UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE TRANSITION PERIOD FROM           TO

Commission File Number 0-29889

Rigel Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ý  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act) (Check one):

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

As of July 28, 2006, there were 24,938,377 shares of the registrant’s common stock outstanding.

RIGEL PHARMACEUTICALS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

INDEX

2

PART I  FINANCIAL INFORMATION

Item 1.  Financial Statements

RIGEL PHARMACEUTICALS, INC.

BALANCE SHEETS

(in thousands, except share amounts)

See accompanying notes.

3

RIGEL PHARMACEUTICALS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

(unaudited)

See accompanying notes.

4

RIGEL PHARMACEUTICALS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)

(unaudited)

See accompanying notes.

5

Rigel Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(unaudited)

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

1. Nature of Operations

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

2. Basis of Presentation

Our accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In our opinion, these unaudited condensed financial statements include all adjustments, consisting only of normal recurring adjustments, which we consider necessary to fairly state our financial position and the results of our operations and cash flows. Interim-period results are not necessarily indicative of results of operations or cash flows for a full-year period. The balance sheet at December 31, 2005 has been derived from audited financial statements at that date, but does not include all disclosures required by generally accepted accounting principles for complete financial statements. These unaudited condensed financial statements and the notes accompanying them should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2005.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.

Comprehensive net loss did not differ materially from the net loss as reported.

3. Basic and Diluted Net Loss Per Share

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

4. Stock Award Plans

We have two stock option plans, the 2000 Equity Incentive Plan and 2000 Non-Employee Directors Stock Option Plan, that provide for granting to officers, directors, all other employees and other non-employees options to purchase shares of our common stock. Under the plans, we may issue non-qualified options or incentive stock options. We also have an employee stock purchase plan, or ESPP, where eligible employees can purchase shares of our common stock at a price per share equal to 85% of the lower of the fair market value on the first and last day of each six-month purchase period. The benefits provided under these plans are share-based payments subject to the provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment (Revised 2004)”, or SFAS 123(R).

Effective January 1, 2006, we adopted the provisions of SFAS 123(R) using the modified prospective application transition method. Under this method, the share-based compensation cost recognized beginning January 1, 2006 includes compensation cost for (i) all share-based payments granted prior to, but not vested as of January 1, 2006, based on the grant date fair value originally estimated in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, or SFAS 123, and calculated for pro forma disclosures under SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, or SFAS 148, and (ii) all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). Compensation cost under SFAS 123(R) for awards granted prior to January 1, 2006 is recognized using an accelerated method pursuant to the Financial Accounting Standards Board, or FASB, Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans”, or FIN 28. For awards granted after January 1, 2006, we have adopted the use of the straight-line attribution method over the requisite service period for the entire award. Results of prior periods do not reflect any restated amounts, and we had no cumulative effect adjustment upon adoption of SFAS No. 123(R) under the modified prospective method.

6

Impact of the Adoption of FAS 123(R)

Total stock-based compensation expense, related to all of the Company’s share-based awards, recognized for the three and six months ended June 30, 2006 and 2005 was comprised as follows (in thousands, except per share amounts):

We recorded approximately $3.1 million in stock-based compensation expense for the three months ended June 30, 2006, consisting of approximately $3.2 million in stock-based awards granted to officers, directors and all other employees from our stock option plans and ESPP, offset by a recovery of approximately $93,000 in options originally granted to consultants, which is discussed below. We recorded approximately $6.7 million in stock-based compensation expense for the six months ended June 30, 2006, consisting of approximately $6.5 million in stock-based awards granted to officers, directors and all other employees from our stock option plans and ESPP and approximately $184,000 in options granted to consultants. Pursuant to SFAS 123(R), we are required to estimate the amount of expected forfeitures when calculating the compensation costs, instead of accounting for forfeitures as incurred, which was our previous method. Our annual weighted average forfeiture rate was 7.6% as of June 30, 2006 as compared to 4.7% as of March 31, 2006. The increase in the forfeiture rate was due to the forfeiture of an executive officer’s unvested options resulting from his departure from the company. We will record actual forfeitures as they occur, and we will review our forfeiture rates each quarter and make changes to our estimate.

For the three months ended June 30, 2006, we recorded a recovery of approximately $93,000, and for the six months ended June 30, 2006, we recorded an expense of approximately $184,000, associated with options granted to consultants, reflecting the fair value and periodic fair value remeasurement of outstanding consultant options under Emerging Issues Task Force No. 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services”, or EITF 96-18.  The valuation is based upon the current market value of our common stock and other assumptions, including the expected future volatility of our stock price, risk-free interest rate and expected term. For consultant options granted in 2006, we amortized stock-based compensation using a straight-line attribution method consistent with the method used for employees and with the attribution election we made upon adoption of FAS 123(R). For options granted prior to January 1, 2006, we used the accelerated method for expensing stock-based compensation, which was the method we used prior to adoption. We recorded stock-based compensation expense of approximately $92,000 for the three months ended June 30, 2005 and a recovery of approximately $115,000 for the six months ended June 30, 2005 relating to consultant options. We expect to see continued fluctuations in the future as a portion of these options are remeasured based on the changes in the current market price of our common stock.

In 2005, we recorded charges associated with the stock options that were eligible for re-pricing under a tender offer initiated in June 2003. All replacement options, as well as the eligible options that were not surrendered under the original offer to exchange, were treated for financial reporting purposes as variable awards. Therefore, for the period prior to adoption of FAS 123(R), we recorded a non-cash charge, generally for the intrinsic value of the options as they vested under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees, or APB 25, utilizing the accelerated vesting method, reflecting increases and decreases (down to, but not below, the exercise price) in the price of our common stock as compensation expense (recovery) in connection with the replacement options and the eligible options that were not exchanged. For the three months ended June 30, 2005, we recorded stock-based compensation expense of approximately $715,000 related to all employee options eligible for replacement options. The expense resulted from the increase in the market price of our common stock during the period. For the six months ended June 30, 2005, we recorded stock-based compensation recovery of approximately $551,000 related to all employee options eligible for replacement options. The recovery resulted from the decrease in the market price of our common stock during the period. For periods after the adoption of FAS 123(R), we account for the vested portion of the options repriced prior to the adoption of SFAS 123(R) in accordance with provisions of SFAS 123. In May 2006, our board of directors approved a plan to grant new options in August 2006 to employees who hold repriced options that expire in the same period. We will record stock-based compensation expense relating to the new options in the third quarter of 2006.

7

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

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

•                  Volatility - We estimated volatility using the historical share price performance over the expected life of the option up to the point where we have historical market data. As our publicly listed options are not actively traded, implied volatility was not representative of our current volatility. We also considered other factors such as our current clinical trials and other company activities that may affect volatility of our stock in the future but determined that at this time, the historical volatility was more indicative of our expected future stock performance.

•                  Expected term - We worked with various data points to determine the most applicable expected term for each option group. The data points included: (1) expected term of the options from option date to exercise date; (2) cancellation term of options from grant date to cancellation date and excluding unvested option forfeitures from the determination; and (3) term of options that remain outstanding from grant date to the end of the reporting period. The analysis of the above data points gave us a range of expected terms to consider; however, we also considered the vesting schedules of the options granted and factors surrounding exercise behavior of our groups, our current market price and company activity that may affect our market price. In addition, we also considered the vesting schedules of the options, the optionee type (i.e., officers and directors and all other employees) and other factors that may affect the expected term of the option. For non-employee options, we use the contractual term of the option, which is generally ten years, for the initial valuation of the option and the remaining contractual term of the option for the succeeding years.

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

•                  Forfeiture rate - We estimated the forfeiture rate using our historical experience with pre-vesting options. Our annual weighted-average forfeiture rate was approximately 7.6% as of June 30, 2006 as compared to 4.7% as of March 31, 2006. The increase in the forfeiture rate was due to the forfeiture of an executive officer’s unvested options resulting from his departure from the company. We review our forfeiture rates each quarter and make changes as factors affecting our forfeiture rate calculations and assumptions change.

•                  Dividend yield - The expected dividend yield is 0% as we have not and do not expect to pay dividends.

The following table summarizes the weighted-average assumptions relating to our employee options for the three and six months ended June 30, 2006 and 2005 as permitted under FAS 123(R) for 2006 and FAS 123 for 2005:

Option prices are not less than the market price of our common stock on the date of grant, become exercisable at varying dates and generally expire ten years from the date of grant. At June 30, 2006, options to purchase 1,543,293 shares of common stock were available for grant under our stock option plans.

Employee Stock Purchase Plan

The fair value of each option element of our employee stock purchase plan (ESPP) is estimated on the date of grant using the Black-Scholes option pricing model that uses weighted-average assumptions in the table below. Our ESPP provides for a twenty-four month offering period comprised of four six-month purchase periods with a look-back option. A look-back option is a provision in an ESPP that establishes the purchase price as an amount based on the lesser of the stock’s market price at the grant date or its market price at the exercise or purchase date. The plan also includes a reset feature whereby participants reset to a new offering when the market price of the stock falls below the market price on the first day of a twenty-four month offering period. Expected volatilities are based on historical volatility of our stock. Expected term represents the purchase periods within our offering period. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury of constant maturity rates. Stock-based compensation expense relating to our employee stock purchase plan is recognized according to the FASB Technical Bulletin No. 97-1, “Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-back Option”, or FTB 97-1. As of June 30, 2006, there were approximately 56,000 shares in reserve for future issuance under the plan. The following table summarizes the weighted-average assumptions relating to our employee stock purchase plan for the six months ended June 30, 2006 and 2005:

8

Stock-based Compensation Award Activity

The following table summarizes activity under our equity incentive and stock option plans as of June 30, 2006 (in thousands, except per share amounts):

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for the options to acquire 2.2 million shares that were in-the-money at June 30, 2006. During the six months ended June 30, 2006 and 2005, the aggregate intrinsic values of options exercised under our stock option plans were approximately $88,000 and $612,332, respectively, determined as of the date of option exercise. As of June 30, 2006, there were approximately $13.3 million of total unrecognized compensation cost, net of forfeitures, related to unvested share-based compensation arrangements granted under our stock option plans and $833,000 of total unamortized compensation cost related to our ESPP. That cost is expected to be recognized over a weighted-average period of 1.45 years. We also had approximately 2.1 million of unvested stock options at June 30, 2006. Future option grants and their valuation will increase our compensation cost in the future as the options are granted, valued and expensed ratably according to their vesting periods. The weighted average grant-date fair values of options granted in the six months ended June 30, 2006 and 2005 were $6.01 and $9.30, respectively.

Pro Forma Information under FAS 123 for Periods Prior to Fiscal 2006

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

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

9

5. Revenue Recognition

We recognize revenue from our contract arrangements. Our revenue arrangements with multiple elements are evaluated under EITF No. 00-21, “Revenue Arrangements with Multiple Deliverables,” and are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.

Non-refundable, up-front payments received in connection with research and development collaboration agreements, including technology access fees, are deferred and recognized on a straight-line basis over the relevant periods of continuing involvement, generally the research term. When a research term is not specified, we estimate the time it will take us to complete our deliverables under the contract and recognize the upfront fee using the straight-line method over that time period. We review our estimates every quarter for reasonableness.

Revenues related to collaborative research with our corporate collaborators are recognized as research services are performed over the related development funding periods for each contract. Under these agreements, we are required to perform research and development activities as specified in each respective agreement. The payments received are not refundable and are generally based on a contractual cost per full-time equivalent employee working on the project. Research and development expenses under the collaborative research agreements, except for the Merck collaboration signed in November 2004 related to ubiquitin ligases, approximate or exceed the revenue recognized under such agreements over the term of the respective agreements. For the Merck collaboration, we are recognizing a pro-rata portion of the invoiced amounts for funding of our research scientists based on the headcount dedicated to the project. It is our policy to recognize revenue based on our level of effort expended, however, revenue recognized will not exceed amounts billable under the arrangement which corresponds to cash receipts.

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

Royalties will be recognized as earned in accordance with the contract terms when the third party results are reliably measurable and collectibility is reasonably assured.

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

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

At June 30, 2006, the above debt securities had a weighted average maturity of approximately 134 days with two federal agency securities with a fair market value of $3.0 million having a maturity greater than 360 days.

10

The following table shows the gross unrealized losses and fair values of our investments in individual securities that are in an unrealized loss position aggregated by investment category, (in thousands):

As of June 30, 2006, there were no investments that had been in a continuous unrealized loss position for more than twelve months. As of December 31, 2005, we had an investment in corporate bonds and notes with a fair market value of approximately $1.0 million that was in a continuous unrealized loss position for more than twelve months. During the periods presented, there were no recorded realized gains or losses on investments.

As of June 30, 2006, a total of 33 individual securities were in an unrealized loss position for less than twelve months and deemed to be temporary. As of December 31, 2005, 34 individual securities were in an unrealized loss position for less than twelve months and deemed to be temporary.

7. Serono Collaboration

In October 2005, we entered into a collaborative research and license agreement with Serono granting it an exclusive license to develop and commercialize product candidates from our Aurora kinase inhibitor program. Even though the agreement includes a basket of compounds within the Aurora kinase inhibitor program, the collaboration and our efforts under the agreement are focused on R763. We are responsible for all costs associated with the preparation and filing of an Investigational New Drug, or IND, for R763, which we filed in December 2005, while Serono is responsible for all development of R763 following regulatory acceptance of the IND and will bear all costs thereafter. In connection with this collaboration, Serono paid us $10.0 million upfront and paid $15.0 million to purchase our common stock at a premium.

During February 2006, we received a payment of $5.0 million triggered by the regulatory acceptance of the R763 IND in January 2006. We have amortized the payment on a straight-line basis thru April 2006 when our involvement with the amended IND was completed. We will be eligible to receive milestone payments, under certain conditions, upon commencement of a Phase I clinical trial for R763, other clinical events, marketing approval and royalties on any future product sales.

We were originally amortizing the $10.0 million upfront amount into revenue over nine months from the initiation of the collaboration in October 2005. This was the period of time during which we originally estimated it would take to perform our deliverables under the contract. When we evaluated this estimate in the second quarter of 2006, we concluded that we had achieved all our deliverables and should therefore recognize all of the remaining unamortized amount that would have been amortized in full in July 2006. The change in estimate resulted in approximately $860,000 of revenue that we recognized in the second quarter of 2006 instead of in the third quarter of 2006.

8. Pfizer Collaboration

In January 2005, we signed a collaborative research and license agreement with Pfizer for the development of inhaled products for the treatment of allergic asthma and chronic obstructive pulmonary disease. The agreement gives Pfizer the exclusive right to nominate up to two Syk inhibitors under certain conditions, to commence advanced preclinical development. Pfizer will have the exclusive right to develop any nominated compound, and we will earn milestones upon the selection of each of the two compounds and other clinical events as well as royalties on any future product sales. Pfizer is responsible for the manufacture of all preclinical and clinical materials for each compound or product and all costs associated with development and commercialization.

In May 2006, we achieved the first milestone when Pfizer nominated R343 to commence advanced preclinical development in allergic asthma. Pfizer paid us $5.0 million for the exclusive right to R343 and will be responsible for all development related to R343 going forward.

11

9. Equipment Lease Line

In July 2005, our equipment credit line under an original master agreement was extended to create a total borrowing limit of $1.5 million through June 2006. In June 2006, we drew down the remaining lease line balance of $153,000 and obtained approval to extend our lease line to create a new total borrowing limit of $1.5 million. We have the ability to draw down on this line through June 2007. The repayment period will be for three years beginning on the first draw down with the interest rate on the line fixed at each drawdown. Each line has a bargain purchase buyout provision of $101. During the three months ended June 30, 2006, we drew down $222,000 on this new 2006 extension, which is included in capital lease obligation on the balance sheet. Approximately $1.3 million remained available under the line as of June 30, 2006.

10. Subsequent Event

 In July 2006, we amended our facility lease in order to defer certain rent payments for 2006 and 2007. The amended lease agreement also included warrants to purchase shares of our common stock.

12

Report of Independent Registered Public Accounting Firm

The Board of Directors

Rigel Pharmaceuticals, Inc.

We have reviewed the accompanying balance sheet of Rigel Pharmaceuticals, Inc. as of June 30, 2006, the related condensed statements of operations for the three and six-month periods ended June 30, 2006 and 2005, and the condensed statements of cash flows for the six-month period ended June 30, 2006 and 2005. These interim financial statements are the responsibility of the Company’s management.

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

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

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheet of Rigel Pharmaceuticals, Inc. as of December 31, 2005, and the related statements of operations, shareholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated March 3, 2006, we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying balance sheet as of December 31, 2005, is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived.

13

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

This discussion and analysis should be read in conjunction with our financial statements and accompanying notes included in this report and the 2005 audited financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2005. Operating results for the three and six months ended June 30, 2006 are not necessarily indicative of results that may occur in future periods.

We usually use words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “future,” “intend,” “potential” or “continue” or the negative of these terms or similar expressions to identify these forward-looking statements. These statements appear throughout this quarterly report on Form 10-Q and are statements regarding our current intent, belief or expectation, primarily with respect to our operations and related industry developments. Examples of these statements include, but are not limited to, statements regarding the following: our business and scientific strategies; the progress of our product development programs, including clinical testing; our corporate collaborations, including revenues that may be received from these collaborations; our drug discovery technologies; our research and development expenses; protection of our intellectual property; sufficiency of our cash resources; and our operations and legal risks. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including as a result of the risks and uncertainties discussed in the “Risk Factors” in Item 1A of Part II of this quarterly report on Form 10-Q. Any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements

Overview

Rigel is a clinical-stage drug development company that discovers and develops novel, small-molecule drugs for the treatment of inflammatory diseases, cancer and viral diseases. Our goal is to file one new drug (IND) application in a significant indication each year. We have achieved this goal each year beginning in 2002. Our pioneering research focuses on intracellular signaling pathways and related targets that are critical to disease mechanisms. Our productivity has resulted in strategic collaborations with large pharmaceutical partners to develop and market our product candidates. We have product development programs in inflammatory/autoimmune diseases such as rheumatoid arthritis, thrombocytopenia, asthma and allergy as well as in cancer.

Rigel has multiple product candidates in development as follows:

•                  R788—Product Candidate for Rheumatoid Arthritis (RA). R788 is our lead product candidate. It has a novel mechanism of action-blocking IgG receptor signaling in macrophages and B-cells. Previously, we studied R788 in a Phase I single center, double-blind, randomized, placebo-controlled trial evaluating the safety and pharmacokinetics of escalating single and multiple doses of R788. We have completed R788 studies to evaluate its safety and pharmacokinetics in combination with methotrexate, a commonly prescribed treatment for RA. Results of this trial suggest no adverse interaction. We expect to commence Phase II clinical trials of R788 for RA in the second half of 2006.

•                  R788—Product Candidate for Immune Thombocytopenia Purpura (ITP). Platelet destruction from ITP is mediated by IgG signaling. R788 is a potent inhibitor of IgG signaling. In preclinical studies, Rigel has shown R788 to improve thrombocytopenia in an ITP mouse model. We plan to commence Phase II clinical trials of R788 to evaluate its safety and efficacy in refractory ITP patients in the second half of 2006.

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

In the first quarter of 2005, we announced that we entered into a collaborative research and license agreement with Pfizer for the development of inhaled products for the treatment of allergic asthma and other respiratory diseases, such as chronic obstructive pulmonary disease, or COPD. The collaboration is focused on our preclinical small molecule compounds, which inhibit IgE receptor signaling in respiratory tract mast cells by blocking the signaling enzyme Syk, or spleen tyrosine kinase, a novel drug target for respiratory diseases. Mast cells play important roles in both early and late phase allergic reactions, and Syk inhibitors could prevent both phases. In May 2006, we achieved the first collaboration milestone when Pfizer nominated R343 to commence advanced

14

preclinical development in allergic asthma. Pfizer paid us $5.0 million for the exclusive right to R343, which will be delivered using Pfizer’s dry powder inhaler and is projected to enter the clinic in 2007.

In addition to the above mentioned product candidates, we have ongoing research programs involving back-up candidates for the product candidates above as well as drug discovery efforts in our immunology/inflammation, virology, and oncology programs. For example, we are pursuing JAK3 inhibition in transplant rejection and in a variety of autoimmune diseases and Axl inhibition in oncology.

Corporate Collaborations

We carry on research and development programs in connection with our corporate collaborations. As of June 30, 2006, we had collaborations with six major pharmaceutical/biotech companies comprised of: one with Janssen Pharmaceutica N.V., a division of Johnson & Johnson, relating to oncology therapeutics and diagnostics, two with Pfizer Inc., one initiated in 1999 and the other in the first quarter of 2005, relating to intrapulmonary asthma and allergy therapeutics, one with Novartis Pharma AG with respect to four different programs relating to immunology, oncology and chronic bronchitis, one with Daiichi Pharmaceuticals Co., Ltd. in the area of oncology, one with Merck, in the area of oncology, and one with Serono in the area of oncology. All of these collaborations, excluding the recent Pfizer and the Serono collaborations, have a research phase during which we receive or received funding based on the level of headcount allocated to a program. In all of these collaborations if certain conditions are met, we are entitled to receive future milestone payments and royalties. We cannot guarantee that these conditions will be met or that research and development efforts will be successful. As a result, we may not receive any further milestone payments or royalties under these agreements. Only the Merck program currently provides for regular research reimbursement payments.

We are exploring new opportunities with existing and potential collaborators. Our earliest partnerships focused on the early stages of drug discovery, specifically on target discovery and validation. Our collaborations with Daiichi and recently with Merck are both later stage, focusing on drug discovery and development. Our 2005 collaboration with Pfizer covers compounds at the preclinical and lead designation stages while our 2005 collaboration with Serono covers a compound for which an IND was filed in December 2005 and obtained FDA approval in January 2006. We currently anticipate that in order to support our current research programs we will need to self-fund our own research programs, which involves an increased rate of spending on later stages of development prior to partnering with collaborative partners. Therefore, it is expected that future collaborations may have an expanded focus and could include high throughput screening, combinatorial and medicinal chemistry, preclinical evaluations and/or clinical development of compounds we have discovered. In addition, we believe these future collaborations could be structured to consist of upfront payments, the purchase of our common stock, milestone payments upon meeting certain conditions, research or development reimbursement payments and/or royalties upon commercialization of products resulting from the collaboration.

Critical Accounting Policies and the Use of Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to terms of the research collaborations (i.e., amortization of upfront fees and certain milestones), investments, stock compensation, impairment issues, the estimated useful life of assets and contingencies. In June 2006, we evaluated the period for amortizing the Serono upfront payment and concluded we had achieved all of our deliverables under the contract. See further discussion in Note 7 above. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

We believe that there have been no significant changes in our critical accounting policies during the period ended June 30, 2006 as compared to those previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005, except for the adoption of SFAS 123(R) for equity-based compensation costs in January 2006.

Revenue Recognition

We recognize revenue from our contract arrangements. Our revenue arrangements with multiple elements are evaluated under Emerging Issues Task Force No. 00-21, “Revenue Arrangements with Multiple Deliverables,” are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.

Non-refundable, up-front payments received in connection with research and development collaboration agreements, including technology access fees, are deferred and recognized on a straight-line basis over the relevant periods of continuing involvement, generally the research term. When a research term is not specified, we estimate the time it will take us to complete our deliverables under the contract and recognize the upfront fee using the straight-line method over that time period. We review our estimates every quarter for reasonableness.

15

Revenues related to collaborative research with our corporate collaborators are recognized as research services are performed over the related development funding periods for each contract. Under these agreements, we are required to perform research and development activities as specified in each respective agreement. The payments received are not refundable and are generally based on a contractual cost per full-time equivalent employee working on the project. Research and development expenses under the collaborative research agreements, except for the Merck collaboration signed in November 2004 related to ubiquitin ligases, approximate or exceed the revenue recognized under such agreements over the term of the respective agreements. For the Merck collaboration, we are recognizing a pro-rata portion of the invoiced amounts for funding of our research scientists based on the headcount dedicated to the project. It is our policy to recognize revenue based on our level of effort expended; however, revenue recognized will not exceed amounts billable under the arrangement which corresponds to cash receipts.

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

Royalties will be recognized as earned in accordance with the contract terms when the third party results are reliably measurable and collectibility is reasonably assured.

Stock-based Compensation

We grant options to purchase our common stock to our employees, directors and consultants under our stock option plans. Eligible employees can also purchase shares of our common stock at 85% of the lower of the fair market value on the first and last day of each six-month purchase period under our employee stock purchase plan. The benefits provided under these plans are share-based payments subject to the provisions of SFAS 123(R). Effective January 1, 2006, we adopted the provisions of SFAS 123(R) using the modified prospective application transition method. Under this method, the share-based compensation cost recognized beginning January 1, 2006 includes compensation cost for (i) all share-based payments granted prior to, but not vested as of January 1, 2006, based on the grant date fair value originally estimated in accordance with the provisions of SFAS 123 and calculated for pro forma disclosures under SFAS No. 148, and (ii) all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). Compensation cost under SFAS 123(R) for awards granted prior to January 1, 2006 is recognized using an accelerated method pursuant to the FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans”, or FIN 28. For awards granted after January 1, 2006, we have adopted the use of the straight-line attribution method over the requisite service period for the entire award. Results of prior periods do not reflect any restated amounts, and the cumulative effect of a change in accounting principle was insignificant upon adoption of SFAS No. 123(R) under the modified prospective method. In addition pursuant to SFAS 123(R), we are required to estimate the amount of expected forfeitures when calculating the compensation costs, instead of accounting for forfeitures as incurred, which was our previous method. We will record actual forfeitures as they occur, and we will review our forfeiture rates each quarter and make any necessary changes our estimates.

Prior to adopting SFAS 123(R) on January 1, 2006, we accounted for equity-based employee compensation costs under the recognition and measurement principles of APB 25. Under APB 25, the intrinsic value method of accounting, no compensation expense is recognized, because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant. Pro forma information regarding net loss and net loss per share was determined as if we had accounted for our employee stock options and employee stock purchase plan under the fair value method prescribed by FAS 123, as amended by FAS 148. The fair value for these options was estimated at the date of grant using the Black-Scholes model.

In 2005, we recorded charges associated with the stock options that were eligible for re-pricing under a tender offer initiated in June 2003. All replacement options, as well as the eligible options that were not surrendered under the original offer to exchange, were treated for financial reporting purposes as variable awards. Therefore, for the period prior to adoption of FAS 123(R), we recorded a non-cash charge, generally for the intrinsic value of the options as they vested, utilizing the accelerated vesting method, reflecting increases and decreases (down to, but not below, the exercise price) in the price of our common stock as compensation expense (recovery) in connection with the replacement options and the eligible options that were not exchanged. For the three

16

months ended June 30, 2005, we recorded non-cash compensation expense of approximately $715,000 related to all employee options eligible for replacement options. This expense resulted from the increase in the market price of our common stock during the period. For the six months ended June 30, 2005, we recorded a non-cash compensation recovery of approximately $551,000 related to all employee options eligible for replacement options. The recovery resulted from the decrease in the market price of our common stock during the six-month period ended June 30, 2005. For periods after the adoption of SFAS 123(R), we are continuing to account for the repriced options prior to the adoption of SFAS 123(R) in accordance with provisions of SFAS 123. In May 2006, our board of directors approved a plan to grant new options in August 2006 to employees who hold repriced options that expire in the same period. We will record stock-based compensation expense relating to the new options in the third quarter of 2006.

We also record charges associated with options granted to consultants reflecting the fair value valuation and periodic fair value remeasurement of outstanding consultant options under EITF 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.”   The valuation is based upon the current market value of our common stock and other assumptions, including the expected future volatility of our stock price, risk-free interest rate and expected term. For consultant options granted in 2006, we amortize stock-based compensation using a straight-line attribution method consistent with the method used for employees and with the attribution election we made upon adoption of FAS 123(R). For options granted prior to January 1, 2006, we used the accelerated method for expensing stock-based compensation, which was the method we used prior to adoption. We expect to see continued fluctuations in the future as a portion of these options are remeasured based on the changes in the current market price of our common stock.

The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

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

The guidance in SFAS 123(R) and SAB 107 is relatively new, and best practices are not well established. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a possibility that we may adopt different valuation models in the future. This may result in a lack of consistency in future periods and materially affect the fair value estimate of share-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.

Three and Six Months Ended June 30, 2006 and 2005

Revenues

Revenues by collaborator were:

Contract revenues from collaborations for the three and six months ended June 30, 2006 and 2005 consisted primarily of research support and amortization of upfront fees and milestone payments from the continuation of our collaborations above. The

17

increase in revenues for the three and six months ended June 30, 2006 compared to the similar periods in 2005 was primarily due to the recognition of the Pfizer milestone of $5.0 million for the nomination of R343 in May 2006 and the amortization of approximately $5.7 million related to upfront payments from Serono, which consisted of the payment we received in February 2006 upon the regulatory acceptance of the IND in January 2006 and the full amortization of the remaining balance of the Serono upfront payment due to the completion of all deliverables under the contract. As of June 30, 2006, no amounts relating to Serono were remaining to be amortized in future periods, therefore, future revenue from Serono in 2006, if any, will only include potential milestone payments. Research support under the Daiichi collaboration ended in August 2005. We have deferred approximately $922,000 of research reimbursement revenue from Merck in order to only account for the headcount effort expended by us for the time period invoiced, which covers the period from the initiation of the collaboration through June 30, 2006. We expect this amount will be recognized as revenue no later than at the end of the research phase of the collaboration, which is scheduled to be in May 2007. We expect contract revenues from collaborations to be a significant component of our total revenues for the foreseeable future.

Research and Development Expenses

The decrease in research and development expenses of $602,000 for the three months ended June 30, 2006, compared to the similar period in 2005, was primarily attributable to a decrease in preclinical and clinical costs, offset by an increase in stock-based compensation expense upon the adoption of SFAS 123(R) as previously discussed under “Stock-based Compensation” in the “Critical Accounting Policies and the Use of Estimates” section. Preclinical and clinical costs decreased in the three months ended June 30, 2006, compared to the similar period in 2005, due to the termination of R112 and R803 programs in 2005 and the transfer of sponsorship relating to R763 to Serono in 2006. The increase in research and development expenses of approximately $2.9 million for the six months ended June 30, 2006 compared to the similar period in 2005 was primarily due to an increase in stock-based compensation expense upon adoption of SFAS 123(R), offset by a decrease in preclinical and clinical costs. The decrease in preclinical and clinical costs in the six months ended June 30, 2006 compared to the same period in 2005 was primarily attributable to the decrease in costs relating to our R112, R803 and R763 programs as discussed above, offset by increased costs relating to our R788 program. We expect that our research and development expenses will increase through the second half of 2006 as we initiate our Phase II trial of R788 for RA.

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

General and Administrative Expenses

The increases in general and administrative expenses of approximately $1.3 million and $3.4 million for the three and six months ended June 30, 2006 compared to the similar periods in 2005 is primarily attributable to an increase in stock-based compensation expense upon the adoption of SFAS 123(R) as previously discussed under “Stock-based Compensation” in the “Critical Accounting Policies and the Use of Estimates” section.

18

Interest Income

Interest income results from our interest-bearing cash and investment balances. The increase in the three and six months ended June 30, 2006 compared to the similar periods in 2005 is attributable to an increase in our overall investment balances as a result of the public offering we completed in July 2005 in which we raised $81.6 million in net proceeds, combined with an increase in the rate of interest we earned on the balances.

Interest Expense