·                  “Delays in clinical testingcould result in increased costs to us.”

 

For further discussion onresearch and development activities, see “Research and Development Expenses”under “Results of Operations” below.

 

**Recent Accounting Pronouncements**

 

In April 2010, theFinancial Accounting Standards Board (FASB) issued Accounting Standards Update,or ASU, No. 2010-17 thereby amending Accounting Standards Codification(ASC) 605 for revenue recognition related to the milestone method of revenuerecognition. ASU No. 2010-17 provides guidance on defining a milestone anddetermining when it may be appropriate to apply the milestone method of revenuerecognition for research or development arrangements. A company may make anaccounting policy election to use the milestone method of revenue recognitionfor transactions within the scope of the amendments.  The amendments will be effective in fiscalyears beginning on or after June 15, 2010, and early adoption ispermitted. We evaluated the impact of adopting ASU No. 2010-17 and believeit will have no material effect on our financial statements.

 

**Critical Accounting Policies andthe Use of Estimates**

 

Ourdiscussion and analysis of our financial condition and results of operations isbased upon our financial statements, which have been prepared in accordancewith U.S. generally accepted accounting principles (GAAP). The preparation ofthese financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andrelated disclosure of contingent assets and liabilities. We evaluate ourestimates, including those related to terms of our research collaborations(i.e. revenue recognition of upfront fees and certain milestone payments),investments, stock-based compensation, impairment issues and the estimateduseful life of assets and contingencies, on an on-going basis. We base ourestimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form thebasis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources. Actual results may differfrom these estimates under different assumptions or conditions. We believe thefollowing critical accounting policies affect our more significant judgmentsand estimates used in the preparation of our financial statements:

 

***Revenue Recognition***

 

We present revenue from our collaboration arrangements under FASB ASC,808, *Collaboration Arrangements*.Our revenue arrangements with multiple elements are evaluated under FASB ASC605-25, *Multiple-Element Arrangements*,and are divided into separate units of accounting if certain criteria are met,including whether the delivered element has stand-alone value to the customerand whether there is objective and reliable evidence of the fair value of anyundelivered items. The consideration we receive is allocated among the separateunits based on their respective fair values, and the applicable revenuerecognition criteria are applied to each of the separate units. Advancepayments received in excess of amounts earned are classified as deferredrevenue until earned.

 

Non-refundable, up-front payments received in connection with researchand development collaboration agreements, including technology access fees, aredeferred and recognized on a straight-line basis over the relevant periods ofcontinuing involvement, generally the research term. When a research term isnot specified, we estimate the time it will take us to complete our deliverablesunder the contract and recognize the upfront fee using the straight-line methodover that time period. We review our estimates every quarter forreasonableness.

 

Revenues related to collaborative research with our corporatecollaborators are recognized as research services are performed over therelated development periods for each agreement. Under these agreements, we arerequired to perform research and development activities as specified in eachrespective agreement. The payments received are not refundable and aregenerally based on a contractual cost per full-time equivalent employee workingon the project. Our research and development expenses under the collaborativeresearch agreements approximate the revenue recognized under such agreementsover the term of the respective agreements. It is our policy to recognizerevenue based on our level of effort expended, however, revenue recognized willnot exceed amounts billable under the agreement.

 

Revenuesassociated with substantive, at-risk milestones pursuant to collaborativeagreements are recognized upon achievement of the milestones.

 

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***Stock-based Compensation***

 

The determination of the fair valueof stock-based payment awards on the date of grant using the Black-Scholesoption-pricing model is affected by our stock price as well as assumptionsregarding a number of complex and subjective variables. These variablesinclude, but are not limited to, volatility, expected term, risk-free interestrate and dividends. We estimate volatility using our historical stock priceperformance over the expected life of the option up to the point where we havehistorical market data. For expected term, among other things, we take intoconsideration our historical data of options exercised, cancelled and expired.The risk-free rate is based on the U.S. Treasury constant maturity rate. Wehave not paid and do not expect to pay dividends in the foreseeable future. Inorder to calculate stock-based compensation expense, we also estimate theforfeiture rate using our historical experience with options that cancel beforethey vest.

 

***Research and Development Accruals***

 

Wehave various contracts with third parties related to our research anddevelopment activities. Costs that are incurred but not billed to us as of theend of the period are accrued. We make estimates of the amounts incurred ineach period based on the information available to us and our knowledge of thenature of the contractual activities generating such costs. Clinical trialcontract expenses are accrued based on units of activity reported by thirdparties. Expenses related to other research and development contracts, such asresearch contracts, toxicology study contracts and manufacturing contracts areestimated to be incurred generally on a straight-line basis over the durationof the contracts. Raw materials and study materials purchased by third partiesare expensed at the time of purchase. Many of our estimates are basedsignificantly or in part on information provided by third parties. If suchinformation were not reported properly, our research and development expenseamounts could be misstated.

 

**Results of Operations**

 

**Three and Six Months Ended June 30,2010 and 2009**

 

**Revenues**

 
| ** **               | ** ** | **Three Months Ended** | ** ** | ** **         | ** ** | **Six Months Ended**      | ** ** | ** ** | ** ** |
|--------------------------|------------|------------------------|------------|--------------------|------------|---------------------------|------------|------------|------------|
| ** **               | ** ** | **June 30,**      | ** ** | ** **         | ** ** | **June 30,**         | ** ** | ** ** | ** ** |
| ** **               | ** ** | **2010**               | ** ** | **2009**           | ** ** | **Aggregate Change** | ** ** | **2010**   | ** ** | **2009** | ** ** | **Aggregate Change** | ** ** |
| ** **               | ** ** | **(in thousands)**     | ** ** | **(in thousands)** | ** ** |
| ***Contract  revenues*** |       | $                      | 49,457     |               | $          | —                    |       | $          | 49,457     |   | $ | 52,718 |   | $ | — |   | $ | 52,718 |   |
|                          |            |                        |            |                    |            |                           |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Contractrevenue from collaborations for the three and six months ended June 302010 consisted of $49.5 million and $52.7 million, respectively, ofamortization of the $100.0 million upfront payment pursuant to our worldwidelicense agreement with AZ, which became effective on March 26, 2010. There were no revenues reported during the three and sixmonths ended June 30, 2009.  As of June 30,2010, we had deferred revenue of approximately $47.3 million representing theremaining unamortized amount of the upfront payment from AZ.  We expect this remainingdeferred amount will be fully recognized as revenue in the three months endedSeptember 30, 2010. Our potential future revenues in 2010 may includecertain milestone payments from our current collaboration partners and upfrontpayments from new collaboration partners we enter into agreements with in thefuture.

 

**Research and Development Expense**

** **
| ** **                                                                            | ** ** | **Three Months Ended** | ** ** | ** **         | ** ** | **Six Months Ended** | ** ** | ** **    | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|----------------------|------------|---------------|------------|
| ** **                                                                            | ** ** | **June 30,**      | ** ** | **Aggregate**      | ** ** | **June 30,**    | ** ** | **Aggregate** | ** ** |
| ** **                                                                            | ** ** | **2010**               | ** ** | **2009**           | ** ** | **Change**           | ** ** | **2010**      | ** ** | **2009** | ** ** | **Change** | ** ** |
| ** **                                                                            | ** ** | **(in thousands)**     | ** ** | **(in thousands)** | ** ** |
| ***Research and  development expenses***                                              |       | $                      | 16,815     |               | $          | 24,948               |       | $             | (8,133     | ) | $ | 34,240 |   | $ | 49,486 |   | $ | (15,246 | ) |
| ***Stock-based  compensation expense included in research and development expenses*** |       | 1,917                  |       | 2,528              |       | (611                 | )          | 5,000         |       | 3,953 |   | 1,047 |   |
|                                                                                       |            |                        |            |                    |            |                      |            |               |            |  |  |  |  |  |  |  |  |  |  |

 

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The decrease in research and development expense for the three monthsended June 30, 2010, compared to the same period in 2009, was primarilydue to the completion of our two Phase 2b clinical trials (*TASKi2* and *TASKi3*), as well as a decrease in stock-based compensationexpense due to the lower valuation of options granted in the first quarter of2010 as discussed under “Stock-Based Compensation Expense” below.  The decrease in research and developmentexpense for the six months ended June 30, 2010, compared to the sameperiod in 2009, was primarily due to the completion of our two Phase 2bclinical trials (*TASKi2* and *TASKi3*), partially offset by the increasein stock-based compensation expense as discussed under “Stock-BasedCompensation Expense” below.

 

**General and Administrative Expense**

 
| ** **                                                                              | ** ** | **Three Months Ended** | ** ** | ** **         | ** ** | **Six Months Ended** | ** ** | ** **    | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|----------------------|------------|---------------|------------|
| ** **                                                                              | ** ** | **June 30,**      | ** ** | **Aggregate**      | ** ** | **June 30,**    | ** ** | **Aggregate** | ** ** |
| ** **                                                                              | ** ** | **2010**               | ** ** | **2009**           | ** ** | **Change**           | ** ** | **2010**      | ** ** | **2009** | ** ** | **Change** | ** ** |
| ** **                                                                              | ** ** | **(in thousands)**     | ** ** | **(in thousands)** | ** ** |
| ***General and  administrative expenses***                                              |       | $                      | 5,664      |               | $          | 5,050                |       | $             | 614        |   | $ | 13,850 |   | $ | 9,653 |   | $ | 4,197 |   |
| ***Stock-based  compensation expense included in general and administrative expenses*** |       | 1,784                  |       | 1,331              |       | 453                  |       | 3,868         |       | 2,050 |   | 1,818 |   |
|                                                                                         |            |                        |            |                    |            |                      |            |               |            |  |  |  |  |  |  |  |  |  |  |

 

Theincrease in general and administrative expense for the three months ended June 30,2010, as compared to the same period in 2009, was primarily due to the increasein stock-based compensation expense  related to the amortization of options granted to officersand directors in the second quarter of 2010 as discussed under “Stock-BasedCompensation Expense” below. The increase in general and administrative expensefor the six months ended June 30, 2010, as compared to the same period in2009, was primarily due to the increase in stock-based compensation expense asdiscussed under  “Stock-BasedCompensation Expense” below, and certain one-time investment banking feesassociated with the closing of our transaction with AZ.

 

**Restructuring Charges**

 
| ** **                                                                | ** ** | **Three Months Ended** | ** ** | ** **         | ** ** | **Six Months Ended**      | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|---------------------------|------------|------------|------------|
| ** **                                                                | ** ** | **June 30,**      | ** ** | ** **         | ** ** | **June 30,**         | ** ** | ** ** | ** ** |
| ** **                                                                | ** ** | **2010**               | ** ** | **2009**           | ** ** | **Aggregate Change** | ** ** | **2010**   | ** ** | **2009** | ** ** | **Aggregate Change** | ** ** |
| ** **                                                                | ** ** | **(in thousands)**     | ** ** | **(in thousands)** | ** ** |
| ***Restructuring charges***                                               |       | $                      | —     |               | $          | —                    |       | $          | —     |   | $ | — |   | $ | 1,141 |   | $ | (1,141 | ) |
| ***Stock-based  compensation expense included in restructuring charges*** |       | —                 |       | —             |       | —                    |       | —     |       | 122 |   | (122 | ) |
|                                                                           |            |                        |            |                    |            |                           |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

InFebruary 2009, we announced that we cut our research programs in virologyand oncology as well as terminated certain related development andadministrative staff, which resulted in the dismissal of 36 employees, orapproximately 20% of our workforce. This measure was intended to maintain ouremphasis on our active preclinical and clinical programs, while conserving ourresources. As a result of the restructuring implemented in the first quarter of2009, we recorded restructuring charges of $1.1 million, including$1.0 million of workforce reduction costs (which had been paid as ofDecember 31, 2009) and $122,000 of non-cash stock-based compensationexpense incurred in connection with the extension of the date the terminatedemployees had to exercise their vested options. The terminated employees weregiven until December 31, 2009 to exercise their outstanding vested optionsrather than 90 days from the termination date as is typically requiredunder our equity incentive plan.

 

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**Stock-Based Compensation Expense**

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** | ** **         | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|--------------------|------------|----------------------|------------|------------|------------|
| ** **                                    | ** ** | **June 30,**      | ** ** | ** **         | ** ** | **June 30,**    | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **2010**               | ** ** | **2009**           | ** ** | **Aggregate Change** | ** ** | **2010**   | ** ** | **2009** | ** ** | **Aggregate Change** | ** ** |
| ** **                                    | ** ** | **(in thousands)**     | ** ** | **(in thousands)** | ** ** |
| **Stock-based compensation expense  from:**   |       |                   |       |               |       |                 |       |       |       |   |   |   |   |
| ***Officer,  director and employee options*** |       | $                      | 3,701      |               | $          | 3,823                |       | $          | (122       | ) | $ | 8,837 |   | $ | 6,089 |   | $ | 2,748 |   |
| ***Consultant  options***                     |       | —                 |       | 36                 |       | (36                  | )          | 31         |       | 36 |   | (5 | ) |
| ***Total***                                   |       | $                      | 3,701      |               | $          | 3,859                |       | $          | (158       | ) | $ | 8,868 |   | $ | 6,125 |   | $ | 2,743 |   |

 

The decrease in stock-basedcompensation expense for the three months ended June 30, 2010, as comparedto the same period in 2009, was primarily due to the lower valuation ofoptions granted in the first quarter of 2010, partially offset by theamortization of options granted in the second quarter of 2010.  The increase instock-based compensation expense for the six months ended June 30, 2010,as compared to the same period in 2009, was primarily due to anadditional full quarter of stock-based compensation expense amortization in thefirst quarter of 2010 related to options granted in late March of 2009,which were fully amortized as of the end of the first quarter of 2010, as wellas amortization in the second quarter of 2010 related to options granted in thesecond quarter of 2010.

 

**Interest Income**

 
| ** **            | ** ** | **Three Months Ended** | ** ** | ** **              | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** |
|-----------------------|------------|----------------------------------|------------|-------------------------|------------|--------------------------------|------------|------------|------------|
| ** **            | ** ** | **June 30,**                | ** ** | ** **              | ** ** | **June 30,**              | ** ** | ** ** | ** ** |
| ** **            | ** ** | **2010**                         | ** ** | **2009**                | ** ** | **Aggregate Change**      | ** ** | **2010**   | ** ** | **2009** | ** ** | **Aggregate Change** | ** ** |
| ** **            | ** ** | **(in thousands)**          | ** ** | **(in thousands)** | ** ** |
| ***Interest income*** |       | $                                | 76         |                    | $          | 159                            |       | $          | (83        | ) | $ | 123 |   | $ | 506 |   | $ | (383 | ) |
|                       |            |                                  |            |                         |            |                                |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Interestincome results from our interest-bearing cash and investment balances. Thedecreases in interest income for the three and six months ended June 30,2010, as compared to the same periods in 2009, were due to lower interest ratesearned on our investments in the 2010 periods.

 

**Interest Expense**

 
| ** **              | ** ** | **Three Months Ended** | ** ** | ** **         | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** |
|-------------------------|------------|------------------------|------------|--------------------|------------|----------------------|------------|------------|------------|
| ** **              | ** ** | **June 30,**      | ** ** | ** **         | ** ** | **June 30,**    | ** ** | ** ** | ** ** |
| ** **              | ** ** | **2010**               | ** ** | **2009**           | ** ** | **Aggregate Change** | ** ** | **2010**   | ** ** | **2009** | ** ** | **Aggregate Change** | ** ** |
| ** **              | ** ** | **(in thousands)**     | ** ** | **(in thousands)** | ** ** |
| ***Interest  expense*** |       | $                      | 25         |               | $          | 69                   |       | $          | (44        | ) | $ | 55 |   | $ | 122 |   | $ | (67 | ) |
|                         |            |                        |            |                    |            |                      |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Interestexpense primarily results from our capital lease obligations associated withfixed asset acquisitions. The decreases in interest expense for the three andsix months ended June 30, 2010, as compared to the same periods in 2009,were primarily due to the lower average outstanding balance of capital leaseobligations during the three and six months ended June 30, 2010, ascompared to the same periods in 2009.

 

**Income taxbenefit**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | ** **         | ** ** | **Six Months Ended**      | ** ** | ** ** | ** ** |
|---------------------------|------------|------------------------|------------|--------------------|------------|---------------------------|------------|------------|------------|
| ** **                | ** ** | **June 30,**      | ** ** | ** **         | ** ** | **June 30,**         | ** ** | ** ** | ** ** |
| ** **                | ** ** | **2010**               | ** ** | **2009**           | ** ** | **Aggregate Change** | ** ** | **2010**   | ** ** | **2009** | ** ** | **Aggregate Change** | ** ** |
| ** **                | ** ** | **(in thousands)**     | ** ** | **(in thousands)** | ** ** |
| ***Income tax  benefit*** |       | $                      | —     |               | $          | 27                        |       | $          | (27        | ) | $ | — |   | $ | 93 |   | $ | (93 | ) |
|                           |            |                        |            |                    |            |                           |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Incometax benefit for the three and six months ended June 30, 2009, resultedfrom our federal refundable credit in accordance with the provisions of theAmerican Recovery and Reinvestment Act of 2009 (or the Act). This benefit underthe Act expired as of December 31, 2009. Although we expect to generateoperating income for the year ended December 31, 2010, we do notanticipate incurring income tax expenses due to the utilization of our netoperating loss carryforwards.

 

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**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 as we continue our research and development activities,including preclinical studies and clinical trials. In February 2010, weentered into an exclusive worldwide license agreement with AZ for the globaldevelopment and commercialization of our oral syk inhibitors for the treatmentof human diseases other than those primarily involving respiratory or pulmonarydysfunction. After a limited transition period, AZ will be responsible forconducting and funding all development, regulatory filings, manufacturing andglobal commercialization of products containing oral syk inhibitors. Theagreement became effective on March 26, 2010 and, in connection with theeffectiveness of the agreement, we received an upfront payment of $100.0million in April 2010 from AZ. AZ is required to pay us up to anadditional $345.0 million if specified development, regulatory and launchmilestones are achieved for FosD. We will also be eligible to receive up to anadditional $800.0 million if specified sales performance milestones areachieved for FosD, as well as significant stepped double-digit royalties on netsales worldwide.

 

As of June 30, 2010, we had approximately $187.5 million incash, cash equivalents and available-for-sale securities, as compared toapproximately $133.3 million as of December 31, 2009, an increase ofapproximately $54.2 million. The increase was primarily attributable tothe receipt of the $100.0 million upfront payment from AZ in April 2010,partially offset by operating expenses for the six months ended June 30,2010. We believe that our existing capital resources will be sufficient tosupport our current and projected funding requirements through at least thenext twelve months. We have based this estimate on assumptions that may proveto be wrong, and we could utilize our available capital resources sooner thanwe currently expect. Because of the numerous risks and uncertainties associatedwith the development of our product candidates and other research anddevelopment activities, including risks and uncertainties that could impact therate of progress of our development activities, we are unable to estimate withcertainty the amounts of increased capital outlays and operating expendituresassociated with our current and anticipated clinical trials and other researchand development activities.

 

Our operations will require significant additional funding for theforeseeable future. Until we are able to generate sufficient amounts of productrevenues and/or royalty revenues, we expect to finance future cash needsthrough public and/or private equity offerings, debt financings orcollaboration and licensing arrangements, as well as through interest incomeearned on the investment of our cash balances and short-term investments. Tothe extent we raise additional capital by issuing equity securities, ourstockholders could at that time experience substantial dilution. Any debtfinancing that we are able to obtain may involve operating covenants thatrestrict our business. To the extent that we raise additional funds throughcollaboration and licensing arrangements, we may be required to relinquish someof our rights to our technologies or product candidates, or grant licenses onterms that are not favorable to us.

 

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

 

·                  the progress and success ofclinical trials and preclinical activities (including studies and manufactureof materials) of our product candidates conducted by our collaborative partnersor licensees or us;

 

·                  our ability to meet themilestones identified in our collaborative agreements that trigger payments tous from our collaboration partners;

 

·                  the progress of researchprograms carried out by us;

 

·                  any changes in the breadthof our research and development programs;

 

·                  the progress of the researchand development efforts of our collaborative partners;

 

·                  our ability to acquire orlicense other technologies or compounds that we seek to pursue;

 

·                  our ability to manage ourgrowth;

 

·                  competing technological andmarket developments;

 

·                  the costs and timing ofobtaining, enforcing and defending our patent and intellectual property rights;

 

·                  the costs and timing ofregulatory approvals and filings by us and our collaborators; and

 

·                  expenses associated with thepending and potential additional related purported securities class actionlawsuits, as well as any unforeseen litigation.

 

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Insufficientfunds may require us to delay, scale back or eliminate some or all of ourresearch or development programs, to lose rights under existing licenses or torelinquish greater or all rights to product candidates at an earlier stage ofdevelopment or on less favorable terms than we would otherwise choose or mayadversely affect our ability to operate as a going concern. For the six monthsended June 30, 2010 and 2009, we maintained an investment portfolioprimarily in money market funds, U.S. treasury bills, government-sponsoredenterprise securities, and corporate bonds and commercial paper. Cash in excessof immediate requirements is invested with regard to liquidity and capitalpreservation. Wherever possible, we seek to minimize the potential effects ofconcentration and degrees of risk.

 

**Cash Flows from Operating, Investing and FinancingActivities**

** **
| ** **                                            | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------|------------|
| ** **                                            | ** ** | **June 30,**    | ** ** |
| ** **                                            | ** ** | **2010**             | ** ** | **2009** | ** ** |
| Net cash provided by (used in):                       |       |                 |       |   |   |
| Net cash provided by (used in) operating  activities  |       | $                    | 55,483     |   | $ | (54,119 | ) |
| Net cash (used in) provided by investing  activities  |       | (38,319              | )          | 31,685 |   |
| Net cash provided by financing activities             |       | 348                  |       | 8 |   |
| Net increase (decrease) in cash and cash  equivalents |       | $                    | 17,512     |   | $ | (22,426 | ) |

 

Netcash provided by operating activities was approximately $55.5 million forthe six months ended June 30, 2010, compared to net cash used in operatingactivities of approximately $54.1 million for the six months ended June 30,2009. The increase in net cash provided by operating activities was primarilydue to the receipt of the $100.0 million upfront payment from AZ in April 2010,partially offset by cash payments related to our research and developmentprograms. The timing of cash requirements may vary from period to perioddepending on our research and development activities, including our plannedpreclinical and clinical trials, and future requirements to establishcommercial capabilities for any products that we may develop.

 

Netcash used in investing activities was approximately $38.3 million for thesix months ended June 30, 2010, compared to net cash provided by investingactivities of approximately $31.7 million for the six months ended June 30,2009.  Net cash used in investingactivities in 2010 was primarily due to purchases of available-for-salesecurities of approximately $114.8 million, partially offset by maturities ofavailable-for-sale securities of approximately $78.3 million.  Net cash provided by investing activities in2009 was primarily due to maturities and sales of available-for-sale securitiesof approximately $92.1 million, partially offset by purchases ofavailable-for-sale securities of approximately $60.4 million. Capital expenditureswere approximately $1.7 million for the six months ended June 30, 2010,compared to approximately $71,000 for the same period in 2009.

 

Netcash provided by financing activities was approximately $348,000 for the sixmonths ended June 30, 2010, compared to approximately $8,000 for thesame period in 2009. Net cash provided by financing activities in 2010 wasprimarily due to the proceeds from the exercise of outstanding options and theissuance of shares under our ESPP of approximately $958,000, partially offsetby payments for capital lease financing of approximately $610,000.  Net cash provided by financing activities in2009 was primarily due to the proceeds from the exercise of outstanding optionsand the issuance of shares under our ESPP of approximately $802,000, partiallyoffset by payments for capital lease financing of approximately $794,000.

 

**Off-Balance Sheet Arrangements**

 

Asof June 30, 2010, we had no off-balance sheet arrangements (as defined inItem 303(a)(4)(ii) of Regulation S-K under the SecuritiesExchange Act of 1934, as amended) that create potential material risks for usand that are not recognized on our balance sheets.

 

**Contractual Obligations**

 

As of June 30, 2010, we hadthe following contractual commitments:

 
| ** **                        | ** ** | ** **         | ** **  | **Payment Due By Period** | ** ** |
|-----------------------------------|------------|--------------------|-------------|---------------------------|------------|
| ** **                        | ** ** | ** **         | ** **  | **Less than**             | ** ** | **1 - 3** | ** ** | **3 - 5** | ** ** | **More than** | ** ** |
| ** **                        | ** ** | **Total**          | ** **  | **1 Year**                | ** ** | **Years** | ** ** | **Years** | ** ** | **5 years** | ** ** |
| ** **                        | ** ** | **(in thousands)** |
| **Capital Lease obligations (1)** | ** ** | **$**              | **1,388**   |                      | $          | 989 |   | $ | 399 |   | $ | — |   | $ | — |   |
| **Facilities lease (2)**          | ** ** | **108,302**        |        | 12,508                    |       | 26,553 |   | 28,718 |   | 40,523 |   |
| **Total**                         | ** ** | **$**              | **109,690** |                      | $          | 13,497 |   | $ | 26,952 |   | $ | 28,718 |   | $ | 40,523 |   |

 

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(1)                                  As of June 30,2010, we had approximately $1.4 million in capital lease obligations(including the interest portion) associated with our equipment. All existingcapital lease agreements as of June 30, 2010 are secured by the equipmentfinanced, bear interest at rates between 4.99% and 10.35% and are due inmonthly installments through 2012.

 

(2)                                  OnMarch 31, 2009, we amended our build-to-suit lease agreement to defercertain rental obligations in the aggregate amount of $6.9 million, for aperiod of up to seventeen months. Under the terms of this amendment, we wereobligated to repay the deferred amounts, including interest accruing at 12%during the deferral period, based on a timeline that could vary depending uponthe occurrence of certain financing or collaborative transactions. InSeptember 2009, we completed an underwritten public offering and receivednet proceeds of approximately $101.5 million after deducting underwritingdiscounts and commissions and offering expenses. As a result of the abovefinancing, we paid our landlord $3.7 million, or 50% of the deferredrental amounts, plus interest at 12% in November 2009. InFebruary 2010, we entered into a worldwide license agreement with AZpursuant to which we received an upfront payment of $100.0 million inApril 2010.  As a result of thisadditional cash received, we paid our landlord $3.9 million, or theremaining 50% of the deferred rental amounts, plus interest at 12%, inApril 2010.

 

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**Item 3.****          ****Quantitative and QualitativeDisclosures About Market Risk**

 

During the six months ended June 30,2010, there were no material changes to our market risk disclosures as setforth in Part II, Item 7A, “Quantitative and Qualitative DisclosuresAbout Market Risk,” of our Annual Report on Form 10-K for the year endedDecember 31, 2009.

 

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

 

*Evaluation of Disclosure Controlsand Procedures.*Based onthe evaluation of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Actof 1934, as amended), our chief executive officer and chief financial officerhave concluded that, as of the end of the period covered by this report, ourdisclosure controls and procedures were effective.

 

*Changes in Internal Controls.*There were no changes in our internal control overfinancial reporting that occurred during the quarter ended June 30, 2010that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

*Limitations on the Effectivenessof Controls.*A controlsystem, no matter how well conceived and operated, can provide only reasonable,not absolute, assurance that the objectives of the controls are met. Because ofthe inherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues, if any, within a companyhave been detected. Accordingly, our disclosure controls and procedures aredesigned to provide reasonable, not absolute, assurance that the objectives ofour disclosure control system are met and, as set forth above, our chief executiveofficer and chief financial officer have concluded, based on their evaluationas of the end of the period covered by this report, that our disclosurecontrols and procedures were sufficiently effective to provide reasonableassurance that the objectives of our disclosure control system were met.

 

**PART II. OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

On February 6, 2009, a purported securities class action lawsuitwas commenced in the United States District Court for the Northern District ofCalifornia, naming as defendants us and certain of our officers, directors andunderwriters for our February 2008 stock offering. An additional purportedsecurities class action lawsuit containing similar allegations was subsequentlyfiled in the United States District Court for the Northern District ofCalifornia on February 20, 2009. By order of the Court datedMarch 19, 2009, the two lawsuits were consolidated into a single action.On June 9, 2009, the Court issued an order naming the Inter-Local PensionFund GCC/IBT as lead plaintiff and Robbins Geller Rudman & Dowd LLP(formerly Coughlin Stoia) as lead counsel. The lead plaintiff filed aconsolidated complaint on July 24, 2009. We filed a motion to dismiss onSeptember 8, 2009. On December 21, 2009, the Court granted our motionand dismissed the consolidated complaint with leave to amend. Plaintiff filedits consolidated amended complaint on January 27, 2010. The lawsuitalleges violations of the Securities Act of 1933 and the Securities ExchangeAct of 1934 in connection with allegedly false and misleading statements madeby us related to the results of the Phase 2a clinical trial of our productcandidate FosD. The plaintiffs seek damages, including rescission or rescissorydamages for purchasers in the stock offering, an award of their costs andinjunctive and/or equitable relief for purchasers of our common stock duringthe period between December 13, 2007 and February 9, 2009, includingpurchasers in the stock offering. We filed a motion to dismiss the consolidated

 

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amendedcomplaint on February 16, 2010. Briefing on the motion to dismiss iscomplete and we are awaiting a ruling on that motion from the Court. It ispossible that additional suits will be filed with respect to these same mattersand also naming us and/or our officers and directors as defendants. If any suchadditional suits are filed in the same court, we believe that they would beconsolidated into the consolidated action.

 

Webelieve that we have meritorious defenses and intend to defend the lawsuitvigorously. This lawsuit and any other related lawsuits are subject to inherentuncertainties, and the actual costs to be incurred relating to the lawsuit willdepend upon many unknown factors. The outcome of the litigation is necessarilyuncertain, and we could be forced to expend significant resources in thedefense of this lawsuit, and we may not prevail.

 

**Item 1A.    Risk Factors**

 

*In evaluating our business, youshould carefully consider the following risks, as well as the other informationcontained in this Quarterly Report on Form 10-Q. These risk factors couldcause our actual results to differ materially from those contained inforward-looking statements we have made in this Quarterly Report onForm 10-Q and those we may make from time to time. If any of the followingrisks actually occurs, our business, financial condition and operating resultscould be harmed. The risks and uncertainties described below are not the onlyones facing us. Additional risks and uncertainties not presently known to us,or that we currently see as immaterial, may also harm our business. We havemarked with an asterisk (*) those risk factors below that reflect a substantivechange from the risk factors included in our Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 2, 2010.*

 

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

 

Our strategy depends upon the formation and sustainability of multiplecollaborative arrangements and license agreements with third parties now and inthe future. We rely on these arrangements for not only financial resources, butalso for expertise we need now and in the future relating to clinical trials,manufacturing, sales and marketing, and for licenses to technology rights. Todate, we have entered into several such arrangements with corporatecollaborators; however, we do not know if these collaborations or additionalthird parties with which we collaborate, if any, will dedicate sufficientresources or if any development or commercialization efforts by third partieswill be successful. Should a collaborative partner fail to develop orcommercialize a compound or product to which it has rights from us for anyreason, including corporate restructuring, such failure might delay our ongoingresearch and development efforts, because we might not receive any futuremilestone payments, and we would not receive any royalties associated with suchcompound or product. In addition, the continuation of some of our partnereddrug discovery and development programs may be dependent on the periodic renewalof 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 our collaborationagreement with Daiichi ended in 2005. In 2004, we signed a new collaborationagreement with Merck, and the research phase of this collaboration ended inMay 2007. In 2005, we signed a new collaboration agreement with Pfizer,and the research phase of this collaboration ended in February 2007. Ourcollaboration agreement with Merck Serono, which, as of February 2010, isno longer active, did not include a research phase. Our collaboration agreementwith AZ, entered into in 2010, also does not include a research phase, althoughwe are responsible for conducting, at our expense, an on-going open labelextension study in FosD during the limited transition period. Each of ourcollaborations could be terminated by the other party at any time, and we maynot be able to renew these collaborations on acceptable terms, if at all, ornegotiate additional corporate collaborations on acceptable terms, if at all.If these collaborations terminate or are not renewed, any resultant loss ofrevenues from these collaborations or loss of the resources and expertise ofour collaborative 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 orotherwise adversely affected.

 

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***If conflicts arise between ourcollaborators or advisors and us, any of them may act 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 ofresources that our corporate collaborators devote to our programs or potentialproducts. We do not know whether current or future collaborative partners, ifany, might pursue alternative technologies or develop alternative productseither on their own or in collaboration with others, including our competitors,as a means for developing treatments for the diseases targeted by collaborativearrangements with us.

 

***If we are unable to obtainregulatory approval to market products in the United States and foreignjurisdictions, we will not be permitted to commercialize products from ourresearch and development.***

 

We cannot predict whether regulatory clearance will be obtained for anyproduct that we, or our collaborative partners, hope to develop. Satisfactionof regulatory requirements typically takes many years, is dependent upon thetype, complexity and novelty of the product and requires the expenditure ofsubstantial resources. Of particular significance to us are the requirementsrelating to research and development and testing.

 

Before commencing clinical trials in humans in the United States, we,or our collaborative partners, will need to submit and receive approval fromthe FDA of an IND. Clinical trials are subject to oversight by institutionalreview boards and the FDA and:

 

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

 

·                  must meet requirements forinstitutional review board oversight;

 

·                  must meet requirements forinformed consent;

 

·                  are subject to continuingFDA oversight;

 

·                  may require large numbers oftest subjects; and

 

·                  may be suspended by us, ourcollaborators or the FDA at any time if it is believed that the subjectsparticipating in these trials are being exposed to unacceptable health risks orif the FDA finds deficiencies in the IND or the conduct 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 demonstratewith substantial clinical evidence that the product is safe and effective inthe patient population and the indication that will be treated. Data obtainedfrom preclinical and clinical activities are susceptible to varyinginterpretations that could delay, limit or prevent regulatory approvals. Inaddition, delays or rejections may be encountered based upon additionalgovernment regulation from future legislation or administrative action orchanges in FDA policy during the period of product development, clinical trialsand FDA regulatory review. Failure to comply with applicable FDA or otherapplicable regulatory requirements may result in criminal prosecution, civilpenalties, recall or seizure of products, total or partial suspension ofproduction or injunction, adverse publicity, as well as other regulatory actionagainst our potential products or us. Additionally, we have limited experiencein conducting and managing the clinical trials necessary to obtain regulatoryapproval.

 

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 and costsassociated with FDA approval described above and may also include additionalrisks and costs.

 

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***We might not be able tocommercialize our product candidates successfully if problems arise in theclinical testing and approval process.***

 

Commercialization of our product candidates depends upon successfulcompletion of extensive preclinical studies and clinical trials to demonstratetheir safety and efficacy for humans. Preclinical testing and clinicaldevelopment are long, expensive and uncertain processes.

 

In connection with clinical trials of our product candidates, we facethe risks that:

 

·                  the product candidate maynot prove to be effective;

 

·                  we may discover that aproduct candidate may cause harmful side effects;

 

·                  the results may notreplicate the results of earlier, smaller trials;

 

·                  we or the FDA or similarforeign regulatory authorities may suspend the trials;

 

·                  the results may not bestatistically significant;

 

·                  patient recruitment may beslower than expected;

 

·                  patients may drop out of thetrials; and

 

·                  regulatory requirements maychange.

 

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

 

***There is a high risk that drugdiscovery and development efforts might not successfully generate good productcandidates.****

 

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 with indications for RA, ITP,B-cell lymphoma and T-cell lymphoma, as well as for certain solid tumors thatis being implemented by the NCI, all of which indications are subject to acollaboration agreement with AZ; and one in Phase 1b testing and intendedfor allergic asthma, which is subject to a collaboration agreement withPfizer, Inc., or Pfizer. In our industry, it is statistically unlikelythat the limited number of compounds that we have identified as potentialproduct candidates will actually lead to successful product developmentefforts, and we do not expect any drugs resulting from our research to becommercially available for several years, if at all.

 

Our compounds in clinical trials and our future leads for potentialdrug compounds are subject to the risks and failures inherent in thedevelopment of pharmaceutical products. These risks include, but are not limitedto, the inherent difficulty in selecting the right drug and drug target andavoiding unwanted side effects, as well as unanticipated problems relating toproduct development, testing, obtaining regulatory approvals, maintainingregulatory compliance, manufacturing, competition and costs and expenses thatmay exceed current estimates. For example, in our recently completed twoPhase 2b clinical trials for FosD in RA, *TASKi2*and *TASKi3*, the most commonclinically meaningful drug-related adverse events noted were diarrhea andhypertension. In both our *TASKi2*and *TASKi3* Phase 2b clinicaltrials, a meaningfully higher percentage of patients in the FosD treatmentgroups had blood pressure medication adjusted or initiated during the course ofthe clinical trials as compared to the placebo group. In larger future clinicaltrials, we may discover additional side effects and/or higher frequency of sideeffects than those observed in completed clinical trials. If approved by theFDA, the side effect profile of FosD may also result in a narrowly approvedindication for use of the product, especially in light of other drugs currentlyavailable to treat RA, dependent on the safety profile of FosD relative tothose drugs.

 

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The results of preliminary and mid-stage studies do not necessarilypredict clinical or commercial success, and larger later-stage clinical trialsmay fail to confirm the results observed in the previous studies. Similarly, aclinical trial may show that a product candidate is safe and effective forcertain patient populations in a particular indication, but other clinicaltrials may fail to confirm those results in a subset of that population or in adifferent patient population, which may limit the potential market for thatproduct candidate. For example, FosD produced significant clinical improvementin RA patients who had failed to respond to methotrexate alone in our *TASKi2* Phase 2b clinical trial, butour *TASKi3* Phase 2b clinicaltrial failed to meet its efficacy endpoints in RA patients who had failed torespond to at least one biologic treatment. In addition, if we were to repeateither of the *TASKi2* and *TASKi3* Phase 2b clinical trials, anysuch additional trials may not confirm the results observed in the originaltrials. If our partner, AZ, is able to initiate a Phase 3 clinical trialevaluating FosD in RA patients, the Phase 3 clinical trial may not showFosD to be safe and effective for the treatment of RA patients. Finally, withrespect to our own compounds in development, we have established anticipatedtimelines with respect to the initiation of clinical studies based on existingknowledge of the compound. However, we cannot provide assurance that we willmeet any of these timelines for clinical development.

 

Because of the uncertainty of whether the accumulated preclinicalevidence (pharmacokinetic, pharmacodynamic, safety and/or other factors) or earlyclinical results will be observed in later clinical trials, we can make noassurances regarding the likely results from our future clinical trials or theimpact of those results on our business.

 

***Our success is dependent onintellectual property rights held by us and third parties, and our interest insuch 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 95 pending patent applicationsand over 165 issued patents in the United States as well as numerous pendingcorresponding foreign patent applications. In the future, our patent positionmight be highly uncertain and involve complex legal and factual questions. Forexample, we may be involved in interferences before the United States Patentand Trademark Office. Interferences are complex and expensive legal proceedingsand there is no assurance we will be successful in any such proceedings. Aninterference could result in our losing our patent rights and/or our freedom tooperate and/or require us to pay significant royalties. Additional uncertaintymay result because no consistent policy regarding the breadth of legal claimsallowed in biotechnology patents has emerged to date. Accordingly, we cannotpredict the breadth of claims allowed in our or other companies’ patents.

 

Because the degree of future protection for our proprietary rights isuncertain, we cannot ensure that:

 

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

 

·                  we were the first to filepatent applications for these inventions;

 

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

 

·                  any of our pending patentapplications will result in issued patents;

 

·                  any patents issued to us orour collaborators will provide a basis for commercially-viable products or willprovide us with any competitive advantages or will not be challenged by thirdparties;

 

·                  we will develop additionalproprietary technologies that are patentable; or

 

·                  the patents of others willnot have a negative effect on our ability to do business.

 

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.

 

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 confidentiality ofour technology and other confidential information in connection with ourcollaborations, our ability to receive patent protection or protect ourproprietary information may otherwise be impaired. In addition, some of thetechnology we have licensed relies on patented inventions developed using U.S.government resources. The U.S. government retains certain rights, as defined bylaw, in such 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.

 

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

 

Our success will depend, in part, on our ability to operate withoutinfringing or misappropriating the proprietary rights of others. There are manyissued patents and patent applications filed by third parties relating toproducts or processes that are similar or identical to our licensors or ours,and others may be filed in the future. There can be no assurance that ouractivities, or those of our licensors, will not infringe patents owned byothers. We believe that there may be significant litigation in the industryregarding patent and other intellectual property rights, and we do not know ifour collaborators or we would be successful in any such litigation. Any legalaction against our collaborators or us claiming damages or seeking to enjoincommercial activities relating to the affected products, our methods orprocesses could:

 

·                  require our collaborators orus to obtain a license to continue to use, manufacture or market the affectedproducts, methods or processes, which may not be available on commerciallyreasonable terms, if at all;

 

·                  prevent us from using thesubject matter claimed in the patents held by others;

 

·                  subject us to potentialliability for damages;

 

·                  consume a substantialportion of our managerial and financial resources; and

 

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

 

***We will need additional capital inthe future to sufficiently fund our operations and research.****

 

We have consumed substantial amounts of capital to date as we continueour research and development activities, including preclinical studies andclinical trials. In February 2010, we entered into an exclusive worldwidelicense agreement with AZ for the global development and commercialization ofour oral syk inhibitors for the treatment of human diseases other than thoseprimarily involving respiratory or pulmonary dysfunction. The agreementincludes a license of rights to FosD, our late-stage investigational productcandidate for the treatment of RA and other indications. The agreement becameeffective on March 26, 2010 and, in connection with the effectiveness ofthe agreement, we received an upfront payment of $100.0 million inApril 2010 from AZ. AZ is required to pay us up to an additional$345.0 million if specified development, regulatory and launch milestonesare achieved for FosD. We will also be eligible to receive up to an additional$800.0 million if specified sales performance milestones are achieved forFosD, as well as significant stepped double-digit royalties on net sales worldwide.We believe that our existing capital resources and the anticipated proceedsfrom our current collaborations will be sufficient to support our current andprojected funding requirements through at least the next 12 months. We mayneed additional funds in the future and the amount of future funds needed willdepend largely on the timing and structure of potential future collaborations.Unless and until we are able to generate a sufficient amount of productrevenue, we expect to finance future cash needs through public and/or privateofferings of equity securities, debt financings or collaboration and licensingarrangements, as well as through interest income earned on the investment ofour cash balances and short-term investments. With the exception of milestoneand royalty payments that we may receive under our existing collaborations, wedo not currently have any commitments for future funding. We do not knowwhether additional financing will be available when needed, or that, ifavailable, we will obtain financing on reasonable terms.

 

To the extent we raise additional capital by issuing equity securities,our stockholders could at that time experience substantial dilution. Any debtfinancing that we are able to obtain may involve operating covenants thatrestrict our business. To the extent that we raise additional funds through anynew collaboration and licensing arrangements, we may be required to relinquishsome rights to our technologies or product candidates, or grant licenses onterms that are not favorable to us.

 

***Our future funding requirements willdepend on many uncertain factors.****

 

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

 

·                  the progress and success ofclinical trials and preclinical activities (including studies and manufactureof materials) of our product candidates conducted by our collaborative partnersor licensees or us;

 

·                  our ability to meet themilestones identified in our collaborative agreements that trigger payments tous from our collaboration partners;

 

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·                  the progress of researchprograms carried out by us;

 

·                  any changes in the breadthof our research and development programs;

 

·                  the progress of the researchand development efforts of our collaborative partners;

 

·                  our ability to acquire orlicense other technologies or compounds that we seek to pursue;

 

·                  our ability to manage ourgrowth;

 

·                  competing technological andmarket developments;

 

·                  the costs and timing ofobtaining, enforcing and defending our patent and intellectual property rights;

 

·                  the costs and timing ofregulatory approvals and filings by us and our collaborators; and

 

·                  expenses associated with thepending and potential additional related purported securities class actionlawsuits, as well as any unforeseen litigation.

 

Insufficient funds may require us to delay, scale back or eliminatesome or all of our research and 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.

 

***Our success as a company isuncertain due to our history of operating losses and the uncertainty of futureprofitability.****

 

Although wegenerated operating income of approximately $27.0 million and $4.7 million forthe three and six months ended June 30, 2010, respectively, this resultedfrom the one-time upfront payment from AZ received in April 2010.  We have historically operated at a loss each year sincewe were incorporated in June 1996, due in large part to the significantresearch and development expenditures required to identify and validate newproduct candidates and pursue our development efforts. There can be no assurance that we willgenerate operating income in the future.  For the years ended December 31,2009 and 2008, we incurred net losses of approximately $111.5 million and$132.3 million, respectively.  Currently, our only potential sourceof revenues is upfront payments, research and development milestone and royaltypayments pursuant to our collaboration arrangements. If our drug candidatesfail or do not gain regulatory approval, or if our drugs do not achieve marketacceptance, we may not be profitable. As of June 30, 2010, we had anaccumulated deficit of approximately $608.6 million. The extent of ourfuture losses or profitability is highly uncertain.

 

***Our ability to use net operatinglosses to offset future taxable income may be subject to certain limitations.***

 

In general, under Section 382 of the Internal Revenue Code, acorporation that undergoes an “ownership change” is subject to limitations onits ability to utilize its pre-change net operating losses to offset futuretaxable income. Our existing net operating losses and credits may be subject tolimitations arising from previous and future ownership changes underSection 382 of the Internal Revenue Code. To the extent we cannotcompletely utilize net operating loss carryforwards or tax credits in ourfinancial statements to offset future taxable income, our tax expense mayincrease in future periods.

 

***Because we expect to be dependentupon collaborative and license agreements, we might not meet our strategicobjectives.****

 

Our ability to generate revenue in the near term depends on the timingof recognition of certain upfront payments, achievement of certain milestonetriggering events with our existing collaboration agreements and our ability toenter into additional collaborative agreements with third parties. Our abilityto enter into new collaborations and the revenue, if any, that may berecognized under these collaborations is highly uncertain. If we are unable toenter into one or more new collaborations, our business prospects could beharmed, which could have an immediate adverse effect on our ability to continueto develop our compounds and on the trading price of our stock. Our ability toenter into a collaboration may be dependent on many factors, such as theresults of our clinical trials, competitive factors and the fit of one of ourprograms with another company’s risk tolerance, including toward regulatoryissues, patent portfolio, clinical pipeline, the stage of the available data,particularly if it is early, overall corporate goals and financial position.

 

To date, a portion of our revenues have been related to the research ortransition phase of each of our collaborative agreements. Such revenues are forspecified periods, and the impact of such revenues on our results of operationsis at least partially offset by corresponding research costs. Following thecompletion of the research or transition phase of each collaborative agreement,

 

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additionalrevenues may come only from milestone payments and royalties, which may not bepaid, if at all, until certain conditions are met. This risk is heightened dueto the fact that unsuccessful research efforts may preclude us from receivingany milestone 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. We have received milestone payments from our collaborationswith Janssen Pharmaceutica N.V., a division of Johnson & Johnson,Novartis Pharma AG, or Novartis, Daiichi Sankyo Co., Ltd., orDaiichi, Merck & Co., Inc., or Merck, Merck Serono andPfizer. We received an upfront payment of $100.0 million in April 2010from AZ. Under many agreements, however, milestone payments may not be earneduntil the collaborator has advanced product candidates into clinical testing,which may never occur or may not occur until some time well into the future. Ifwe are not able to generate revenue under our collaborations when and inaccordance with our expectations or the expectations of industry analysts, thisfailure could harm our business and have an immediate adverse effect on the tradingprice of our common 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.

 

***Delays in clinical testing couldresult 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 redesigned or will becompleted on schedule, or at all. In addition, clinical trials can be delayedfor a variety of reasons, including delays in obtaining regulatory approval tocommence a study, delays from scaling up of a study, delays in reachingagreement on acceptable clinical study agreement terms with prospectiveclinical sites, delays in obtaining institutional review board approval toconduct a study at a prospective clinical site or delays in recruiting subjectsto participate in a study.

 

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. Theclinical investigators are not our employees, and we cannot control the amountor timing of resources that they devote to our programs. Failure of the third-party organizations to meet their obligations could adversely affect clinicaldevelopment of our products. As a result, we may face additional delayingfactors outside our control if these parties do not perform their obligationsin a timely fashion. While we have not yet experienced delays that havematerially impacted our clinical trials or product development costs, delays ofthis sort could occur for the reasons identified above or other reasons. If wehave delays in testing or obtaining regulatory approvals, our productdevelopment costs will increase. For example, we may need to make additionalpayments to third-party investigators and organizations to retain theirservices 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. Moreover, these third-party investigators and organizations may alsohave relationships with other commercial entities, some of which may competewith us. If these third-party investigators and organizations assist ourcompetitors at our expense, it could harm our competitive position.

 

***We have been named a defendant in apurported securities class action lawsuit. This, and potential similar orrelated litigation, could result in substantial damages and may divertmanagement’s time and attention from our business.****

 

On February 6, 2009, a purported securities class action lawsuitwas commenced in the United States District Court for the Northern District ofCalifornia, naming as defendants us and certain of our officers, directors andunderwriters for our February 2008 stock offering. An additional purportedsecurities class action lawsuit containing similar allegations was subsequentlyfiled in the United States District Court for the Northern District ofCalifornia on February 20, 2009. By order of the Court datedMarch 19, 2009, the two lawsuits were consolidated into a single action.On June 9, 2009, the Court issued an order naming the Inter-Local PensionFund GCC/IBT as lead plaintiff and Robbins Geller Rudman & Dowd LLP(formerly Coughlin Stoia) as lead counsel. The lead plaintiff filed aconsolidated complaint on July 24, 2009. We filed a motion to dismiss onSeptember 8, 2009. On December 21, 2009, the Court granted our motionand dismissed the consolidated complaint with leave to amend. Plaintiff filedits consolidated amended complaint on January 27, 2010. The lawsuitalleges violations of the Securities Act of 1933 and the Securities ExchangeAct of 1934 in connection with allegedly false and misleading statements madeby us related to the results of the Phase 2a clinical trial of our productcandidate FosD. The plaintiffs seek damages, including rescission or rescissorydamages for purchasers in the stock offering, an award of their costs andinjunctive and/or equitable relief for purchasers of our common stock duringthe period between December 13, 2007 and February 9, 2009, includingpurchasers in the stock offering. We filed a motion to dismiss the consolidatedamended complaint on February 16, 2010. Briefing on the motion to dismissis complete and we are awaiting a ruling on that motion from the Court. It ispossible that additional suits will be filed with respect to these same mattersand also naming us and/or our officers and directors as defendants. If any suchadditional suits are filed in the same court, we believe that they would beconsolidated into the consolidated action.

 

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We believe that we have meritorious defenses and intend to defend thelawsuit vigorously. This lawsuit and any other related lawsuits are subject toinherent uncertainties, and the actual costs to be incurred relating to thelawsuit will depend upon many unknown factors. The outcome of the litigation isnecessarily uncertain, and we could be forced to expend significant resourcesin the defense of this suit, and we may not prevail. Monitoring and defendingagainst legal actions is time-consuming for our management and detracts fromour ability to fully focus our internal resources on our business activities.In addition, we may incur substantial legal fees and costs in connection withthe litigation. We are not currently able to estimate the possible cost to usfrom this matter, and we cannot be certain how long it may take to resolve thismatter or the possible amount of any damages that we may be required to pay. Wehave not established any reserves for any potential liability relating to thislawsuit. It is possible that we could, in the future, incur judgments or enterinto settlements of claims for monetary damages. A decision adverse to ourinterests on this action could result in the payment of substantial damages, orpossibly fines, and could have a material adverse effect on our cash flow,results of operations and financial position. In addition, the uncertainty ofthe currently pending litigation could lead to increased volatility in ourstock price.

 

***We lack the capability tomanufacture compounds for development and rely on third parties to manufactureour product candidates, and we may be unable to obtain required material in atimely manner, at an acceptable cost or at a quality level required to receiveregulatory approval.****

 

We currently do not have the manufacturing capabilities or experiencenecessary to produce our product candidates for clinical testing. For eachclinical trial of our unpartnered product candidates, we rely on third-partymanufacturers for the active pharmaceutical ingredients, as well as variousmanufacturers to manufacture starting components, excipients and formulateddrug products. We rely on manufacturers to produce and deliver all of thematerials required for our clinical trials, and many of our preclinicalefforts, on a timely basis and to comply with applicable regulatoryrequirements, including the FDA’s current Good Manufacturing Practices, orcGMP. In addition, we rely on our suppliers to deliver sufficient quantities ofmaterials produced under cGMP conditions to enable us to conduct plannedpreclinical studies and clinical trials.

 

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 material on a timely basis or manufacture material atthe quality level or in the quantity required to meet our development timelinesand applicable regulatory requirements and may also experience a shortage inqualified personnel. 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 ourinvestigational new drug, or IND, applications and/or the initiation ofclinical trials that we have currently planned.

 

Drug manufacturers are subject to ongoing periodic unannouncedinspection by the FDA, the Drug Enforcement Administration, and other federaland state agencies to ensure strict compliance with cGMP and other governmentregulations and corresponding foreign standards. We do not have control overthird-party manufacturers’ compliance with these regulations and standards andthey may not be able to comply. Switching manufacturers may be difficultbecause the number of potential manufacturers is limited. It may be difficultor impossible for us to find a replacement manufacturer quickly on acceptableterms, or at all. Additionally, if we are required to enter into new supplyarrangements, we may not be able to obtain approval from the FDA of anyalternate supplier in a timely manner, or at all, which could delay or preventthe clinical development and commercialization of any related productcandidates. Failure of our third- party manufacturers or us to comply withapplicable regulations could result in sanctions being imposed on us, includingfines, civil penalties, delays in or failure to grant marketing approval of ourproduct candidates, injunctions, delays, suspension or withdrawal of approvals,license revocation, seizures or recalls of products and compounds, operatingrestrictions and criminal prosecutions, any of which could significantly andadversely affect our business.

 

***If our competitors developtechnologies that are more effective than ours, our commercial opportunity willbe 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, and will continue to face, intense competition from pharmaceuticaland biotechnology companies, as well as from academic and research institutionsand government agencies, both in the United States and abroad. Some of thesecompetitors are pursuing the development of pharmaceuticals that target thesame diseases and conditions as our research programs. Our major competitorsinclude fully integrated pharmaceutical companies that have extensive drugdiscovery efforts and are developing novel small molecule pharmaceuticals. Wealso face significant competition from organizations that are pursuing the sameor similar technologies, including the discovery of targets that are useful incompound screening, as the technologies used by us in our drug discoveryefforts.

 

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Competition may also arise from:

 

·                  new or better methods oftarget identification or validation;

 

·                  other drug developmenttechnologies and methods of preventing or reducing the incidence of disease;

 

·                  new small molecules; or

 

·                  other classes of therapeuticagents.

 

Our competitors or their collaborative partners may utilize discoverytechnologies and techniques or partner with collaborators in order to developproducts more rapidly or successfully than we or our collaborators are able todo. Many of our competitors, particularly large pharmaceutical companies, havesubstantially greater financial, technical and human resources and largerresearch and development staffs than we do. In addition, academic institutions,government agencies and other public and private organizations conductingresearch may seek patent protection with respect to potentially competitiveproducts or technologies and may establish exclusive collaborative or licensingrelationships 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 any of our collaborators or us in any of those areas may prevent thesuccessful commercialization of our potential drug targets.

 

Many of our competitors, either alone or together with theircollaborative partners, have significantly greater experience than we do in:

 

·                  identifying and validatingtargets;

 

·                  screening compounds againsttargets; and

 

·                  undertaking preclinicaltesting and clinical trials.

 

Accordingly, our competitors may succeed in obtaining patentprotection, identifying or validating new targets or discovering new drugcompounds before we do.

 

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 product candidates 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.

 

We face and will continue to face intense competition from othercompanies for collaborative arrangements with pharmaceutical and biotechnologycompanies, for establishing relationships with academic and researchinstitutions and for licenses to additional technologies. These competitors,either alone or with their collaborative partners, may succeed in developingtechnologies or products that are more effective than ours.

 

***Our ability to generate revenueswill be diminished if our collaborative partners fail to obtain acceptableprices or an adequate level of reimbursement for products from third-partypayors or government agencies.***

 

The drugs we hope to develop may be rejected by the marketplace due tomany factors, including cost. Our ability to commercially exploit a drug may belimited due to the continuing efforts of government and third-party payors tocontain or reduce the costs of health care through various means. For example,in some foreign markets, pricing and profitability of prescriptionpharmaceuticals are subject to government control. In the United States, weexpect that there will continue to be a number of federal and state proposalsto implement similar government control. In addition, increasing emphasis onmanaged care in the United States will likely continue to put pressure on thepricing of pharmaceutical products. Cost control initiatives could decrease theprice that any of our collaborators would receive for any products in thefuture. Further, cost control initiatives could adversely affect ourcollaborators’ ability to commercialize our products and our ability to realizeroyalties from this commercialization.

 

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Our ability to commercialize pharmaceutical products with collaboratorsmay depend, in part, on the extent to which reimbursement for the products willbe available from:

 

·                  government and healthadministration authorities;

 

·                  private health insurers; and

 

·                  other third-party payors.

 

Significant uncertainty exists as to the reimbursement status of newly-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 labelingapproval. Third- party insurance coverage may not be available to patients forany products we discover and develop, alone or with collaborators. Ifgovernment and other third-party payors do not provide adequate coverage andreimbursement levels for our products, the market acceptance of these productsmay be reduced.

 

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

 

The testing and marketing of medical products entail an inherent riskof product liability. If we cannot successfully defend ourselves against productliability claims, we may incur substantial liabilities or be required to limitcommercialization of our products. We carry product liability insurance that islimited in scope and amount and may not be adequate to fully protect us againstproduct liability claims. Our inability to obtain sufficient product liabilityinsurance at an acceptable cost to protect against potential product liabilityclaims could prevent or inhibit the commercialization of pharmaceuticalproducts we develop, alone or with corporate collaborators. We, or ourcorporate collaborators, might not be able to obtain insurance at a reasonablecost, if at all. While under various circumstances we are entitled to beindemnified against losses by our corporate collaborators, indemnification maynot be available or adequate should any claim arise.

 

***Our research and development effortswill be seriously jeopardized, if we are unable to attract and retain keyemployees and relationships.***

 

As a small company, our success depends on the continued contributionsof our principal management and scientific personnel and on our ability todevelop and maintain important relationships with leading academicinstitutions, scientists and companies in the face of intense competition forsuch personnel. In particular, our research programs depend on our ability toattract and retain highly skilled chemists, other scientists, and development,regulatory and clinical personnel. If we lose the services of any of our keypersonnel, our research and development efforts could be seriously andadversely affected. Our employees can terminate their employment with us at anytime.

 

***We depend on various scientificconsultants and advisors for the success and continuation of our research anddevelopment efforts.***

 

We work extensively with various scientific consultants and advisors.The potential success of our drug discovery and development programs depends,in part, on continued collaborations with certain of these consultants andadvisors. We, and various members of our management and research staff, rely oncertain of these consultants and advisors for expertise in our research,regulatory and clinical efforts. Our scientific advisors are not our employeesand may have commitments to, or consulting or advisory contracts with, otherentities that may limit their availability to us. We do not know if we will beable to maintain such consulting agreements or that such scientific advisorswill not enter into consulting arrangements, exclusive or otherwise, withcompeting pharmaceutical or biotechnology companies, any of which would have adetrimental impact on our research objectives and could have a material adverseeffect on our business, financial condition and results of operations.

 

***If we use biological and hazardousmaterials in a manner that causes injury or violates laws, we may be liable fordamages.***

 

Our research and development activities involve the controlled use ofpotentially harmful biological materials as well as hazardous materials,chemicals and various radioactive compounds. We cannot completely eliminate therisk of accidental contamination or injury from the use, storage, handling ordisposal of these materials. In the event of contamination or injury, we couldbe held liable for damages that result, and such liability could exceed ourresources. We are also subject to federal, state and local laws and regulationsgoverning the use, storage, handling and disposal of these materials andspecified waste products. The cost of compliance with, or any potential violationof, these laws and regulations could be significant.

 

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

 

Our facilities are located in the San Francisco 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.

 

***Future interest income and value ofour investments may be impacted by further declines in interest rates and thebroader effects of the recent turmoil in the global credit markets.***

 

Recently, the credit markets and the financial services industry havebeen experiencing a period of unprecedented turmoil and upheaval. As a resultof this turmoil, the interest paid on certain of our investments may decreaseand the value of certain securities we hold may decline in the future, whichcould negatively affect our financial condition, cash flows and reportedearnings.

 

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

 

The market prices for our common stock and the securities of otherbiotechnology companies have been highly volatile and may continue to be highlyvolatile in the future. The following factors, in addition to other riskfactors described in this section, may have a significant impact on the marketprice of our common stock:

 

·                  the progress and success ofclinical trials and preclinical activities (including studies and manufactureof materials) of our product candidates conducted by us or our collaborativepartners or licensees;

 

·                  the receipt or failure toreceive the additional funding necessary to conduct our business;

 

·                  selling by largestockholders;

 

·                  presentations of detailedclinical trial data at medical and scientific conferences and investorperception thereof;

 

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

 

·                  developments concerningproprietary rights, including patents;

 

·                  developments concerning ourcollaborations;

 

·                  publicity regarding actualor potential medical results relating to products under development by ourcompetitors or us;

 

·                  regulatory developments inthe United States and foreign countries;

 

·                  litigation;

 

·                  economic and other externalfactors or other disaster or crisis; and

 

·                  period-to-periodfluctuations in financial results.

 

***Future equity issuances or a sale ofa substantial number of shares of our common stock may cause the price of ourcommon stock to decline.***

 

Because we may need to raise additional capital in the future tocontinue to expand our business and our research and development activities,among other things, we may conduct additional equity offerings. If we or ourstockholders sell substantial amounts of our common stock (including sharesissued upon the exercise of options and warrants) in the public market, themarket price of our common stock could fall. A decline in the market price ofour common stock could make it more difficult for us to sell equity orequity-related securities in the future at a time and price that we deemappropriate.

 

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***Anti-takeover provisions in ourcharter documents and under Delaware law may make an acquisition of us, whichmay 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:

 

·                  establish that members ofthe board of directors may be removed only for cause upon the affirmative voteof stockholders owning a majority of our capital stock;

 

·                  authorize the issuance of “blankcheck” preferred stock that could be issued by our board of directors toincrease the number of outstanding shares and thwart a takeover attempt;

 

·                  limit who may call a specialmeeting of stockholders;

 

·                  prohibit stockholder actionby written consent, thereby requiring all stockholder actions to be taken at ameeting of our stockholders;

 

·                  establish advance noticerequirements for nominations for election to the board of directors or forproposing matters that can be acted upon at stockholder meetings;

 

·                  provide for a board ofdirectors with staggered terms; and

 

·                  provide that the authorizednumber of directors may be changed only by a resolution of our board ofdirectors.

 

Inaddition, Section 203 of the Delaware General Corporation Law, whichimposes certain restrictions relating to transactions with major stockholders,may discourage, delay or prevent a third party from acquiring us.

 

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

 

Theexhibits listed on the accompanying index to exhibits are filed or incorporatedby reference (as stated therein) as part of this Quarterly Report onForm 10-Q.

 
| **Exhibit  Number** | ** ** | **Description of Document**                                                                                                                                                             |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                        |
| 3.1                 |       | Amended and Restated Certificate  of Incorporation. (1)                                                                                                                                           |
|                |       |                                                                                                                                                                                              |
| 3.2                 |       | Amended and Restated Bylaws. (2)                                                                                                                                                                  |
|                |       |                                                                                                                                                                                              |
| 4.1                 |       | Form of warrant to purchase  shares of common stock. (3)                                                                                                                                     |
|                |       |                                                                                                                                                                                              |
| 4.2                 |       | Specimen Common Stock  Certificate. (4)                                                                                                                                                           |
|                |       |                                                                                                                                                                                              |
| 4.3                 |       | Warrant issued to HCP BTC, LLC  for the purchase of shares of common stock. (5)                                                                                                                   |
|                |       |                                                                                                                                                                                              |
| 10.19               | *          | 2000 Equity Incentive Plan, as  amended. (6)                                                                                                                                                      |
|                |       |                                                                                                                                                                                              |
| 10.22               | *          | 2000 Non-Employee Directors’  Stock Option Plan, as amended.                                                                                                                                 |
|                |       |                                                                                                                                                                                              |
| 10.30               | *          | 2010 Cash Incentive Plan. (6)                                                                                                                                                                     |
|                |       |                                                                                                                                                                                              |
| 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). |

 

----

| (1)    | Filed as an exhibit to Rigel’s  Current Report on Form 8-K filed on June 24, 2003 and incorporated  herein by reference.                        |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                           |
| (2)    | Filed as an exhibit to Rigel’s  Current Report on Form 8-K filed on February 2, 2007 and  incorporated herein by reference.                     |
|   |                                                                                                                                                           |
| (3)    | Filed as an exhibit to Rigel’s  Registration Statement on Form S-1 (No. 333-45864), as amended, and  incorporated herein by reference.          |
|   |                                                                                                                                                           |
| (4)    | Filed as an exhibit to Rigel’s  Current Report on Form 8-K (No. 000-29889) filed on June 24,  2003, and incorporated herein by reference.  |
|   |                                                                                                                                                           |
| (5)    | Filed as an exhibit to Rigel’s  Quarterly Report on Form 10-Q (No. 000-29889) filed on May 5,  2009, and incorporated herein by reference. |
|   |                                                                                                                                                           |
| (6)    | Filed as an exhibit to Rigel’s  Current Report on Form 8-K (No. 000-29889) filed on June 1,  2010, and incorporated herein by reference.   |
|   |                                                                                                                                                           |
| *      | Represents a management contract  or compensatory plan or arrangement.                                                                                         |

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, as amended, the registrant has duly caused thisreport 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 |
|   |                             | (Principal Executive Officer) |
|   |                             |   |
|   | Date: August 3, 2010        |
|   |                             |   |
|   | By:                              | /s/ RYAN D. MAYNARD |
|   |                             | Ryan D. Maynard |
|   |                             | Executive Vice President and  Chief Financial Officer |
|   |                             | (Principal Financial and  Accounting Officer) |
|   |                             |   |
|   | Date: August 3, 2010        |

 

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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                 |       | Form of warrant to purchase  shares of common stock. (3)                                                                                                                                     |
|                |       |                                                                                                                                                                                              |
| 4.2                 |       | Specimen Common Stock  Certificate. (4)                                                                                                                                                           |
|                |       |                                                                                                                                                                                              |
| 4.3                 |       | Warrant issued to HCP BTC, LLC  for the purchase of shares of common stock. (5)                                                                                                                   |
|                |       |                                                                                                                                                                                              |
| 10.19               | *          | 2000 Equity Incentive Plan, as  amended. (6)                                                                                                                                                      |
|                |       |                                                                                                                                                                                              |
| 10.22               | *          | 2000 Non-Employee Directors’  Stock Option Plan, as amended.                                                                                                                                 |
|                |       |                                                                                                                                                                                              |
| 10.30               | *          | 2010 Cash Incentive Plan. (6)                                                                                                                                                                     |
|                |       |                                                                                                                                                                                              |
| 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). |

 

----

| (1)    | Filed as an exhibit to  Rigel’s Current Report on Form 8-K filed on June 24, 2003 and  incorporated herein by reference.                        |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                           |
| (2)    | Filed as an exhibit to  Rigel’s Current Report on Form 8-K filed on February 2, 2007 and  incorporated herein by reference.                     |
|   |                                                                                                                                                           |
| (3)    | Filed as an exhibit to  Rigel’s Registration Statement on Form S-1 (No. 333-45864), as  amended, and incorporated herein by reference.          |
|   |                                                                                                                                                           |
| (4)    | Filed as an exhibit to  Rigel’s Current Report on Form 8-K (No. 000-29889) filed on  June 24, 2003, and incorporated herein by reference.  |
|   |                                                                                                                                                           |
| (5)    | Filed as an exhibit to  Rigel’s Quarterly Report on Form 10-Q (No. 000-29889) filed on  May 5, 2009, and incorporated herein by reference. |
|   |                                                                                                                                                           |
| (6)    | Filed as an exhibit to  Rigel’s Current Report on Form 8-K (No. 000-29889) filed on  June 1, 2010, and incorporated herein by reference.   |
|   |                                                                                                                                                           |
| *      | Represents a management  contract or compensatory plan or arrangement.                                                                                         |

 

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