10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarter Ended June 30, 2011

Commission File No. 000-21429

ArQule, Inc.

(Exact Name of Registrant as Specified in its Charter)

Delaware	04-3221586
(State of Incorporation)	(I.R.S. Employer Identification Number)

19 Presidential Way, Woburn, Massachusetts 01801

(Address of Principal Executive Offices)

(781) 994-0300

(Registrant’s Telephone Number, including Area Code)

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 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 x  No o

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

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

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

Number of shares outstanding of the registrant’s Common Stock as of July 27, 2011:

Common Stock, par value $.01     53,727,220 shares outstanding

ARQULE, INC.

QUARTER ENDED JUNE 30, 2011

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
Item 1. — Unaudited Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets (Unaudited) June 30, 2011 and December 31, 2010	3
	Condensed Consolidated Statements of Operations (Unaudited) three and six months ended June 30, 2011 and 2010	4
	Condensed Consolidated Statements of Cash Flows (Unaudited) six months ended June 30, 2011 and 2010	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2. — Management’s Discussion and Analysis of Financial Condition and Results of Operations		15
Item 3. — Quantitative and Qualitative Disclosures about Market Risk		24
Item 4. — Controls and Procedures		24
PART II - OTHER INFORMATION
Item 1. — Legal Proceedings		25
Item 1A. — Risk Factors		25
Item 2. — Unregistered Sales of Equity Securities and Use Of Proceeds		25
Item 3. — Defaults Upon Senior Securities		25
Item 4. — (Removed and Reserved)		25
Item 5. — Other Information		25
Item 6. — Exhibits		25
SIGNATURES		26

2

ARQULE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

	June 30, 2011			December 31, 2010
	(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
Current assets:
Cash and cash equivalents	$	27,844		$	20,457
Marketable securities-short term		56,246			60,238
Prepaid expenses and other current assets		5,616			1,119
Total current assets		89,706			81,814
Marketable securities-long term		43,158			2,154
Property and equipment, net		3,243			3,517
Other assets		1,405			1,381
Total assets	$	137,512		$	88,866
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses	$	26,198		$	16,836
Note payable		1,700			1,700
Current portion of deferred revenue		33,170			27,825
Current portion of deferred gain on sale leaseback		552			552
Total current liabilities		61,620			46,913
Deferred revenue, net of current portion		48,179			54,627
Deferred gain on sale leaseback, net of current portion		1,611			1,888
Total liabilities		111,410			103,428
Commitments and contingencies
Stockholders’ equity (deficit):
Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued or outstanding		—			—
Common stock, $0.01 par value; 100,000,000 shares authorized; 53,700,171 and 44,973,335 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively		537			450
Additional paid-in capital		436,496			383,713
Accumulated other comprehensive income (loss)		57			(7	)
Accumulated deficit		(410,988	)		(398,718	)
Total stockholders’ equity (deficit)		26,102			(14,562	)
Total liabilities and stockholders’ equity (deficit)	$	137,512		$	88,866

The accompanying notes are an integral part of these interim unaudited financial statements.

3

ARQULE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	THREE MONTHS ENDED June 30,						SIX MONTHS ENDED June 30,
	2011			2010			2011			2010
	(IN THOUSANDS, EXCEPT PER SHARE DATA)
Research and development revenue	$	5,447		$	7,106		$	18,852		$	13,431
Costs and expenses:
Research and development		12,836			12,318			24,229			24,762
General and administrative		3,552			3,526			7,095			6,855
Total costs and expenses		16,388			15,844			31,324			31,617
Loss from operations		(10,941	)		(8,738	)		(12,472	)		(18,186	)
Interest income		112			217			167			527
Interest expense		(6	)		(133	)		(12	)		(255	)
Other income (expense)		31			(123	)		47			(615	)
Loss before taxes		(10,804	)		(8,777	)		(12,270	)		(18,529	)
Income tax benefit		—			550			—			550
Net loss	$	(10,804	)	$	(8,227	)	$	(12,270	)	$	(17,979	)
Basic and diluted net loss per share:
Net loss per share	$	(0.20	)	$	(0.18	)	$	(0.24	)	$	(0.40	)
Weighted average basic and diluted common shares outstanding		53,255			44,517			51,961			44,461

The accompanying notes are an integral part of these interim unaudited financial statements.

4

ARQULE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	SIX MONTHS ENDED JUNE 30,
	2011			2010
	(IN THOUSANDS)
Cash flows from operating activities:
Net loss	$	(12,270	)	$	(17,979	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		598			744
Amortization of premium/discount on marketable securities		570			522
Amortization of deferred gain on sale leaseback		(277	)		(277	)
Non-cash stock compensation		2,301			1,906
Loss on auction rate securities put option		—			5,074
Gain on auction rate securities		(47	)		(4,459	)
Changes in operating assets and liabilities:
Prepaid expenses and other current assets		(4,497	)		993
Other long-term assets		(24	)		(5	)
Accounts payable and accrued expenses		9,362			2,107
Deferred revenue		(1,103	)		(9,622	)
Net cash used in operating activities		(5,387	)		(20,996	)
Cash flows from investing activities:
Purchases of marketable securities		(95,131	)		(36,821	)
Proceeds from sale or maturity of marketable securities		57,660			76,998
Purchases of property and equipment		(324	)		(144	)
Net cash provided by (used in) investing activities		(37,795	)		40,033
Cash flows from financing activities:
Payment of notes payable		—			(29,900	)
Proceeds from stock offering, net		46,761			—
Proceeds from stock option exercises		3,808			460
Net cash provided by (used in) financing activities		50,569			(29,440	)
Net increase (decrease) in cash and cash equivalents		7,387			(10,403	)
Cash and cash equivalents, beginning of period		20,457			36,551
Cash and cash equivalents, end of period	$	27,844		$	26,148

The accompanying notes are an integral part of these interim unaudited financial statements.

5

ARQULE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION

We are a clinical-stage biotechnology company organized as a Delaware corporation in 1993 and engaged in the research and development of innovative cancer therapeutics. Our mission is to produce novel medicines with differentiated mechanisms of action that target specific biological pathways implicated in a wide range of cancers.

Our lead product candidate is tivantinib (ARQ 197), an orally administered, small molecule inhibitor of the c-Met receptor tyrosine kinase that is currently being evaluated in Phase 2 and Phase 3 clinical trials in a number of indications. In January 2011, we enrolled the first patient in the Phase 3 trial of tivantinib in non-small cell lung cancer (“NSCLC”) in combination with erlotinib, and in February 2011, we received a $25 million payment from Daiichi Sankyo Co., Ltd. (“Daiichi Sankyo”) resulting from the achievement of this clinical milestone. We have licensed commercial rights to tivantinib for human cancer indications to Daiichi Sankyo in the U.S., Europe, South America and the rest of the world, excluding Japan and certain other Asian countries, where we have licensed commercial rights to Kyowa Hakko Kirin Co., Ltd. (“Kyowa Hakko Kirin”).  We expect that Kyowa Hakko Kirin will independently initiate the recruitment of a Phase 3 trial in Asia of tivantinib and erlotinib in non-squamous NSCLC patients with wild type EGFR in the near future.
 

Our proprietary pipeline is directed toward molecular targets and biological processes with demonstrated roles in the development of human cancers. The most advanced candidates in this pipeline are ARQ 621, an inhibitor of the Eg5 kinesin motor protein, and ARQ 736, an inhibitor of the RAF kinases, both of which are in Phase 1 clinical testing. A third pipeline program, focused on small molecule inhibitors of fibroblast growth factor receptor, is in pre-clinical development. Our drug discovery efforts are focused primarily on the ArQule Kinase Inhibitor Platform (“AKIP™”), which we are using to generate compounds designed to inhibit kinases without competing with adenosine triphosphate (“ATP”) for binding to the target kinase, as well as other types of kinase inhibitors. We have assessed the potential of AKIP™ to target multiple kinases in oncology and other therapeutic areas, and we are generating and validating compounds that inhibit these kinase targets.

We have prepared the accompanying condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to these rules and regulations.  These condensed consolidated financial statements should be read in conjunction with our audited financial statements and footnotes related thereto for the year ended December 31, 2010 included in our annual report on Form 10-K filed with the SEC on March 2, 2011.

The unaudited condensed consolidated financial statements include, in our opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of our financial position as of June 30, 2011, the results of our operations for the three and six months ended June 30, 2011and June 30, 2010, and cash flows for the six months ended June 30, 2011 and June 30, 2010. The results of operations for such interim periods are not necessarily indicative of the results to be achieved for the full year.

2. COLLABORATIONS AND ALLIANCES

Daiichi Sankyo Kinase Inhibitor Discovery Agreement

On November 7, 2008, we entered into a research collaboration, exclusive license and co-commercialization agreement with Daiichi Sankyo under which we are applying our proprietary technology and know-how using our AKIP™ technology for the discovery of therapeutic compounds that selectively inhibit certain kinases in the field of oncology. The agreement defines two such kinase targets, and Daiichi Sankyo will have an option to license compounds directed to these targets following the completion of certain pre-clinical studies. The agreement provides for a $15 million upfront payment, which we received in November 2008, research support payments for the first and second years of the collaboration, licensing fees for compounds discovered as a result of this research, milestone payments related to clinical development, regulatory review and sales, and royalty payments on net sales of compounds from the collaboration. We retain the option to co-commercialize licensed products developed under this agreement in the U.S. In May 2009, we entered into an agreement with Daiichi Sankyo related to potential future milestones and royalties for our AKIP™ collaboration, under which we could receive up to $265 million in potential development and sales milestone payments for each product selected for clinical development. Upon commercialization of a licensed product, we would also receive tiered, double-digit royalties on its net sales. On October 12, 2010, we and Daiichi Sankyo announced the expansion of this agreement, establishing a third target, with an option for a fourth, in oncology, and including a two-year extension through November 2012.

6

The duration and termination of the agreement are tied to future events. Unless earlier terminated due to breach, insolvency or upon 90 days notice by Daiichi Sankyo, the agreement terminates on the later of (i) the expiration of the research collaboration period, or (ii) various periods specified in the agreement for development and commercialization of products. If Daiichi Sankyo has commercialized a licensed product or products, the agreement will continue in force until such time as all royalty terms for all licensed products have ended. The royalty term, on a country-by-country basis for a product, ends as of the later of (i) the expiration of the last valid claim under a patent covering the manufacture, use, or sale of a licensed product or (ii) a certain number of years from the date of the commercial sale of the licensed product in such country.

Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated performance period through November 2012. For the three and six months ended June 30, 2011 and 2010, $3.2 million and $5.6 million, and $2.8 million and $5.3 million, respectively were recognized as revenue. At June 30, 2011, $13.2 million remains in deferred revenue.

Daiichi Sankyo Tivantinib Agreement

On December 18, 2008, we entered into a license, co-development and co-commercialization agreement with Daiichi Sankyo to conduct research, clinical trials and the commercialization of tivantinib in human cancer indications in the U.S., Europe, South America and the rest of the world, excluding Japan, China (including Hong Kong), South Korea and Taiwan, where Kyowa Hakko Kirin has exclusive rights for development and commercialization.

The agreement provides for a $60 million cash upfront licensing payment from Daiichi Sankyo to us, which we received in December 2008, and an additional $560 million in potential development and sales milestone payments. Upon commercialization, we will receive tiered, double-digit royalties from Daiichi Sankyo on net sales of tivantinib commensurate with the magnitude of the transaction. We retain the option to participate in the commercialization of tivantinib in the U.S. We and Daiichi Sankyo will share equally the costs of Phase 2 and Phase 3 clinical studies, with our share of Phase 3 costs payable solely from milestone and royalty payments by Daiichi Sankyo.

In each quarter the tivantinib collaboration costs that we incur are compared with those of Daiichi Sankyo. If our costs for the quarter exceed Daiichi Sankyo’s, we recognize revenue on the amounts due to us under the contingency adjusted performance model. Revenue is calculated on a pro-rata basis using the time elapsed from inception of the agreement over the estimated duration of the development period under the agreement. If our costs for the quarter are less than those of Daiichi Sankyo’s, we report the amount due to Daiichi Sankyo as contra-revenue in that quarter. For the three and six months ended June 30, 2011 and 2010 our tivantinib collaboration costs incurred were less than those of Daiichi Sankyo’s by $3.7 million and  $8.7 million, and $0.1 million and $0.8 million, respectively.  Accordingly those amounts were recognized as contra-revenue and were netted against our tivantinib Daiichi Sankyo research and development revenue. For the three and six month’s ended June 30, 2011 our  non-refundable share of advance drug purchases for the tivantinib trial was $4.8 million.  These costs will be recognized as contra-revenue as the related drugs are administered to patients.  For the three and six month’s ended June 30, 2011 $0.3 million was recognized as contra-revenue and at June 30, 2011 $4.5 million remains deferred and is reported in prepaid and other assets.

The dosing of the first patient in a Phase 3 clinical trial of tivantinib in NSCLC, announced in January 2011, triggered the payment of a $25 million development milestone from Daiichi Sankyo that was received in February 2011. We determined that the milestone is not considered substantive under FASB guidance related to multiple element arrangements. Accordingly, the milestone payment was recorded as deferred revenue and is being recognized as revenue using the contingency-adjusted performance model with an estimated development period through December 2013. For the three and six months ended June 30, 2011, $1.3 million and $12.7 million, respectively was recognized as revenue from the milestone.

The duration and termination of the agreement are tied to future events. Unless earlier terminated due to breach, insolvency or upon 90 days notice if prior to phase 3 clinical trials or 180 days notice if on or after the beginning of phase 3 clinical trials by Daiichi Sankyo, the agreement shall continue until the later of (i) such time as Daiichi Sankyo is no longer developing at least one licensed product or (ii) if Daiichi Sankyo has commercialized a licensed product or products, such time as all royalty terms for all licensed products have ended. The royalty term, on a country-by-country basis for a product, ends as of the later of (i) the expiration of the last valid claim under a patent covering the manufacture, use, or sale of a licensed product or (ii) a certain number of years from the date of the commercial sale of the licensed product in such country.

Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated development period through December 2013. For the three and six months ended June 30, 2011 and 2010, $1.0 million and $10.9 million, and $3.4 million and $6.2 million, respectively were recognized as net revenue. At June 30, 2011, $46.4 million remains in deferred revenue.

7

Kyowa Hakko Kirin Licensing Agreement

On April 27, 2007, we entered into an exclusive license agreement with Kyowa Hakko Kirin to develop and commercialize tivantinib in Japan and parts of Asia. A $3 million portion of an upfront licensing fee was received by the Company under this agreement in the first quarter of 2007, and an additional $27 million in upfront licensing fees was received on May 7, 2007. The agreement includes $123 million in upfront and potential development milestone payments from Kyowa Hakko Kirin to ArQule, including the $30 million cash upfront licensing payments. In February 2008, we received a $3 million milestone payment from Kyowa Hakko Kirin. Upon commercialization, ArQule will receive tiered royalties in the mid-teen to low-twenty percent range from Kyowa Hakko Kirin on net sales of tivantinib. Kyowa Hakko Kirin will be responsible for all clinical development costs and commercialization of the compound in certain Asian countries, consisting of Japan, China (including Hong Kong), South Korea and Taiwan. In July 2010, we announced the initiation of a Phase 2 trial with tivantinib by Kyowa Hakko Kirin in gastric cancer, for which we received a $5 million milestone payment in September 2010. The milestone payment was recorded as deferred revenue and is being recognized as revenue using the contingency-adjusted performance model with an estimated development period through April 2016. We expect that Kyowa Hakko Kirin will independently initiate the recruitment of a Phase 3 trial in Asia of tivantinib and erlotinib in non-squamous NSCLC patients with wild type EGFR in the near future.

In addition to the upfront and possible regulatory milestone payments totaling $123 million, the Company will be eligible for future milestone payments based on the achievement of certain levels of net sales. The Company will recognize the payments, if any, as revenue in accordance with its revenue recognition policies. As of June 30, 2011, the Company had not recognized any revenue from these sales milestone payments, and there can be no assurance that it will do so in the future.

The duration and termination of the agreement are tied to future events. Unless earlier terminated due to breach, insolvency or upon 90 days notice by Kyowa Hakko Kirin, the agreement terminates on the date that the last royalty term expires in all countries in the territory. The royalty term ends as of the later of (i) the expiration of the last pending patent application or expiration of the patent in the country covering the manufacture, use, or sale of a licensed product or (ii) a certain number of years from the date of the commercial launch in such country of such license product.

Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated development period through April 2016. For the three and six months ended June 30, 2011 and 2010 $1.2 million and $2.3 million, and $1.0 million and $1.9 million, respectively were recognized as revenue. At June 30, 2011 $21.8 million remains in deferred revenue.

3. MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS

We generally classify our marketable securities as available-for-sale at the time of purchase and re-evaluate such designation as of each consolidated balance sheet date. Since we generally intend to convert them into cash as necessary to meet our liquidity requirements our marketable securities are classified as cash equivalents if the original maturity, from the date of purchase, is ninety days or less and as short-term investments if the original maturity, from the date of purchase, is in excess of ninety days but less than one year. Our marketable securities are classified as long-term investments if the maturity date is in excess of one year of the balance sheet date.

We report available-for-sale investments at fair value as of each balance sheet date and include any unrealized gains and, to the extent deemed temporary, unrealized losses in stockholders’ equity. Realized gains and losses are determined using the specific identification method and are included in other income (expense) in the statement of operations. Certain of our marketable securities are classified as trading securities and any changes in the fair value of those securities are recorded as other income (expense) in the statement of operations.

We conduct quarterly reviews to determine the fair value of our investment portfolio and to identify and evaluate each investment that has an unrealized loss, in accordance with the meaning of other-than-temporary impairment and its application to certain investments. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. In the event that the cost basis of a security exceeds its fair value, we evaluate, among other factors, the duration of the period that, and extent to which, the fair value is less than cost basis, the financial health of and business outlook for the issuer, including industry and sector performance, and operational and financing cash flow factors, overall market conditions and trends, our intent to sell the investment and if it is more likely than not that we would be required to sell the investment before its anticipated recovery. Unrealized losses on available-for-sale securities that are determined to be temporary, and not related to credit loss, are recorded in accumulated other comprehensive income (loss).

For available-for-sale debt securities with unrealized losses, we perform an analysis to assess whether we intend to sell or whether we would more likely than not be required to sell the security before the expected recovery of the amortized cost basis. Where we intend to sell a security, or may be required to do so, the security’s decline in fair value is deemed to be other-than-temporary and the full amount of the unrealized loss is reflected in the consolidated statement of operations as an impairment loss.

8

Regardless of our intent to sell a security, we perform additional analysis on all securities with unrealized losses to evaluate losses associated with the creditworthiness of the security. Credit losses are identified where we do not expect to receive cash flows sufficient to recover the amortized cost basis of a security.

We invest our available cash primarily in U.S. Treasury bill funds, money market funds, commercial paper, and U.S. federal and state agency backed certificates, including auction rate securities that have investment grade ratings. Auction rate securities are structured with short-term interest reset dates of generally less than 90 days, but with contractual maturities that can be well in excess of ten years. At the end of each reset period, which occurs every seven to twenty-eight days, investors can sell or continue to hold the securities at par value. If auction rate securities fail an auction, due to sell orders exceeding buy orders, the funds associated with a failed auction would not be accessible until a successful auction occurred, a buyer was found outside the auction process, the underlying securities matured or a settlement with the underwriter is reached.  ArQule’s marketable securities portfolio includes auction rate securities of $2.3 million (at cost) at June 30, 2011 and $2.6 million (at cost) at December 31, 2010. These auction rate securities failed at auction due to sell orders exceeding buy orders.

The following is a summary of the fair value of available-for-sale marketable securities we held at June 30, 2011 and December 31, 2010:

June 30, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
U.S. Federal Treasury and U.S. government agencies securities-short term	$	8,680	$	4	$	—		$	8,684
Corporate debt securities-short term		47,546		24		(8	)		47,562
		56,226		28		(8	)		56,246
U.S. Federal Treasury and U.S. government agencies securities -long term		41,217		37		—			41,254
Total available-for-sale marketable securities	$	97,443	$	65	$	(8	)	$	97,500

December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
U.S. Federal Treasury and U.S. government agencies securities	$	12,184	$	2	$	(1	)	$	12,185
Corporate debt securities-short term		48,061		12		(20	)		48,053
Total available-for-sale marketable securities	$	60,245	$	14	$	(21	)	$	60,238

The Company’s available-for-sale marketable securities in a loss position at June 30, 2011 and December 31, 2010 were in a continuous unrealized loss position for less than 12 months.

The following is a summary of the fair value of trading securities we held at June 30, 2011 and December 31, 2010:

June 30, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
Auction rate securities	$	2,300	$	—	$	(396	)	$	1,904
Total trading securities	$	2,300	$	—	$	(396	)	$	1,904

December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
Auction rate securities	$	2,600	$	—	$	(446	)	$	2,154
Total trading securities	$	2,600	$	—	$	(446	)	$	2,154

9

The underlying collateral of our auction rate securities consists of student loans, supported by the federal government as part of the Federal Family Education Loan Program (FFELP).

At June 30, 2011 and December 31, 2010, the Company’s auction rate securities are included in marketable securities-long term and total $1,904 and $2,154, respectively. The net increase in fair value of our auction rate securities of $31 and $47 in the three and six months ended June 30, 2011, respectively was recorded as a gain in other income (expense) in the statement of operations.

In January 2011, we adopted a newly issued accounting standard which requires additional disclosure about the amounts of and reasons for significant transfers in and out of Level 1 and Level 2 fair value measurements. This standard also clarified existing disclosure requirements related to the level of disaggregation of fair value measurements for each class of assets and liabilities and requires disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring Level 2 and Level 3 measurements. In addition, effective for interim and annual periods beginning after December 15, 2010, this standard further requires an entity to present disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. As this accounting standard only requires enhanced disclosure, the adoption of this standard did not impact our financial position or results of operations and will not affect them in the future.

The following tables present information about our assets that are measured at fair value on a recurring basis for the periods presented and indicates the fair value hierarchy of the valuation techniques we utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. We value our level 2 investments using quoted prices for identical assets in the markets where they are traded, although such trades may not occur daily. These quoted prices are based on observable inputs, primarily interest rates. Fair values determined by Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. There were no transfers in or out of Level 1 or Level 2 measurements for the periods presented:

	June 30, 2011		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	23,133	$	23,133	$	—	$	—
Marketable securities—short term		56,246		—		56,246		—
Marketable securities—long term		43,158		—		41,254		1,904
Total	$	122,537	$	23,133	$	97,500	$	1,904

	December 31, 2010		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	16,871	$	16,871	$	—	$	—
Marketable securities—short term		60,238		—		60,238		—
Marketable securities—long term		2,154		—		—		2,154
Total	$	79,263	$	16,871	$	60,238	$	2,154

Due to the lack of market quotes relating to our auction rate securities, the fair value measurements for our auction rate securities have been estimated using an income approach model (discounted cash flow analysis), which is exclusively based on Level 3 inputs. The model considers factors that reflect assumptions market participants would use in pricing including, among others, the collateralization underlying the investments, the creditworthiness of the counterparty, the expected future cash flows, liquidity premiums, the probability of successful auctions in the future, and interest rates. The assumptions used are subject to volatility and may change as the underlying sources of these assumptions and markets conditions change.

Due to the lack of market quotes relating to our auction rate put option, the fair value measurements for our put option at June 30, 2010 were estimated using a valuation approach commonly used for forward contracts in which one party agrees to sell a financial instrument (generating cash flows) to another party at a particular time for a predetermined price, which is based on Level 3 inputs. In this approach the present value of all expected future cash flows is subtracted from the current fair value of the security, and the resulting value is calculated as a future value at an interest rate reflective of counterparty risk. On June 30, 2010, the company exercised the auction rate put option and in July 2010, UBS AG redeemed at par value all of the Company’s auction rate securities held by UBS AG that were outstanding at June 30, 2010.

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The following tables roll forward the fair value of our auction rate securities and put option, whose fair values are determined by Level 3 inputs for the periods presented:

	Amount
Balance at December 31, 2010	$	2,154
Gain on auction rate securities	47
Settlements	(297)
Balance at June 30, 2011	$	1,904

	Amount
Balance at March 31, 2011	$	2,072
Gain on auction rate securities	31
Settlements	(199		)
Balance at June 30, 2011	$	1,904

	Amount
Balance at December 31, 2009	$	59,791
Loss on auction rate securities and put option	(615		)
Settlements	(33,850		)
Balance at June 30, 2010	$	25,326

	Amount
Balance at March 31, 2010	$	53,074
Loss on auction rate securities and put option	(123		)
Settlements	(27,625		)
Balance at June 30, 2010	$	25,326

4.    COMPREHENSIVE LOSS

Comprehensive loss is comprised of net loss and other comprehensive gain (loss). Other comprehensive income (loss) includes unrealized losses on our available-for-sale securities that are excluded from net loss. Total comprehensive loss for the three and six months ended June 30, 2011 and 2010 was as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Net loss	$	(10,804	)	$	(8,227	)	$	(12,270	)	$	(17,979	)
Unrealized gain (loss) on marketable securities		101			(7	)		64			(36	)
Comprehensive loss	$	(10,703	)	$	(8,234	)	$	(12,206	)	$	(18,015	)

5.    ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses include the following at June 30, 2011 and December 31, 2010:

	June 30, 2011		December 31, 2010
Accounts payable	$	454	$	1,260
Accrued payroll		2,116		3,450
Accrued outsourced pre-clinical and clinical fees		21,960		10,375
Accrued professional fees		690		785
Other accrued expenses		978		966
	$	26,198	$	16,836

Accrued outsourced pre-clinical and clinical fees include amounts payable for our share of tivantinib collaboration costs that are netted against revenue as contra-revenue.

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6.    NET LOSS PER SHARE

Net loss per share is computed using the weighted average number of common shares outstanding. Basic and diluted net loss per share amounts are equivalent for the periods presented as the inclusion of potential common shares in the number of shares used for the diluted computation would be anti-dilutive to loss per share. Unvested restricted stock, although legally issued and outstanding, are not considered outstanding for purposes of calculating basic net income per share. The weighted average number of common shares outstanding excludes 206,653 and 334,214 unvested shares of restricted stock for the three and six months ended June 30, 2011 and 2010, respectively and 390,000 performance-based stock units for the three and six months ended June 30, 2011.  There were no performance-based stock units outstanding at June 30, 2010. Potential common shares, the shares that would be issued upon the exercise of outstanding stock options, were 6,965,518 and 6,238,332 for the three and six months ended June 30, 2011 and 2010, respectively.

7.    STOCK-BASED COMPENSATION AND STOCK PLANS

Our  stock-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employees’ requisite service period (generally the vesting period of the equity grant). We estimate the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price of the award, expected option term, expected volatility of our stock over the option’s expected term, risk-free interest rate over the option’s expected term, and the expected annual dividend yield. We believe that the valuation technique and approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock options granted in the three and six months ended June 30, 2011 and 2010.

The following table presents stock-based compensation expense included in our Condensed Consolidated Statements of Operations:

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Research and development	$	394	$	308	$	831	$	664
General and administrative		815		732		1,470		1,242
Total stock-based compensation expense	$	1,209	$	1,040	$	2,301	$	1,906

In the three and six months ended June 30, 2011 and 2010, no stock-based compensation expense was capitalized and there were no recognized tax benefits associated with the stock-based compensation expense.

Option activity under our stock plans for the six months ended June 30, 2011 was as follows:

Stock Options	Number of Shares			Weighted Average Exercise Price
Outstanding as of December 31, 2010		6,355,827		$	5.29
Granted		1,658,950			6.71
Exercised		(670,796	)		5.50
Cancelled		(378,463	)		9.77
Outstanding as of June 30, 2011		6,965,518			5.37
Exercisable as of June 30, 2011		4,015,734		$	5.45

The aggregate intrinsic value of options outstanding at June 30, 2011 was $8,015, of which $4,366 related to exercisable options. The weighted average fair value of options granted in the six months ended June 30, 2011 and 2010 was $4.00 and $2.18 per share, respectively. The intrinsic value of options exercised in the six months ended June 30, 2011 and 2010 was $897 and $175, respectively.

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Shares vested, expected to vest and exercisable at June 30, 2011 are as follows:

	Shares		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Vested and unvested expected to vest at June 30, 2011		6,818,903	$	5.37		7.1	$	13,671
Exercisable at June 30, 2011		4,015,734	$	5.45		5.7	$	4,366

The total compensation cost not yet recognized as of June 30, 2011 related to non-vested option awards was $7.9 million, which will be recognized over a weighted-average period of 2.9 years. During the six months ended June 30, 2011, there were 118,113 shares forfeited with a weighted average grant date fair value of $3.21 per share. The weighted average remaining contractual life for options exercisable at June 30, 2011 was 5.7 years.

No restricted stock was granted in 2010. In 2009, we granted 412,200 shares of restricted stock to employees, vesting annually over a four year period. In 2008 we granted 103,316 shares of restricted stock to employees, vesting annually over a four year period and 125,000 shares vesting annually over a two year period. The shares of restricted stock were issued at no cost to the recipients. The weighted average fair value of the restricted stock at the time of grant in 2009 and 2008 was $3.54 and $4.31 respectively, per share, and is being expensed ratably over the vesting period. Through June 30, 2011, 50,271 shares have been forfeited, and 383,592 shares have vested. We recognized share-based compensation expense related to restricted stock of $186 and $214 for the six months ended June 30, 2011 and 2010, respectively.

Restricted stock activity under the Plan for the six months ended June 30, 2011 was as follows:

Restricted Stock	Number of Shares			Weighted Average Grant Date Fair Value
Unvested as of December 31, 2010		333,314		$	3.68
Granted		—			—
Vested		(117,648	)		3.74
Cancelled		(9,013	)		3.80
Unvested as of June 30, 2011		206,653		$	3.64

The fair value of restricted stock vested in the six months ended June 30, 2011 and 2010 was $440 and $449, respectively.

In July 2010, the Company amended its chief executive officer’s (the “CEO’s”) employment agreement to grant the CEO 100,000 stock options, of which 25% vested upon grant and 25% vest annually over the following three years, and a maximum of 390,000 performance-based stock units that vest upon the achievement of certain performance and market based targets. Through June 30, 2011, no expense has been recorded for these performance-based stock units.

In June 2011 our stockholders voted to increase the number of common shares available for awards under our Amended and Restated 1994 Equity Incentive Plan by 3,000,000 from 12,500,000 to 15,500,000, to increase the number of common shares available for purchase by participants under our Amended and Restated 1996 Employee Stock Purchase Plan by 400,000 from 2,000,000 to 2,400,000, and to increase the number of common shares available for awards under our Amended and Restated 1996 Director Stock Option Plan by 200,000 from 750,500 to 950,500.

8.    STOCK OFFERING

On January 25, 2011, we sold 8,050,000 shares of common stock at $6.15 per share for aggregate net proceeds of approximately $46.8 million after commissions and other offering expenses.

9.    RECENT ACCOUNTING PRONOUNCEMENTS

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption.

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Recently Issued and Adopted Accounting Standards

In October 2009, the FASB issued an accounting standards update (“ASU”) on Multiple-Deliverable Revenue Arrangements. This standards update amends existing revenue recognition accounting pronouncements and provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. Among other provisions, this guidance eliminates the requirement to have objective evidence for undelivered products and services and instead provides for separate revenue recognition based upon management’s best estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. Previous accounting principles required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately. Revenue from our existing multiple-deliverable arrangements is recognized over the estimated development period using the contingency adjusted performance model. Under the new approach, revenue for new agreements or material modifications of existing agreements will be recognized based upon the relative selling price of each element in the arrangement. The Company adopted this guidance prospectively on January 1, 2011 and the adoption of this standard did not have a material impact on our financial position and results of operations; however, the new guidance will impact any new collaboration agreements or material modifications to any existing agreements.

In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition—Milestone Method”. This ASU provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. Under the milestone method of revenue recognition, consideration that is contingent upon achievement of a milestone in its entirety can be recognized as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. This standard provides the criteria to be met for a milestone to be considered substantive which includes that: a) performance consideration earned by achieving the milestone be commensurate with either performance to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from performance to achieve the milestone; and b) relate to past performance and be reasonable relative to all deliverables and payment terms in the arrangement. The Company adopted this guidance on a prospective basis for milestones on or after January 1, 2011 and the adoption of this standard did not have a material impact on our financial position and results of operations; however, the new guidance will impact any new collaboration agreements or material modifications to any existing agreements.

In January 2011, we adopted ASU No. 2010-06, ”Improving Disclosures About Fair Value Measurements” which requires additional disclosure about the amounts of and reasons for significant transfers in and out of Level 1 and Level 2 fair value measurements. In addition, effective for interim and annual periods beginning after December 15, 2010, which for us is January 1, 2011, this standard further requires an entity to present disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. As this accounting standard only requires enhanced disclosure, the adoption of this newly issued accounting standard did not impact our financial position or results of operations.

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011, which for us is January 1, 2012. We do not expect that adoption of this standard will have a material impact on our financial position or results of operations.

In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220)”. This newly issued accounting standard (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented. This ASU is required to be applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011, which for us is January 1, 2012. As this accounting standard only requires enhanced disclosure, the adoption of this standard will not impact our financial position or results of operations.

10.    INCOME TAXES

The Company recorded a $0.6 million income tax benefit in the quarter ended June 30, 2010 attributable to an election it made in the second quarter of 2010 under revised legislation that allowed net operating losses to offset 100% of alternative minimum tax (“AMT”).  Prior to this legislation, only 90% of AMT could be offset by net operating losses.  The Company received a refund in July 2010 of the $0.6 million AMT paid in 2009.

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As of December 31, 2010, we had federal net operating loss (“NOL”), state NOL, and research and development credit carryforwards of approximately $219,187, $159,727 and $22,816 respectively, which can be used to offset future federal and state income tax liabilities and expire at various dates through 2030. Federal net capital loss carryforwards of approximately $571 can be used to offset future federal capital gains and expire in 2015. Approximately $15,004 of our federal NOL and $1,568 of our state NOL were generated from excess tax deductions from share- based awards, the tax benefit of which will be credited to additional paid-in-capital when the deductions reduce current taxes payable.

At June 30, 2011, and December 31, 2010 we had no unrecognized tax benefits. We do not expect that the total amount of unrecognized tax benefits will significantly increase in the next twelve months. We recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2011 and December 31, 2010, we had no accrued interest or penalties related to uncertain tax positions. The tax years 2007 through 2010 remain open to examination by the major taxing jurisdictions to which we are subject, which is primarily the U.S. Prior tax years remain open to the extent of net operating loss and tax credit carryforwards.

Utilization of NOL and research and development credit carryforwards may be subject to a substantial annual limitation in the event of an ownership change that has occurred previously or could occur in the future pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, as well as similar state provisions. An ownership change may limit the amount of NOL and research and development credit carryforwards that can be utilized annually to offset future taxable income and tax, and may, in turn, result in the expiration of a portion of those carryforwards before utilization. In general, an ownership change, as defined by Section 382, results from transactions that increase the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three year period. We undertook a detailed study of our NOL and research and development credit carryforwards in the fourth quarter of 2009 to determine whether such amounts are likely to be limited by Section 382. As a result of this analysis, and a detailed review of ownership changes through 2010, we currently do not believe Sections 382’s limitations will significantly impact our ability to offset income with available NOL and research and development credit carryforwards. However, future ownership changes under Section 382 may limit our ability to fully utilize these tax benefits.

11.    NOTES PAYABLE

On July 8, 2008, we entered into a collateralized, revolving credit line agreement for up to $47.5 million with UBS Bank USA, secured by a first priority lien and security interest in the auction rate securities held by us in an account with UBS Financial Services Inc. On June 30, 2010, the company exercised its UBS auction rate put option and in July 2010, UBS AG redeemed at par value all of the Company’s auction rate securities held by them that were outstanding at June 30, 2010. The Company used a portion of the 2010 redemptions to retire the notes payable to UBS AG and the credit line at UBS AG was cancelled in July 2010.

In October 2008, we entered into a margin loan agreement with another financial institution collateralized by $2.9 million of our auction rate securities and borrowed $1.7 million which is the maximum amount allowed under this facility. The amount outstanding under this facility of $1.7 million at June 30, 2011 is due on demand and is collateralized by $2.3 million of auction rate securities.

Interest expense was $6 and $12 for the three and six months ended June 30, 2011, respectively.  Interest expense was $133 and $255 for the three and six months ended June 30, 2010, respectively.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We are a clinical-stage biotechnology company engaged in the research and development of innovative cancer therapeutics. Our mission is to produce novel medicines with differentiated mechanisms of action that target specific biological pathways implicated in a wide range of cancers. We employ novel technologies such as our ArQule Kinase Inhibitor Platform (“AKIP™”) to design and develop drugs that have the potential to fulfill this mission.

Our products and programs span a continuum of research and development ranging from drug discovery to advanced clinical testing. They are based on our understanding of biological processes that lead to the proliferation and metastasis of cancer cells, combined with our ability to generate product candidates possessing certain pre-selected, drug-like properties. We believe that these qualities, when present from the earliest stages of product development, increase the likelihood of producing safe, effective and marketable drugs.

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Our lead product candidate is tivantinib (ARQ 197), an orally administered, small molecule inhibitor of the c-Met receptor tyrosine kinase (“c-Met”) which recently was assigned the non-proprietary generic name, tivantinib. c-Met is a promising target for cancer therapy, based on its multiple roles in cancerous cell proliferation, tumor spread, new blood vessel formation and resistance to certain drug therapies. We and our partners, Daiichi Sankyo Co., Ltd. (“Daiichi Sankyo”) and Kyowa Hakko Kirin Co., Ltd., (“Kyowa Hakko Kirin”) are implementing a clinical development program designed to realize the broad potential of tivantinib as a well tolerated single agent and in combination with other anti-cancer therapies in a number of disease indications. These include non-small cell lung cancer (“NSCLC”) (our most advanced indication), liver cancer, colorectal cancer and gastric cancer. We are also completing earlier-stage combination therapy trials with tivantinib and other anti-cancer agents that may provide data to support later-stage trials in additional indications.

In January 2011, we enrolled the first patient in the Phase 3 trial of tivantinib in NSCLC in combination with erlotinib, an approved anti-cancer agent, and in February 2011, we received a $25 million payment from Daiichi Sankyo resulting from the achievement of this clinical milestone. The Phase 3 trial is a randomized, double-blinded, controlled study of previously treated patients with locally advanced or metastatic, non-squamous, NSCLC who will receive tivantinib plus erlotinib or placebo plus erlotinib. This trial is being conducted under a Special Protocol Assessment (“SPA”) agreement with the U.S. Food and Drug Administration (“FDA”).

We have incorporated into the SPA a broad genotyping and biomarker program designed to expand what is an evolving understanding of the biology of c-Met and of tivantinib.  In addition, we continue to investigate and add to our understanding of the profile of tivantinib and its metabolites to better characterize their scope and effect as anti-cancer agents.  These efforts include the generation and interpretation of clinical and pre-clinical data that may suggest potential anti-cancer activity in addition to c-Met inhibition.  These findings taken together may help to define additional clinical settings and patient populations for tivantinib.

In July 2011, we initiated patient recruitment in a randomized, open-label Phase 2 trial of previously treated patients with locally advanced or metastatic NSCLC patients with KRAS mutations who will receive tivantinib plus erlotinib or chemotherapy.  The primary objective of this trial is to evaluate progression-free survival in the intent-to-treat population. In addition, we expect that Kyowa Hakko Kirin will independently initiate the recruitment of a Phase 3 trial in Asia of tivantinib and erlotinib in non-squamous NSCLC patients with wild type EGFR in the near future.

We have licensed commercial rights to tivantinib for human cancer indications to Daiichi Sankyo in the U.S., Europe, South America and the rest of the world, excluding Japan and certain other Asian countries, where we have licensed commercial rights to Kyowa Hakko Kirin. Our agreements with these partners provide for possible future milestone payments, royalties on product sales, and development funding, in addition to significant payments that we have already received.

Our proprietary pipeline is directed toward molecular targets and biological processes with demonstrated roles in the development of human cancers. The most advanced candidates in this pipeline are ARQ 621, an inhibitor of the Eg5 kinesin motor protein, and ARQ 736, an inhibitor of the RAF kinases, both of which are in Phase 1 clinical testing. A third pipeline program, focused on small molecule inhibitors of fibroblast growth factor receptor, is in pre-clinical development.

Our drug discovery efforts are focused primarily on AKIP™, which we are using to generate compounds designed to inhibit kinases without competing with adenosine triphosphate (“ATP”) for binding to the target kinase, as well as other types of kinase inhibitors. ATP is a chemical found in all living cells and is the energy source involved in a variety of physiological processes. We have assessed the potential of AKIP™ to target multiple kinases in oncology and other therapeutic areas, and we are generating and validating compounds that inhibit these kinases. We have incurred a cumulative deficit of $411 million at June 30, 2011. We expect research and development costs to increase during the course of 2011, due to clinical testing of our lead product candidates. We recorded a net loss for 2008, 2009, 2010 and expect to incur a net loss for 2011.

Our revenue consists almost exclusively of development funding from our alliances with Daiichi Sankyo and Kyowa Hakko Kirin. Revenue and expenses fluctuate from quarter to quarter based upon a number of factors, notably the timing and extent of our cancer-related research and development activities together with the length and outcome of our clinical trials.

On December 18, 2008, we entered into a license, co-development and co-commercialization agreement with Daiichi Sankyo to conduct research, clinical trials and commercialization of tivantinib in human cancer indications. The agreement provides for a $60 million cash upfront licensing payment from Daiichi Sankyo to us, which we received in December 2008, and an additional $560 million in potential development and sales milestone payments. Upon commercialization, we will receive tiered, double-digit royalties from Daiichi Sankyo on net sales of tivantinib commensurate with the magnitude of the transaction. We retain the option to participate in the commercialization of tivantinib in the U.S. We and Daiichi Sankyo will share equally the costs of Phase 2 and Phase 3 clinical studies, with our share of Phase 3 costs payable solely from milestone and royalty payments by Daiichi Sankyo.

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In each quarter the tivantinib collaboration costs that we incur are compared with those of Daiichi Sankyo. If our costs for the quarter exceed Daiichi Sankyo’s we recognize revenue on the amounts due to us under the contingency adjusted performance model. Revenue is calculated on a pro-rata basis using the time elapsed from inception of the agreement over the estimated duration of the development period under the agreement. If our costs for the quarter are less than those of Daiichi Sankyo’s, we report the amount due to Daiichi Sankyo as contra-revenue in that quarter. For the three and six months ended June 30, 2011 and 2010 our tivantinib collaboration costs incurred were less than those of Daiichi Sankyo’s by $3.7 million and  $8.7 million, and $0.1 million and $0.8 million, respectively.  Accordingly those amounts were recognized as contra-revenue and were netted against our tivantinib Daiichi Sankyo research and development revenue. For the three and six month’s ended June 30, 2011 our non-refundable share of advance drug purchases for the tivantinib trial was $4.8 million.  These costs will be recognized as contra-revenue as the related drugs are administered to patients.  For the three and six month’s ended June 30, 2011 $0.3 million was recognized as contra-revenue and at June 30, 2011 $4.5 million remains deferred and is reported in prepaid and other assets.

The dosing of the first patient in a Phase 3 clinical trial of tivantinib in NSCLC, announced in January 2011, triggered the payment of a $25 million development milestone from Daiichi Sankyo that was received in February 2011. Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated development period through December 2013.

On November 7, 2008, we entered into a research collaboration, exclusive license and co-commercialization agreement with Daiichi Sankyo under which we will apply our proprietary technology and know-how from our AKIP™ platform for the discovery of therapeutic compounds that selectively inhibit certain kinases. The agreement defines two such kinase targets, and Daiichi Sankyo will have an option to license compounds directed to these targets following the completion of certain pre-clinical studies. The agreement provides for a $15 million upfront payment, which we received in November 2008, research support payments for the first two years of the collaboration, licensing fees for compounds discovered as a result of this research, milestone payments related to clinical development, regulatory review and sales, and royalty payments on net sales of compounds from the collaboration. We retain the option to co-commercialize licensed products developed under this agreement in the U.S. In May 2009, we entered into an agreement with Daiichi Sankyo related to potential future milestones and royalties for our AKIP™ collaboration, under which we could receive up to $265 million in potential development and sales milestone payments for each product selected for clinical development. Upon commercialization of a licensed product, we would also receive tiered, double-digit royalties on its net sales. On October 12, 2010, we and Daiichi Sankyo announced the expansion of this agreement, establishing a third target, with an option for a fourth, in oncology, and including a two-year extension through November 2012. Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated performance period through November 2012.

On April 27, 2007, we entered into an exclusive license agreement with Kyowa Hakko Kirin to develop and commercialize tivantinib in Japan and parts of Asia. A $3 million portion of an upfront licensing fee was received by the Company under this agreement in the first quarter of 2007, and an additional $27 million in upfront licensing fees was received on May 7, 2007. The agreement includes $123 million in upfront and potential development milestone payments from Kyowa Hakko Kirin to ArQule, including the $30 million cash upfront licensing payments. In February 2008, we received a $3 million milestone payment from Kyowa Hakko Kirin, and in September 2010, we received a $5 million milestone payment from them. Upon commercialization, ArQule will receive tiered royalties in the mid-teen to low-twenty percent range from Kyowa Hakko Kirin on net sales of tivantinib. Kyowa Hakko Kirin will be responsible for all clinical development costs and commercialization of the compound in certain Asian countries, consisting of Japan, China (including Hong Kong), South Korea and Taiwan. In addition to the upfront and possible regulatory milestone payments totaling $123 million, the Company will be eligible for future milestone payments based on the achievement of certain levels of net sales. The Company will recognize the payments, if any, as revenue in accordance with its revenue recognition policies. As of June 30, 2011, the Company has not recognized any revenue from these sales milestone payments, and there can be no assurance that it will do so in the future. Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated development period through April 2016.

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LIQUIDITY AND CAPITAL RESOURCES

	June 30,		December 31,		Increase (decrease)
	2011		2010		$			%
	(in millions)
Cash, cash equivalents and marketable securities-short term	$	84.1	$	80.7	$	3.4			4	%
Marketable securities-long term		43.2		2.2		41.0			1904	%
Notes payable		1.7		1.7		—			—
Working capital		28.1		34.9		(6.8	)		(20	)%

	Six Months Ended
	June 30, 2011			June 30,  2010			Increase (decrease)
	(in millions)
Cash flow from:
Operating activities	$	(5.4	)	$	(21.0	)	$	15.6
Investing activities		(37.8	)		40.0			(77.8	)
Financing activities		50.6			(29.4	)		80.0

Cash flow from operating activities.  Our uses of cash for operating activities have primarily consisted of salaries and wages for our employees, facility and facility-related costs for our offices and laboratories, fees paid in connection with preclinical and clinical studies, laboratory supplies and materials, and professional fees. The sources of our cash flow from operating activities have consisted primarily of payments received from our collaborators for services performed or upfront payments for future services. For the six months ended June 30, 2011, our net use of cash was primarily driven by the difference between cash receipts from our collaborators, including the $25 million milestone payment from Daiichi Sankyo triggered by the dosing of the first patient in the Phase 3 NSCLC clinical trial, and payments for operating expenses which resulted in a net cash outflow of $5.4 million.

Cash flow from investing activities.  Our net cash used in investing activities of $37.8 million for the six months ended June 30, 2011, was primarily comprised of net purchases of marketable securities. The composition and mix of cash, cash equivalents and marketable securities may change frequently as a result of the Company’s constant evaluation of conditions in financial markets, the maturity of specific investments, and our near term liquidity needs.

Our cash equivalents and marketable securities include U.S. Treasury bill funds, money market funds, commercial paper, and U.S. federal and state agency backed certificates, including auction rate securities that have investment grade ratings.

Our cash equivalents and our portfolio of marketable securities are subject to market risk due to changes in interest rates. Fixed rate interest securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectation due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. ArQule’s marketable securities portfolio includes $2.3 million (at cost) at June 30, 2011 and $2.6 million (at cost) at December 31, 2010, invested in auction rate securities.

Cash flow from financing activities.  Our net cash provided by financing activities for the six months ended June 30, 2011 consisted of $46.8 million from the net proceeds of our January 2011 stock offering and $3.8 million from the issuance of common stock from the exercise of stock options.

Our cash requirements may vary materially from those now planned depending upon the results of our drug discovery and development strategies, our ability to enter into additional corporate collaborations and the terms of such collaborations, results of research and development, unanticipated required capital expenditures, competitive and technological advances, acquisitions and other factors. We cannot guarantee that we will be able to develop any of our drug candidates into a commercial product. It is likely we will need to raise additional capital or incur indebtedness to continue to fund our operations in the future. Our ability to raise additional funds will depend on financial, economic and market conditions, and due to global capital and credit market conditions or for other reasons, we may be unable to raise capital when needed, or on terms favorable to us. If necessary funds are not available, we may have to delay, reduce the scope of, or eliminate some of our development programs, potentially delaying the time to market for any of our product candidates.

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In January 2011, we received net proceeds of $46.8 million from our 8,050,000 share stock offering. In February 2011, we received a $25 million milestone payment from Daiichi Sankyo triggered by the dosing of the first patient in the Phase 3 NSCLC clinical trial. In light of these two cash inflows, cash, cash equivalents and marketable securities on hand at June 30, 2011 and our collaboration agreements, we expect that our available cash and cash equivalents will be sufficient to finance our working capital and capital requirements into 2013.

Our contractual obligations were comprised of the following as of June 30, 2011 (in thousands):

	Payment due by period
Contractual Obligations	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
Note payable	$	1,700	$	1,700	$	—	$	—	$	—
Operating lease obligations		12,662		3,548		6,452		2,662		—
Purchase obligations		22,106		22,106		—		—		—
Total	$	36,468	$	27,354	$	6,452	$	2,662	$	—

Purchase obligations are comprised primarily of outsourced preclinical and clinical trial expenses and payments to license certain intellectual property to support the Company’s research efforts. Interest on notes payable is variable and is excluded from the table above. Notes payable currently bears interest at LIBOR plus 125 basis points.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

A “critical accounting policy” is one which is both important to the portrayal of the Company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. For additional information, please see the discussion of our significant accounting policies in Note 2 to the Consolidated Financial Statements included in our Annual Report for the fiscal year ended December 31, 2010 on Form 10-K filed with the SEC on March 2, 2011 and the additional critical accounting policy below.

Accounting for Non-refundable Advance Payments for Research and Development - Non-refundable advance payments for goods or services that will be used or rendered for future research and development activities are initially deferred and capitalized.  Related expenses (or contra-revenues) are then recognized as expense (or contra-revenue) as the goods are delivered and consumed or the related services are performed.

RESULTS OF OPERATIONS

The following are the results of operations for the three and six months ended June 30, 2011 and 2010:

Revenue

					Increase (decrease)
	2011		2010		$			%
	(in millions)
For the three months ended June 30:
Research and development revenue	$	5.4	$	7.1	$	(1.7	)		(23	)%
For the six months ended June 30:
Research and development revenue	$	18.9	$	13.4	$	5.5			40	%

Research and development revenue in the three and six months ended June 30, 2011 and 2010 is comprised of revenue from the Daiichi Sankyo development and research collaborations agreements entered into in 2008 and the Kyowa Hakko Kirin exclusive license agreement.

Under the terms of our tivantinib collaboration agreement with Daiichi Sankyo we share development costs equally with our share of Phase 3 costs funded from milestones and royalties. In each quarter the tivantinib collaboration costs that we incur are compared with those of Daiichi Sankyo. If our costs for the quarter exceed Daiichi Sankyo’s we recognize revenue on the amounts due to us under the contingency adjusted performance model. Revenue is calculated on a pro-rata basis using the time elapsed from inception of the agreement over the estimated duration of the development period under the agreement. If our costs for the quarter are less than those of Daiichi Sankyo’s, we report the amount due to Daiichi Sankyo as contra-revenue in that quarter. For the three and six months ended June 30, 2011 and 2010 our tivantinib collaboration costs incurred were less than those of Daiichi Sankyo’s by $3.7 million and $8.7 million, and $0.1 million and $0.8 million, respectively.  Accordingly those amounts were recognized as contra-revenue and were netted against our tivantinib Daiichi Sankyo research and development revenue.

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The $1.7 revenue decrease in the three month period is primarily due to an increase in contra-revenue of $3.6 million from our tivantinib collaboration with Daiichi Sankyo.  This revenue decrease was partially offset by $1.3 million of revenue recognized in the current quarter on the $25 million milestone payment received from Daiichi Sankyo in the first quarter of 2011 upon dosing the first patient in the Phase 3 NSCLC clinical trial.  In addition, revenue increased in the three month period by $0.7 million from our other collaboration agreements.

The $5.5 million revenue increase in the six months ended June 30, 2011 is primarily due to $12.7 million of revenue recognized in the six months ended June 30, 2011 on the $25 million milestone payment received from Daiichi Sankyo in the first quarter of 2011 upon dosing the first patient in the Phase 3 NSCLC clinical trial.  This revenue increase was partially offset by an increase of $7.9 million of contra revenue.

Research and development

					Increase (decrease)
	2011		2010		$			%
	(in millions)
For the three months ended June 30:
Research and development	$	12.8	$	12.3	$	0.5			4	%
For the six months ended June 30:
Research and development	$	24.2	$	24.8	$	(0.6	)		(2	)%

Research and development expense in the three months ended June 30, 2011 increased by $0.5 million due to an increase in labor and related costs of $0.3 million and outsourcing costs of $0.2 million. Research and development expense in the six months ended June 30, 2011 decreased by $0.6 million primarily due to the completion of our Phase 2 NSCLC clinical trial. We had 82 employees dedicated to our research and development program at June 30, 2011 and 2010.

Overview

Our research and development expense consists primarily of salaries and related expenses for personnel, costs of contract manufacturing services, costs of facilities and equipment, fees paid to professional service providers in conjunction with our clinical trials, fees paid to research organizations in conjunction with pre-clinical animal studies, costs of materials used in research and development, consulting, license, and sponsored research fees paid to third parties and depreciation of associated laboratory equipment. We expect our research and development expense to increase as we continue to develop our portfolio of oncology programs.

We have not accumulated and tracked our internal historical research and development costs or our personnel and personnel-related costs on a program-by-program basis. Our employee and infrastructure resources are allocated across several projects, and many of our costs are directed to broadly applicable research endeavors. As a result, we cannot state the costs incurred for each of our oncology programs on a program-by-program basis.

The expenses incurred by us to third parties for pre-clinical and clinical trials in the current quarter and since inception of our lead clinical stage program were as follows (in millions):

Oncology program	Current status	Six Months Ended June 30, 2011		Program-to-date
c-Met program—tivantinib	Phase 3	$	5.9	$	70.9

Our future research and development expenses in support of our current and future oncology programs will be subject to numerous uncertainties in timing and cost to completion. We test potential products in numerous pre-clinical studies for safety, toxicology, and efficacy. We may conduct multiple clinical trials for each product. As we obtain results from trials, we may elect to discontinue or delay clinical trials for certain products in order to focus our resources on more promising products. Completion of, clinical trials may take several years or more, but the length of time generally varies substantially according to the type, complexity novelty, and intended use of a product. It is not unusual for the pre-clinical and clinical development of these types of products to each take nine years or more, and for total development costs to exceed $500 million for each product.

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We estimate that clinical trials of the type generally needed to secure new drug approval are typically completed over the following timelines:

Clinical Phase	Estimated Completion Period
Phase 1	1-2 years
Phase 2	2-3 years
Phase 3	2-4 years

The duration and the cost of clinical trials may vary significantly over the life of a project as a result of differences arising during clinical development, including, among others, the following:

●  the number of clinical sites included in the trials;

●  the length of time required to enroll suitable patients;

●  the number of patients that ultimately participate in the trials;

●  the duration of patient follow-up to ensure the absence of long-term product-related adverse events; and

●  the efficacy and safety profile of the product.

An element of our business strategy is to pursue the research and development of a broad pipeline of products. This is intended to allow us to diversify the risks associated with our research and development expenditures. As a result, we believe our future capital requirements and future financial success are not substantially dependent on any one product. To the extent we are unable to build and maintain a broad pipeline of products, our dependence on the success of one or a few products increases.

Our strategy includes entering into alliance arrangements with third parties to participate in the development and commercialization of our products, such as our collaboration agreements with Daiichi and Kyowa Hakko Kirin. In the event that third parties have control over the clinical trial process for a product, the estimated completion date would be under control of that third party rather than under our control. We cannot forecast with any degree of certainty whether our products will be subject to future collaborative arrangements or how such arrangements would affect our development plans or capital requirements.

As a result of the uncertainties discussed above, we make significant estimates in determining the duration and completion costs of our oncology programs or when and to what extent we will receive cash inflows from the commercialization and sale of a product. Our inability to complete our oncology programs in a timely manner or our failure to enter into appropriate collaborative agreements could significantly increase our capital requirements and could adversely impact our liquidity. These uncertainties could force us to seek additional, external sources of financing from time-to-time in order to continue with our product development strategy. Our inability to raise additional capital, or to do so on terms reasonably acceptable to us, would jeopardize the future success of our business.

General and administrative

					Increase (decrease)
	2011		2010		$		%
	(in millions)
For the three months ended June 30:
General and administrative	$	3.6	$	3.6	$	—		—
For the six months ended June 30:
General and administrative	$	7.1	$	6.9	$	0.2		4	%

General and administrative expense increased in the first six months of 2011 principally due to an increase in non-cash stock-based compensation expense. General and administrative headcount was 28 at June 30, 2011, compared to 29 at June 30, 2010.

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Interest income, interest expense and other income (expense)

							Increase (decrease)
	2011			2010			$			%
	(in thousands)
For the three months ended June 30:
Interest income	$	112		$	217		$	(105	)		(48	)%
Interest expense		(6	)		(133	)		(127	)		(95	)%
Other income (expense)		31			(123	)		(154	)		(125	)%
For the six months ended June 30:
Interest income	$	167		$	527		$	(360	)		(68	)%
Interest expense		(12	)		(255	)		(243	)		(95	)%
Other income (expense)		47			(615	)		(662	)		(108	)%

Interest income is comprised primarily of interest income derived from our portfolio of cash, cash equivalents and investments and decreased in the three and six month periods ended June 30, 2011 due to lower interest rates. Interest expense is incurred on our notes payable and decreased in the three and six month periods ended June 30, 2011 due to a lower loan balance. Other income (expense) in the three and six month periods ended June 30, 2011 includes a gain of $31and $47, respectively from the increase in fair value of our auction rate securities. Other income (expense) in the three and six month periods ended June 30, 2010 includes a net loss of $123 and $615, respectively from the decrease in fair value of our auction rate securities and auction rate securities put option.

Income tax benefit

The Company recorded a $0.6 million income tax benefit in the quarter ended June 30, 2010 attributable to an election it made in the second quarter of 2010 under revised legislation that allowed net operating losses to offset 100% of alternative minimum tax (“AMT”).  Prior to this legislation, only 90% of AMT could be offset by net operating losses.  The Company received a refund in July 2010 of the $0.6 million AMT paid in 2009.

RECENT ACCOUNTING PRONOUNCEMENTS

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption.

Recently Issued and Adopted Accounting Standards

In October 2009, the FASB issued an accounting standards update (“ASU”) on Multiple-Deliverable Revenue Arrangements. This standards update amends existing revenue recognition accounting pronouncements and provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. Among other provisions, this guidance eliminates the requirement to have objective evidence for undelivered products and services and instead provides for separate revenue recognition based upon management’s best estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. Previous accounting principles required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately. Revenue from our existing multiple-deliverable arrangements is recognized over the estimated development period using the contingency adjusted performance model. Under the new approach, revenue for new agreements or material modifications of existing agreements will be recognized based upon the relative selling price of each element in the arrangement. The Company adopted this guidance prospectively on January 1, 2011 and the adoption of this standard did not have a material impact on our financial position and results of operations; however, the new guidance will impact any new collaboration agreements or material modifications to any existing agreements.

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In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition—Milestone Method”. This ASU provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. Under the milestone method of revenue recognition, consideration that is contingent upon achievement of a milestone in its entirety can be recognized as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. This standard provides the criteria to be met for a milestone to be considered substantive which includes that: a) performance consideration earned by achieving the milestone be commensurate with either performance to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from performance to achieve the milestone; and b) relate to past performance and be reasonable relative to all deliverables and payment terms in the arrangement. The Company adopted this guidance on a prospective basis for milestones on or after January 1, 2011 and the adoption of this standard did not have a material impact on our financial position and results of operations; however, the new guidance will impact any new collaboration agreements or material modifications to any existing agreements.

In January 2011, we adopted ASU No. 2010-06, “Improving Disclosures About Fair Value Measurements” which requires additional disclosure about the amounts of and reasons for significant transfers in and out of Level 1 and Level 2 fair value measurements. In addition, effective for interim and annual periods beginning after December 15, 2010, which for us is January 1, 2011, this standard further requires an entity to present disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. As this accounting standard only requires enhanced disclosure, the adoption of this newly issued accounting standard did not impact our financial position or results of operations.

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011, which for us is January 1, 2012. We do not expect that adoption of this standard will have a material impact on our financial position or results of operations.

In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220)”. This newly issued accounting standard (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented. This ASU is required to be applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011, which for us is January 1, 2012. As this accounting standard only requires enhanced disclosure, the adoption of this standard will not impact our financial position or results of operations.

FORWARD LOOKING STATEMENTS

In addition to historical information, this report contains forward-looking statements. You can identify these forward-looking statements by their use of words such as “anticipate,” “assume,” “believe,” “estimate,” “expect,” “forecast,” “intend,” “may,” “plan,” “project,” “target,” “will” and other words and terms of similar meaning. You also can identify them by the fact that they do not relate strictly to historical or current facts.  All statements which address operating performance, events or developments that the Company expects or anticipates will occur in the future, such as projections about its future results of operations, its financial condition, research, development and commercialization of its products and anticipated trends in its business are forward-looking statements.

In this report we make forward-looking statements regarding our drug development pipeline and our clinical trials involving tivantinib. Additional forward-looking statements relate to our agreements with Kyowa Hakko Kirin and Daiichi Sankyo, including potential future milestones and royalty payments that could result from the future development of tivantinib.

Drug development involves a high degree of risk. Only a small number of research and development programs result in the commercialization of a product.  For example, pre-clinical efforts associated with our product pipeline may fail or prove disappointing because our technology platform did not produce candidates with the desired characteristics. Animal xenograft pre-clinical studies may be unpredictive of human response.  Positive information about early stage clinical trial results will not ensure that later stage or larger scale clinical trials will be successful.

Furthermore, our drugs may not demonstrate promising therapeutic effects; in addition, they may not demonstrate appropriate safety profiles in ongoing or later stage or larger scale clinical trials as a result of known or as yet unidentified side effects. The results achieved in later stage trials may not be sufficient to meet applicable regulatory standards. Problems or delays may arise during clinical trials or in the course of developing, testing or manufacturing our drugs that could lead us or our partner to discontinue development.

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Even if later stage clinical trials are successful, the risk exists that unexpected concerns may arise from analysis of data or from additional data or that obstacles may arise or issues be identified in connection with review of clinical data with regulatory authorities or that regulatory authorities may disagree with the Company’s view of the data or require additional data or information or additional studies. Also, the planned timing of initiation of clinical trials and the duration and conclusion of such trials for our drugs are subject to the ability of the company or its partners or their agents including CRO’s, to enroll patients, enter into agreements with clinical trial sites and investigators, and other technical hurdles and issues that may not be resolved.

We also make forward-looking statements regarding the adequacy of our financial resources.  Our capital resources may not be adequate because our cash requirements may vary materially from those now planned depending upon the results of our drug discovery and development strategies, the outcomes of our clinical trials, our ability to enter into additional corporate collaborations in the future and the terms of such collaborations, results of research and development, the need for currently unanticipated capital expenditures, competitive and technological advances, acquisitions, financial market conditions, our ability to liquidate our investments in auction rate securities and other factors.  Additionally, our corporate collaborators may terminate their agreements with us, thereby eliminating that source of funding, because we may fail to satisfy the prescribed terms of the collaborations or for other reasons.  Finally, we can not assure that UBS will have adequate financial resources to fulfill its repurchase obligations to us.

We cannot guarantee that we will be able to develop any of our drug candidates into a commercial product generating revenues.  If we experience increased losses, we may have to seek additional financing from public and private sales of our securities, including equity securities.  There can be no assurance that additional funding will be available when needed or on acceptable terms.

The factors, risks and uncertainties referred to above and others are more fully described under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the SEC on March 2, 2011, as updated from time to time in our subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.  The forward-looking statements contained herein represent the judgment of the Company as of the date of this report.  We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise, except to the extent required by law.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We own financial instruments that are sensitive to market risk as part of our investment portfolio. We have implemented policies regarding the amount and credit ratings of investments. Our investment portfolio is used to preserve our capital until it is used to fund operations, including our research and development activities. Our investments are evaluated quarterly to determine the fair value of the portfolio.

Our cash and marketable securities include US Treasury bill funds, money market funds, and U.S. federal and state agency backed certificates, including auction rate securities that have strong credit ratings. Our cash equivalents and our portfolio of marketable securities are subject to market risk due to changes in interest rates. Fixed rate interest securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectation due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates.

Auction rate securities are securities that are structured with short-term interest reset dates of generally less than 90 days, but with contractual maturities that can be well in excess of ten years. At the end of each reset period, which occurs every seven to twenty-eight days, investors can sell or continue to hold the securities at par value. If any of our auction rate securities were to fail an auction, due to sell orders exceeding buy orders, the funds associated with a failed auction would not be accessible until a successful auction occurred, a buyer was found outside the auction process, the underlying securities matured or a settlement with the underwriter is reached. ArQule’s marketable securities portfolio at June 30, 2011 included $2.3 million (at cost) and $2.6 million (at cost) at December 31, 2010 invested in auction rate securities that have not successfully auctioned since February 12, 2008.

ITEM 4.  CONTROLS AND PROCEDURES

Our management, with the participation of our Chief Executive Officer (Principal Executive Officer) and President and Chief Operating Officer (Principal Financial Officer), evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2011. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and financial officer, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and our management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2011, our Chief Executive Officer (Principal Executive Officer) and President and Chief Operating Officer (Principal Financial Officer) concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

24

There have been no changes in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. — LEGAL PROCEEDINGS.  None.

ITEM 1A. — RISK FACTORS.  For information regarding factors that could affect the Company’s results of operations, financial condition and liquidity, see the risk factors discussion provided under “Risk Factors” in Item 1A of ArQule’s Annual Report on Form 10-K for the year ended December 31, 2010 filed with the SEC on March 2, 2011, as updated from time to time in our subsequent Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.  See also, “Forward-Looking Statements” included in this Quarterly Report on Form 10-Q.

ITEM 2. — UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.  None.

ITEM 3. — DEFAULTS UPON SENIOR SECURITIES.  None.

ITEM 4. — (REMOVED AND RESERVED).

ITEM 5. — OTHERS INFORMATION. None.

ITEM 6. — EXHIBITS.

EXHIBIT NO.	DESCRIPTION
10.1*	Amended and Restated 1994 Equity Incentive Plan (Incorporated by reference from Appendix A to the Registrant’s Definitive Proxy Statement dated April 29, 2011).
10.2*	Amended and Restated 1996 Director Stock Option Plan (Incorporated by reference from Appendix C to the Registrant’s Definitive Proxy Statement dated April 29, 2011).
31.1	Rule 13a-14(a) Certificate of Chief Executive Officer, filed herewith.
31.2	Rule 13a-14(a) Certificate of Principal Financial Officer, filed herewith.
32	Rule 13a-14(b) Certificate of Chief Executive Officer and Chief Financial Officer, filed herewith.

*      Management compensatory plan or arrangement

25

ARQULE, INC.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ArQule, Inc.
Date: August 4, 2011	/s/ PETER S. LAWRENCE
	Peter S. Lawrence
	President and Chief Operating Officer
	(Principal Financial Officer)
	/s/ ROBERT J. WEISKOPF
	Robert J. Weiskopf Vice President of Finance, Corporate Controller and Treasurer (Principal Accounting Officer)

26

EX-10.1

Exhibit 10.1

ARQULE, INC.

Amended and Restated

1994 Equity Incentive Plan

Section 1.  Purpose

The purpose of the Plan is to attract and retain key employees and consultants of the Company and its Affiliates, to provide an incentive for them to achieve long-range performance goals, and to enable them to participate in the long-term growth of the Company. Independent contractors and leased employees of the Company shall not be eligible to participate in the Plan notwithstanding that they may be deemed to be “common law” employees of the Company for other purposes.

Section 2.  Definitions

“Affiliate” means any business entity that directly, or indirectly through one or more intermediaries, controls, is controlled by or is under common control with the Company. For purposes hereof, “Control” (and with correlative meanings, the terms “controlled by” and “under common control with”) shall mean the possession of the power to direct or cause the direction of the management and policies of the Company, whether through the ownership of voting stock, by contract or otherwise. In the case of a corporation “control” shall mean, among other things, the direct or indirect ownership of more than fifty percent (50%) of its outstanding voting stock. In the case of an Incentive Stock Option, the term “Affiliate” shall only include each entity which is either a “parent corporation” or a “subsidiary corporation,” both as defined in Section 424 of the Code, with respect to the Company (and any entity which becomes such a “parent corporation” or “subsidiary corporation” after the adoption of the Plan).

“Award” means any Option, Stock Appreciation Right, Performance Share, Restricted Stock, Stock Unit or Other Stock-Based Award awarded under the Plan or any Award previously granted under the 1994 Equity Incentive Plan of the Company or the Amended and Restated 1994 Equity Incentive Plan of the Company as in effect prior to date this Plan was adopted by the Board of Directors.

“Board” means the Board of Directors of the Company.

“Code” means the Internal Revenue Code of 1986, as amended from time to time, and any successor to such Code.

“Committee” means a committee of not fewer than two members of the Board appointed by the Board to administer the Plan. If a Committee is authorized to grant Options to a Reporting Person or a “covered employee” within the meaning of Section 162(m) of the Code, each member shall be a “non-employee director” or the equivalent within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934 and an “outside director” or the equivalent within the meaning of Section 162(m) of the Code, respectively. Until such committee is appointed, “Committee” means the Board.

“Common Stock” or “Stock” means the Common Stock, $0.01 par value, of the Company.

“Company” means ArQule, Inc.

“Designated Beneficiary” means the beneficiary designated by a Participant, in a manner determined by the Committee, to receive amounts due or exercise rights of the Participant in the event of the Participant’s death. In the absence of an effective designation of a beneficiary by a Participant, “Designated Beneficiary” shall mean (i) the Participant’s estate, if such amounts or rights are, under applicable law, deemed to be part of the Participant’s estate, or (ii) such person who acquired the right to receive amounts due or exercise rights of the Participant by bequest or inheritance.

“Effective Date” means October 28, 1994.

“Fair Market Value” means, with respect to a share of Common Stock its closing price on the NASDAQ National Market on the date an Award is made and if the Company’s Common Stock shall cease to be listed or any other security, constitutes a part of the Award the fair market value thereof shall be as determined by the Committee in good faith or in the manner established by the Committee from time to time.

“Full Value Award” means any Award of Performance Shares, Restricted Stock, or Stock Units or any combination thereof and any Other Stock-Based Award other than an Option or Stock Appreciation Right awarded under the Plan.

“Incentive Stock Option” means an option to purchase shares of Common Stock awarded to a Participant under Section 6 that is intended to meet the requirements of Section 422 of the Code or any successor provision and is designated by the Committee as such.

“Nonstatutory Stock Option” means an option to purchase shares of Common Stock awarded to a Participant under Section 6 that is not intended to be an Incentive Stock Option.

“Option” means an Incentive Stock Option or a Nonstatutory Stock Option.

“Other Stock-Based Award” means an Award, other than an Option, Stock Appreciation Right, Performance Share, Restricted Stock or Stock Unit, having a Common Stock element and awarded to a Participant under Section 11.

“Participant” means, subject to Section 4 hereof, a person selected by the Committee to receive an Award under the Plan.

“Performance Cycle” or “Cycle” means the period of time selected by the Committee during which performance is measured for the purpose of determining the extent to which an award of Performance Shares has been earned.

“Performance Shares” mean shares of Common Stock, which may be earned by the achievement of performance goals, awarded to a Participant under Section 8.

“Reporting Person” means a person subject to Section 16 of the Securities Exchange Act of 1934 or any successor provision.

“Restricted Period” means the period of time selected by the Committee during which an Award may be forfeited to the Company pursuant to the terms and conditions of such Award.

“Restricted Stock” means shares of Common Stock subject to forfeiture awarded to a Participant under Section 9.

“Stock Appreciation Right” or “SAR” means a right to receive any excess in value of shares of Common Stock over the exercise price awarded to a Participant under Section 7.

“Stock Unit” means an award of Common Stock or units that are valued in whole or in part by reference to, or otherwise based on, the value of Common Stock, awarded to a Participant under Section 10.

“Ten-Percent Stockholder” shall mean a Participant who, at the time of grant of an Incentive Stock Option, owns, applying Section 424(d) of the Code, stock possessing more than ten percent of the total combined voting power of all classes of stock of the Company or a “parent corporation” or “subsidiary corporation” (both as defined in Section 424 of the Code) with respect to the Company.

Section 3.  Administration

The Plan shall be administered by the Committee. The Committee shall have authority and discretion to adopt, alter and repeal such administrative rules, guidelines and practices governing the operation of the Plan as it shall from time to time consider advisable, to interpret the provisions of the Plan, subject to the provisions of the Plan, to grant Awards to Participants and determine the terms of all such Awards, to determine the identity of a Participant’s Designated Beneficiary and to determine the identity of a Participant’s (or Designated Beneficiary’s) legal representative in the event such person becomes legally disabled. The Committee’s decisions shall be final and binding. The Committee may also recommend Awards to the full Board for approval. To the extent permitted by applicable law, the Committee may delegate to one or more executive officers of the Company the power to make Awards to Participants who are not Reporting Persons or covered employees and all determinations under the Plan with respect thereto, provided that the Committee shall fix the maximum amount of such Awards for all such Participants and a maximum for any one Participant.

Section 4.  Eligibility

All employees (but excluding any independent contractor or leased employee who is deemed to be a “common law” employee of the Company or any Affiliate) and, in the case of Awards other than Incentive Stock Options, any consultant of the Company or any Affiliate, capable of contributing significantly to the successful performance of the Company, other than a person who has irrevocably elected not to be eligible, are eligible to be Participants in the Plan.

Section 5.  Stock Available for Awards

(a)           Subject to adjustment under subsection (b), the maximum number of shares of Common Stock that may be issued under the Plan is 15,500,000 shares of Common Stock. If any Award in respect of shares of Common Stock expires or is terminated unexercised or is forfeited without the Participant having had the benefits of ownership (other than voting rights, if any), the shares subject to such Award, to the extent of such expiration, termination or forfeiture, shall again be available for award under the Plan to the same extent such shares would have been available if such expired, terminated or forfeited Award had not been made. Common Stock issued through the assumption or substitution of outstanding grants from an acquired company shall not reduce the shares available for Awards under the Plan to the extent permitted under Section 422 of the Code. Shares issued under the Plan may consist in whole or in part of authorized but unissued shares or treasury shares; provided, however, that shares of Common Stock that have actually been issued under the Plan, whether upon exercise or of an Award or issuance with respect thereto, shall not be returned to the Plan and shall not become available for future Awards under the Plan, except that if unvested Shares of Restricted Stock or Restricted Stock Units are repurchased by or forfeited to the Company, such Shares shall become available for future grant under the Plan.

(b)           Notwithstanding the provisions of Section 5(a), for any two (2) shares of Common Stock issued in connection with a Full Value Award, three (3) fewer shares of Common Stock will be available for issuance in connection with Awards under Section 5(a).

(c)           In the event that the Committee determines that any stock dividend, extraordinary cash dividend, creation of a class of equity securities, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock at a price substantially below fair market value, or other similar transaction affects the Common Stock such that an adjustment is required or desirable in order to preserve the benefits or potential benefits intended to be made available under the Plan, then the Committee (subject, in the case of Incentive Stock Options, to any limitation required under the Code) may in its discretion equitably adjust any or all of, or provide substitution for, (i) the number and kind of shares in respect of which Awards may be made under the Plan, (ii) the number and kind of shares subject to outstanding Awards, and (iii) the award, exercise or conversion price with respect to any of the foregoing, and if considered appropriate, the Committee may make provision for a cash payment with respect to an outstanding Award, provided that the number of shares subject to any Award shall always be a whole number.

Section 6.  Stock Options

(a)           Subject to the provisions of the Plan, the Committee may award Incentive Stock Options and Nonstatutory Stock Options and determine the number of shares to be covered by each Option, the option price therefor and the conditions and limitations applicable to the exercise of the Option. The terms and conditions of Incentive Stock Options shall be subject to and comply with Section 422 of the Code or any successor provision and any regulations thereunder, and no Incentive Stock Option may be granted hereunder more than ten years after May 19, 2004.

(b)           The Committee shall establish the option price at the time each Option is awarded, which price shall not be less than 100% (110% in the case of a Ten-Percent Stockholder) of the Fair Market Value of the Common Stock on the date of award with respect to Incentive Stock Options.

(c)           Each Option shall be exercisable at such times and subject to such terms and conditions as the Committee may specify in the applicable Award or thereafter, provided, however, that no Option may be exercised more than ten years (five years in the case of a Ten-Percent Stockholder) from the date of award. The Committee may impose such conditions with respect to the exercise of Options, including conditions relating to applicable federal or state securities laws, as it considers necessary or advisable.

(d)           No shares shall be delivered pursuant to any exercise of an Option until payment in full of the option price therefor is received by the Company. Such payment may be made in whole or in part in cash or (A) to the extent permitted by the Committee at or after the award of the Option, by delivery (i) of a note or (ii) shares of Common Stock owned by the optionee, including, if vested, shares of Restricted Stock, or (B) to the extent permitted under the terms of the written agreement evidencing the grant of an Option, by (i) retaining shares otherwise issuable pursuant to the Option, in each case valued at their Fair Market Value on the date of delivery or retention, or (ii) such other lawful consideration as the Committee may determine.

(e)           The Committee may provide that, subject to such conditions as it considers appropriate, upon the delivery or retention of shares to the Company in payment of an Option, the Participant automatically be awarded an Option for up to the number of shares so delivered.

Section 7.  Stock Appreciation Rights

(a)           Subject to the provisions of the Plan, the Committee may award SARs in tandem with an Option (at or after the award of the Option), or alone and unrelated to an Option. SARs in tandem with an Option shall terminate to the extent that the related Option is exercised, and the related Option shall terminate to the extent that the tandem SARs are exercised. SARs granted in tandem with Options shall have an exercise price not less than the exercise price of the related Option. SARs granted alone and unrelated to an Option may be granted at such exercise prices as the Committee may determine; provided, however, such exercise price shall not be less than 100% (110% in the case of a Ten-Percent Stockholder) of the Fair Market Value of the Common Stock on the date of the Award of such SARs.

(b)           An SAR related to an Option, which SAR can only be exercised upon or during limited periods following a change in control of the Company, may entitle the Participant to receive an amount based upon the highest price paid or offered for Common Stock in any transaction relating to the change in control or paid during the thirty-day period immediately preceding the occurrence of the change in control in any transaction reported in the stock market in which the Common Stock is normally traded. No SAR may be exercised more than ten years (five years in the case of a Ten-Percent Stockholder) from the date of award.

Section 8.  Performance Shares

(a)           Subject to the provisions of the Plan, the Committee may award Performance Shares and determine the number of such shares for each Performance Cycle and the duration of each Performance Cycle. There may be more than one Performance Cycle in existence at any one time, and the duration of Performance Cycles may differ from each other. The payment value of Performance Shares shall be equal to the Fair Market Value of the Common Stock on the date the Performance Shares are earned or, in the discretion of the Committee, on the date the Committee determines that the Performance Shares have been earned.

(b)           The Committee shall establish performance goals for each Cycle, for the purpose of determining the extent to which Performance Shares awarded for such Cycle are earned, on the basis of such criteria and to accomplish such objectives as the Committee may from time to time select. During any Cycle, the Committee may adjust the performance goals for such Cycle as it deems equitable in recognition of unusual or non-recurring events affecting the Company, changes in applicable tax laws or accounting principles, or such other factors as the Committee may determine.

(c)           As soon as practicable after the end of a Performance Cycle, the Committee shall determine the number of Performance Shares that have been earned on the basis of performance in relation to the established performance goals. The payment values of earned Performance Shares shall be distributed to the Participant or, if the Participant has died, to the Participant’s Designated Beneficiary, as soon as practicable thereafter. The Committee shall determine, at or after the time of award, whether payment values will be settled in whole or in part in cash or other property, including Common Stock or Awards.

Section 9.  Restricted Stock

(a)           Subject to the provisions of the Plan, the Committee may award shares of Restricted Stock and determine the duration of the Restricted Period during which, and the conditions under which, the shares may be forfeited to the Company and the other terms and conditions of such Awards. Shares of Restricted Stock may be issued for no cash consideration or such minimum consideration as may be required by applicable law.

(b)           Shares of Restricted Stock may not be sold, assigned, transferred, pledged or otherwise encumbered, except as permitted by the Committee, during the Restricted Period. Shares of Restricted Stock shall be evidenced in such manner as the Committee may determine. Any certificates issued in respect of shares of Restricted Stock shall be registered in the name of the Participant and unless otherwise determined by the Committee, deposited by the Participant, together with a stock power endorsed in blank, with the Company. At the expiration of the Restricted Period, the Company shall deliver such certificates to the Participant or if the Participant has died, to the Participant’s Designated Beneficiary.

Section 10.  Stock Units

(a)           Subject to the provisions of the Plan, the Committee may award Stock Units subject to such terms, restrictions, conditions, performance criteria, vesting requirements and payment rules as the Committee shall determine.

(b)           Shares of Common Stock awarded in connection with a Stock Unit Award shall be issued for no cash consideration or such minimum consideration as may be required by applicable law.

Section 11.  Other Stock-Based Awards

(a)           Subject to the provisions of the Plan, the Committee may make other awards of Common Stock and other awards that are valued in whole or in part by reference to, or are otherwise based on, Common Stock, including without limitation convertible preferred stock, convertible debentures, exchangeable securities and Common Stock awards or options. Other Stock-Based Awards may be granted either alone or in tandem with other Awards granted under the Plan and/or cash awards made outside of the Plan.

(b)           The Committee may establish performance goals, which may be based on performance goals related to book value, subsidiary performance or such other criteria as the Committee may determine, Restricted Periods, Performance Cycles, conversion prices, maturities and security, if any, for any Other Stock-Based Award. Other Stock-Based Awards may be sold to Participants at the face value thereof or any discount therefrom or awarded for no consideration or such minimum consideration as may be required by applicable law.

Section 12.  General Provisions Applicable to Awards

(a)           Vesting of Full Value Awards.   Notwithstanding anything to the contrary contained herein, the minimum vesting periods for a Full Value Award shall be (i) for three years for Awards that vest based on continued service to the Company and (ii) for one year for Awards that vest based upon the accomplishment of performance criteria (where such performance criteria are determined in the discretion of the Board or the Committee.

(b)           Documentation.  Each Award under the Plan shall be evidenced by a writing delivered to the Participant or accessible by electronic meansspecifying the terms and conditions thereof and containing such other terms and conditions not inconsistent with the provisions of the Plan as the Committee considers necessary or advisable to achieve the purposes of the Plan or to comply with applicable tax and regulatory laws and accounting principles.

(c)           Committee Discretion.  Each type of Award may be made alone, in addition to or in relation to any other type of Award. The terms of each type of Award need not be identical, and the Committee need not treat Participants uniformly. Except as otherwise provided by the Plan or a particular Award, any determination with respect to an Award may be made by the Committee at the time of award or at any time thereafter.

(d)           Settlement.  The Committee shall determine whether Awards are settled in whole or in part in cash, Common Stock, other securities of the Company, Awards or other property. The Committee may permit a Participant to defer all or any portion of a payment under the Plan, including the crediting of interest on deferred amounts denominated in cash and dividend equivalents on amounts denominated in Common Stock.

(e)           Dividends and Cash Awards.  In the discretion of the Committee, any Award under the Plan may provide the Participant with (i) dividends or dividend equivalents payable currently or deferred with or without interest, and (ii) cash payments in lieu of or in addition to an Award.

(f)           Termination of Employment.  The Committee shall determine the effect on an Award of the disability, death, retirement or other termination of employment of a Participant and the extent to which, and the period during which, the Participant’s legal representative, guardian or Designated Beneficiary may receive payment of an Award or exercise rights thereunder.

(g)           Change in Control.  In order to preserve a Participant’s rights under an Award in the event of a change in control of the Company, the Committee in its discretion may, at the time an Award is made or at any time thereafter, take one or more of the following actions: (i) provide for the acceleration of any time period relating to the exercise or realization of the Award, (ii) provide for the purchase of the Award upon the Participant’s request for an amount of cash or other property that could have been received upon the exercise or realization of the Award had the Award been currently exercisable or payable, (iii) adjust the terms of the Award in a manner determined by the Committee to reflect the change in control, (iv) cause the Award to be assumed, or new rights substituted therefor, by another entity, or (v) make such other provision as the Committee may consider equitable and in the best interests of the Company.

(h)           Withholding Taxes.  The Participant shall pay to the Company, or make provision satisfactory to the Committee for payment of, any taxes required by law to be withheld in respect of Awards under the Plan no later than the date of the event creating the tax liability. The Company’s obligation to issue or deliver shares of Common Stock or pay any amount pursuant to any Award shall be subject to the Participant’s satisfaction of his or her obligations under the preceding sentence. In the Committee’s discretion, such tax obligations may be paid in whole or in part in shares of Common Stock, including shares retained from the Award creating the tax obligation, valued at their Fair Market Value on the date of delivery. The Company and its Affiliates may, to the extent permitted by law, deduct any such tax obligations from any payment of any kind otherwise due to the Participant.

(i)           Foreign Nationals.  Awards may be made to Participants who are foreign nationals or employed outside the United States on such terms and conditions different from those specified in the Plan as the Committee considers necessary or advisable to achieve the purposes of the Plan or to comply with applicable laws.

(j)           Amendment of Award.  The Committee may amend, modify or terminate any outstanding Award, including substituting therefor another Award of the same or a different type, changing the date of exercise or realization and converting an Incentive Stock Option to a Nonstatutory Stock Option, provided that the Participant’s consent to such action shall be required unless the Committee determines that the action, taking into account any related action, would not materially and adversely affect the Participant Notwithstanding the foregoing sentence, unless such action is approved by the Company’s stockholders or is an adjustment resulting from the operation of Section 5 (b) of the Plan: (A) no outstanding Option granted under the Plan may be amended to provide an exercise price per share that is lower than the then-current exercise price per share stated in such outstanding Option, and (B) the Committee may not cancel any outstanding Option and grant in substitution therefor new Awards under the Plan covering the same or a different number of shares of Common Stock and having an exercise price per share lower than the then-current exercise price per share of the cancelled Option.

(k)           Transferability.  In the discretion of the Committee, any Award may be made transferable upon such terms and conditions and to such extent as the Committee determines (which terms and conditions may be waived by the Committee in its discretion), provided that Incentive Stock Options may be transferable only to the extent permitted by the Code.

Section 13.  Miscellaneous

(a)           No Right To Employment.  No person shall have any claim or right to be granted an Award, and the grant of an Award shall not be construed as giving a Participant the right to continued employment. The Company expressly reserves the right at any time to dismiss a Participant free from any liability or claim under the Plan, except as expressly provided in the applicable Award.

(b)           No Rights As Stockholder.  Subject to the provisions of the applicable Award, no Participant or Designated Beneficiary shall have any rights as a stockholder with respect to any shares of Common Stock to be distributed under the Plan until he or she becomes the holder thereof. A Participant to whom Common Stock is awarded shall be considered the holder of the Stock at the time of the Award except as otherwise provided in the applicable Award.

(c)           Effective Date.  Subject to the approval of the stockholders of the Company, the Plan shall be effective on the Effective Date. Before such approval, Awards may be made under the Plan expressly subject to such approval.

(d)           Amendment of Plan.  The Board may amend, suspend or terminate the Plan or any portion thereof at any time, subject to any stockholder approval that the Board determines to be necessary or advisable.

(e)           Governing Law.  The provisions of the Plan shall be governed by and interpreted in accordance with the laws of Delaware.

This Plan was approved by the Board of Directors on October 17, 1994.

This Plan was approved by the stockholders on October 17, 1994.

The Board of Directors amended and restated this Plan on April 8, 1998.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 14, 1998.

The Board of Directors amended and restated this Plan on March 16, 2000.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 18, 2000.

The Board of Directors amended and restated this Plan on March 23, 2001.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 17, 2001.

The Board of Directors amended and restated this Plan on March 21, 2002.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 16, 2002.

The Board of Directors amended and restated this Plan on April 7, 2004.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 19, 2004.

The Board of Directors amended and restated this Plan on April 4, 2005.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 18, 2005.

The Board of Directors authorized the amendment and restatement of this Plan on May 11, 2005, effective September 13, 2005.

Pursuant to Section 13 (d) of the Plan, the Board determined that it was not necessary or advisable to obtain stockholder approval of the amendment and restatement.

The Board of Directors amended and restated this Plan on January 21, 2008.

These amendments and restatement were submitted to the stockholders for approval at the Annual Meeting of Stockholders on May 14, 2008 but were not approved.

The Board of Directors amended and restated this Plan on January 21, 2009.

The amendments and restatement were approved by the stockholders at the Annual Meeting of Stockholders on May 13, 2009.

The Board of Directors amended and restated this Plan on March 11, 2010.

The amendments and restatement were approved by the stockholders at the Annual Meeting of Stockholders on May 13, 2010.

The Board of Directors amended and restated this Plan on March 11, 2010.

The amendments and restatement were approved by the stockholders at the Annual Meeting of Stockholders on May 13, 2010.

The Board of Directors amended and restated this Plan on March 14, 2011.

The amendments and restatement were approved by the stockholders at the Annual Meeting of Stockholders on June 1, 2011.

EX-10.2

Exhibit 10.2

ARQULE, INC.

Amended and Restated 1996 Director Stock Option Plan

The purpose of this Amended and Restated 1996 Director Stock Option Plan (the “Plan”) of ArQule, Inc. (the “Company”) is to attract and retain highly qualified non-employee directors of the Company and to encourage ownership of stock of the Company by such directors so as to provide additional incentives to promote the success of the Company.

1. ADMINISTRATION OF THE PLAN.

Grants of stock options under this Plan shall be automatic as provided in Section 6. However, all questions of interpretation with respect to this Plan and options granted under it shall be determined by the Board of Directors of the Company (the “Board”) or by a committee consisting of one or more directors appointed by the Board and such determination shall be final and binding upon all persons having an interest in this Plan.

2. PERSONS ELIGIBLE TO PARTICIPATE IN THE PLAN.

Each director of the Company who is not an employee of the Company or of any subsidiary of the Company shall be eligible to participate in this Plan unless such director irrevocably elects not to participate.

3. SHARES SUBJECT TO THE PLAN.

(a)           The aggregate number of shares of the Company’s Common Stock, $0.01 par value (“Common Stock”) which may be optioned under this Plan is 950,000 shares. Shares issued under this Plan may consist in whole or in part of authorized but unissued shares or treasury shares.

(b)           In the event of a stock dividend, split-up, combination or reclassification of shares, recapitalization or other similar capital change relating to the Company’s Common Stock, the maximum aggregate number and kind of shares or securities of the Company as to which options may be granted under this Plan and as to which options then outstanding shall be exercisable, and the option price of such options shall be appropriately adjusted so that the proportionate number of shares or other securities as to which options may be granted and the proportionate interest of holders of outstanding options shall be maintained as before the occurrence of such event.

(c)           In the event of a consolidation or merger of the Company with another corporation where the Company’s stockholders do not own a majority in interest of the surviving or resulting corporation, or the sale or exchange of all or substantially all of the assets of the Company, or a reorganization or liquidation of the Company, any deferred exercise period shall be automatically accelerated and each holder of an outstanding option shall be entitled to receive upon exercise and payment in accordance with the terms of the option the same shares, securities or property as he would have been entitled to receive upon the occurrence of such event if he had been, immediately prior to such event, the holder of the number of shares of Common Stock purchasable under his or her option; provided, however, that in lieu of the foregoing the Board may upon written notice to each holder of an outstanding option or right under this Plan, provide that such option or right shall terminate on a date not less than 20 days after the date of such notice unless theretofore exercised.

(d)           Whenever options under this Plan lapse or terminate or otherwise become unexercisable the shares of Common Stock which were subject to such options may again be subjected to options under this Plan. The Company shall at all times while this Plan is in force reserve such number of shares of Common Stock as will be sufficient to satisfy the requirements of this Plan.

4. NON-STATUTORY STOCK OPTIONS.

All options granted under this Plan shall be non-statutory options not entitled to special tax treatment under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”).

5. FORM OF OPTIONS.

Options granted hereunder shall be in substantially the form of the attached EXHIBIT A or in such other form as the Board or any committee appointed pursuant to Section 1 above may from time to time determine.

1.

6. GRANT OF OPTIONS AND OPTION TERMS

(a)           AUTOMATIC GRANT OF OPTIONS. Upon the initial election or appointment of any person as a member of the Board who is an eligible director (whether or not such election is at an annual meeting of stockholders or otherwise), such person shall automatically be granted (i) an option to purchase 30,000 shares of Common Stock (an “Initial Option”). In addition, at each annual meeting of stockholders, each eligible director serving as a member of the Board (other than the Chairman of the Board) prior to and immediately after such annual meeting (whether or not such director was reelected at such meeting) shall automatically be granted an annual option to purchase 15,000 shares of Common Stock (an “Annual Option”). Upon the initial election or appointment of any person who is an eligible director (whether or not such election is at an annual meeting of stockholders or otherwise) as the Chairman of the Board of Directors, such person shall automatically be granted (i) an option to purchase 25,000 shares of Common Stock (the “Initial Chairman Option”). In addition, at each annual meeting of stockholders, such eligible director serving as Chairman of the Board prior to and immediately after such annual meeting (whether or not such director was reelected at such meeting) shall automatically be granted an annual option to purchase 25,000 shares of Common Stock (the “Annual Chairman Option” and, together with the Initial Chairman Option, (the “Chairman Options”). The Annual Options together with the Initial Options and Chairman Options are sometimes collectively referred to as “Options”). No Options shall be granted hereunder after May 18, 2016. (1)

(b)           DATE OF GRANT. The “Date of Grant” for Options granted under this Plan shall be the date of initial election as a director or appointment as Chairman or the date of the annual stockholder meeting at which such Option was granted, as the case may be in accordance with Section 6(a).

(c)           OPTION PRICE. The option price for each Option granted under this Plan shall be not be less than 100% of the Fair Market Value of the Company’s Common Stock on the Date of Grant. For purposes of this Plan, “Fair Market Value” means, unless otherwise determined by the Board, the closing price for the Company’s Common Stock as reported by the NASDAQ Stock Market, Inc. on the Date of Grant; provided, however, that in all events shall Fair Market Value be determined pursuant to a method that complies with Proposed Treasury Regulation §1.409A-1(b) (5) or any successor provision. (2)

(d)           TERM OF OPTION. The term of each Option granted under this Plan shall be ten years from the Date of Grant.

(e)            EXERCISABILITY OF OPTIONS.

(1)           The Initial Options granted under this Plan shall become exercisable with respect to 10,000 shares on the date of each of the Company’s next three annual meetings of stockholders following the Date of Grant, but in all cases if, and only if, the Option holder is a member of the Board at the opening of business on that date. The Initial Chairman Options granted under this Plan shall become exercisable with respect to 8,334 shares on the date of the Company’s next annual meeting of stockholders from the Date of Grant and with respect to 8,333 shares on the date of each of the next two annual meetings of stockholders following such annual meeting of stockholders, but in all cases if, and only if, the Option holder is a member of the Board at the opening of business on that date.

(2)           The Annual Options and Annual Chairman Options granted under this Plan shall become exercisable with respect to all shares on the Date of Grant.

(f)            GENERAL EXERCISE TERMS. Directors holding exercisable Options under this Plan who cease to serve as members of the Board may, during their lifetime, exercise the rights they had under such Options at the time they ceased being a director for the full unexpired term of such Option. Any rights that have not yet become exercisable shall terminate upon cessation of membership on the Board. Upon the death of a director, those entitled to do so shall have the right, at any time within twelve months after the date of death, to exercise in whole or in part any rights which were available to the director at the time of his or her death. The rights of the Option holder may be exercised by the holder’s guardian or legal representative in the case of disability and by the beneficiary designated by the holder in writing delivered to the Company or, if none has been designated, by the holder’s estate or his or her transferee in accordance with this Plan, in the case of death. Options granted under this Plan shall terminate, and no rights thereunder may be exercised, after the expiration of the applicable exercise period. Notwithstanding the foregoing provisions of this section, no rights under any Options may be exercised after the expiration of ten years from their Date of Grant.

(1) This Plan was amended by the Board to extend the period during which Options may be granted to ten years after May 18, 2006, the date of the 2006 Annual Meeting of Stockholders of the Company at which the stockholders approved the amendment.

(2) This section was amended by the Board on January 16, 2007 to make the date of determination of Fair Market Value, the Date of Grant.

2.

(g)           METHOD OF EXERCISE AND PAYMENT. Options may be exercised only by written notice to the Company at its principal office accompanied by payment of the full Option price for the shares of Common Stock as to which they are exercised. The Option price shall be paid in cash or by check or in shares of Common Stock of the Company, or in any combination thereof. Shares of Common Stock surrendered in payment of the Option price shall have been held by the person exercising the Option for at least six months, unless otherwise permitted by the Board. The value of shares delivered in payment of the Option price shall be their fair market value, as determined in accordance with Section 6(c) above, as of the date of exercise. Upon receipt of such notice and payment, the Company shall promptly issue and deliver to the optionee (or other person entitled to exercise the Option) a certificate or certificates for the number of shares as to which the exercise is made.

(h)           NON-TRANSFERABILITY. Options granted under this Plan shall not be transferable by the holder thereof otherwise than by will or the laws of descent and distribution or as permitted by Rule 16b-3 (or any successor provision) under the Securities Exchange Act of 1934, as amended (“Rule 16b-3”).

7. LIMITATION OF RIGHTS.

(a)           NO RIGHT TO CONTINUE AS A DIRECTOR. Neither this Plan, nor the granting of an Option or any other action taken pursuant to this Plan, shall constitute an agreement or understanding, express or implied, that the Company will retain an Option holder as a director for any period of time or at any particular rate of compensation.

(b)           NO STOCKHOLDERS’ RIGHTS FOR OPTIONS. A director shall have no rights as a stockholder with respect to the shares covered by Options until the date the director exercises such Options and pays the Option price to the Company, and no adjustment will be made for dividends or other rights for which the record date is prior to the date such Option is exercised and paid for.

8. AMENDMENT OR TERMINATION.

The Board may amend or terminate this Plan at any time, provided that, to the extent necessary or desirable to comply with Rule 16b-3, this Plan shall not be amended more than once every six months, other than to comport with changes in the Code, ERISA or the rules thereunder.

9. STOCKHOLDER APPROVAL.

The 1996 Director Stock Option Plan was approved by the stockholders of the Company by an affirmative vote of the holders of a majority of the shares of Common Stock present, or represented and entitled to vote, at the Company’s 1997 annual meeting of stockholders. Any further amendments hereto shall be subject to stockholder approval to the extent (i) required by law, (ii) required by Nasdaq or stock exchange listing requirements, as determined by the Board of Directors, or (iii) as desirable, as determined by the Board of Directors, to comply with Rule 16b-3. In the event any amendment to increase the number of shares of Common Stock which may be optioned under this Plan is not approved by the stockholders, all Options granted under this Plan with respect to shares from an increase not approved by stockholders shall be void and without effect.

10. GOVERNING LAW.

This Plan shall be governed by and interpreted in accordance with the laws of the State of Delaware.

11. COMPLIANCE WITH SECTION 409A OF THE CODE.

Notwithstanding any other provision of this Plan to the contrary, to the extent any grant (or a modification of a grant) of options under this Plan results in the deferral of compensation (for purposes of Section 409Aof the Code), the terms and conditions of the grant shall comply with Section 409A of the Code.

3.

The Board of Directors amended and restated this Plan on March 16, 2000.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 18, 2000.

The Board of Directors amended and restated this Plan on March 21, 2002.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 16, 2002.

The Board of Directors amended and restated this Plan on March 14, 2003.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 21, 2003.

The Board of Directors amended and restated this Plan on April 7, 2004.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 19, 2004.

The Board of Directors amended and restated this Plan on April 4, 2005.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 18, 2005.

The Board of Directors amended and restated this Plan on March 13, 2006.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 18, 2006.

The Board of Directors amended and restated this Plan on January 16, 2007.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on May 18, 2007.

Pursuant to Section 13 (d) of this Plan, the Board of Directors amended and restated this Plan on January 21, 2010.

The Board of Directors determined that, in accordance with the terms of this Plan, applicable securities laws and regulations and Nasdaq market rules it was not necessary to obtain the stockholder approval for the amendment and restatement.

The Board of Directors amended and restated this Plan on March 14, 2011.

The amendment and restatement was approved by the stockholders at the Annual Meeting of Stockholders on June 1, 2011.

4.

EX-31.1

Exhibit 31.1

CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER

I, Paolo Pucci, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ArQule, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  August 4, 2011

/s/ PAOLO PUCCI

Paolo Pucci

Chief Executive Officer

(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATE OF THE PRINCIPAL FINANCIAL OFFICER

I, Peter S. Lawrence, certify that:

1. I have reviewed this quarterly report on Form 10-Q of ArQule, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  August 4, 2011

/s/ PETER S. LAWRENCE

Peter S. Lawrence

President and Chief Operating Officer

(Principal Financial Officer)

EX-32

Exhibit 32

ARQULE, INC.

CERTIFICATE OF THE CHIEF EXECUTIVE OFFICER AND

PRINCIPAL FINANCIAL OFFICER

The undersigned, Paolo Pucci Chief Executive Officer (Principal Executive Officer) of ArQule, Inc. (the “Company”) and Peter S. Lawrence, President and Chief Operating Officer (Principal Financial Officer), of the Company, both duly elected and currently serving, hereby certify that, to the best of his or her knowledge:

1. the quarterly report on Form 10-Q for the period ending June 30, 2011, filed on behalf of the Company pursuant to the Securities Exchange Act of 1934 (the “Exchange Act”) and containing the financial statements of the Company, fully complies with the requirements of section 13(a) of the Exchange Act; and

2. the information contained in such quarterly report fairly presents, in all material respects, the financial condition and results of operations of the Company for the dates and periods covered by such quarterly report.

This certification accompanies the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2011, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (the “2002 Act”) and shall not be deemed filed by the Company for purposes of Section 18 of the Exchange Act.

This certification is being made for the exclusive purpose of compliance by the Principal Executive Officer and Principal Financial Officer of the Company with the requirements of Section 906 of the 2002 Act, and may not be disclosed, distributed or used by any person for any reason other than as specifically required by law.

IN WITNESS WHEREOF, the undersigned have executed this Certificate as of the 4th day of August 2011.

/s/ PAOLO PUCCI
Name:	Paolo Pucci
Title:	Chief Executive Officer
	(Principal Executive Officer)
/s/ PETER S. LAWRENCE
Name:	Peter S. Lawrence
Title:	President and Chief Operating Officer
	(Principal Financial Officer)

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CONDENSED CONSOLIDATED BALANCE SHEETS (Parentheticals) (USD $) In Thousands, except Per Share data	Jun. 30, 2011	Dec. 31, 2010
Statement Of Financial Position [Abstract]
Preferred stock, par value (in dollars per share)	$ 0.01	$ 0.01
Preferred stock, shares authorized	1,000,000	1,000,000
Preferred stock, shares issued
Preferred stock, shares outstanding
Common stock, par value (in dollars per share)	$ 0.01	$ 0.01
Common stock, shares authorised	100,000,000	100,000,000
Common stock, shares issued	53,700,171	44,973,335
Common stock, shares outstanding	53,700,171	44,973,335

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (USD $) In Thousands, except Per Share data	3 Months Ended		6 Months Ended
	Jun. 30, 2011	Jun. 30, 2010	Jun. 30, 2011	Jun. 30, 2010
Research and development revenue	$ 5,447	$ 7,106	$ 18,852	$ 13,431
Costs and expenses:
Research and development	12,836	12,318	24,229	24,762
General and administrative	3,552	3,526	7,095	6,855
Total costs and expenses	16,388	15,844	31,324	31,617
Loss from operations	(10,941)	(8,738)	(12,472)	(18,186)
Interest income	112	217	167	527
Interest expense	(6)	(133)	(12)	(255)
Other income (expense)	31	(123)	47	(615)
Loss before taxes	(10,804)	(8,777)	(12,270)	(18,529)
Income tax benefit		550		550
Net loss	$ (10,804)	$ (8,227)	$ (12,270)	$ (17,979)
Basic and diluted net loss per share:
Net loss per share (in dollars per shares)	$ (0.20)	$ (0.18)	$ (0.24)	$ (0.40)
Weighted average basic and diluted common shares outstanding (in shares)	53,255	44,517	51,961	44,461

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Document and Entity Information	6 Months Ended
	Jun. 30, 2011	Jul. 27, 2011
Document and Entity Information [Abstract]
Entity Registrant Name	ARQULE INC
Entity Central Index Key	0001019695
Trading Symbol	arql
Entity Current Reporting Status	Yes
Entity Voluntary Filers	No
Current Fiscal Year End Date	--12-31
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		53,727,220
Document Type	10-Q
Document Period End Date	Jun. 30, 2011
Amendment Flag	false
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	Q2

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STOCK-BASED COMPENSATION AND STOCK PLANS

6 Months Ended

Jun. 30, 2011

Disclosure Of Compensation Related Costs, Share-Based Payments [Abstract]

STOCK-BASED COMPENSATION AND STOCK PLANS

7.    STOCK-BASED COMPENSATION AND STOCK PLANS

Our  stock-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employees’ requisite service period (generally the vesting period of the equity grant). We estimate the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price of the award, expected option term, expected volatility of our stock over the option’s expected term, risk-free interest rate over the option’s expected term, and the expected annual dividend yield. We believe that the valuation technique and approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock options granted in the three and six months ended June 30, 2011 and 2010.

The following table presents stock-based compensation expense included in our Condensed Consolidated Statements of Operations:

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Research and development	$	394	$	308	$	831	$	664
General and administrative		815		732		1,470		1,242
Total stock-based compensation expense	$	1,209	$	1,040	$	2,301	$	1,906

In the three and six months ended June 30, 2011 and 2010, no stock-based compensation expense was capitalized and there were no recognized tax benefits associated with the stock-based compensation expense.

Option activity under our stock plans for the six months ended June 30, 2011 was as follows:

Stock Options	Number of Shares			Weighted Average Exercise Price
Outstanding as of December 31, 2010		6,355,827		$	5.29
Granted		1,658,950			6.71
Exercised		(670,796	)		5.50
Cancelled		(378,463	)		9.77
Outstanding as of June 30, 2011		6,965,518			5.37
Exercisable as of June 30, 2011		4,015,734		$	5.45

The aggregate intrinsic value of options outstanding at June 30, 2011 was $8,015, of which $4,366 related to exercisable options. The weighted average fair value of options granted in the six months ended June 30, 2011 and 2010 was $4.00 and $2.18 per share, respectively. The intrinsic value of options exercised in the six months ended June 30, 2011 and 2010 was $897 and $175, respectively.

Shares vested, expected to vest and exercisable at June 30, 2011 are as follows:

	Shares		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Vested and unvested expected to vest at June 30, 2011		6,818,903	$	5.37		7.1	$	13,671
Exercisable at June 30, 2011		4,015,734	$	5.45		5.7	$	4,366

The total compensation cost not yet recognized as of June 30, 2011 related to non-vested option awards was $7.9 million, which will be recognized over a weighted-average period of 2.9 years. During the six months ended June 30, 2011, there were 118,113 shares forfeited with a weighted average grant date fair value of $3.21 per share. The weighted average remaining contractual life for options exercisable at June 30, 2011 was 5.7 years.

No restricted stock was granted in 2010. In 2009, we granted 412,200 shares of restricted stock to employees, vesting annually over a four year period. In 2008 we granted 103,316 shares of restricted stock to employees, vesting annually over a four year period and 125,000 shares vesting annually over a two year period. The shares of restricted stock were issued at no cost to the recipients. The weighted average fair value of the restricted stock at the time of grant in 2009 and 2008 was $3.54 and $4.31 respectively, per share, and is being expensed ratably over the vesting period. Through June 30, 2011, 50,271 shares have been forfeited, and 383,592 shares have vested. We recognized share-based compensation expense related to restricted stock of $186 and $214 for the six months ended June 30, 2011 and 2010, respectively.

Restricted stock activity under the Plan for the six months ended June 30, 2011 was as follows:

Restricted Stock	Number of Shares			Weighted Average Grant Date Fair Value
Unvested as of December 31, 2010		333,314		$	3.68
Granted		—			—
Vested		(117,648	)		3.74
Cancelled		(9,013	)		3.80
Unvested as of June 30, 2011		206,653		$	3.64

The fair value of restricted stock vested in the six months ended June 30, 2011 and 2010 was $440 and $449, respectively.

In July 2010, the Company amended its chief executive officer’s (the “CEO’s”) employment agreement to grant the CEO 100,000 stock options, of which 25% vested upon grant and 25% vest annually over the following three years, and a maximum of 390,000 performance-based stock units that vest upon the achievement of certain performance and market based targets. Through June 30, 2011, no expense has been recorded for these performance-based stock units.

In June 2011 our stockholders voted to increase the number of common shares available for awards under our Amended and Restated 1994 Equity Incentive Plan by 3,000,000 from 12,500,000 to 15,500,000, to increase the number of common shares available for purchase by participants under our Amended and Restated 1996 Employee Stock Purchase Plan by 400,000 from 2,000,000 to 2,400,000, and to increase the number of common shares available for awards under our Amended and Restated 1996 Director Stock Option Plan by 200,000 from 750,500 to 950,500.

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MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS

6 Months Ended

Jun. 30, 2011

Marketable Securities and Fair Value Measurements [Abstract]

MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS

3. MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS

We generally classify our marketable securities as available-for-sale at the time of purchase and re-evaluate such designation as of each consolidated balance sheet date. Since we generally intend to convert them into cash as necessary to meet our liquidity requirements our marketable securities are classified as cash equivalents if the original maturity, from the date of purchase, is ninety days or less and as short-term investments if the original maturity, from the date of purchase, is in excess of ninety days but less than one year. Our marketable securities are classified as long-term investments if the maturity date is in excess of one year of the balance sheet date.

We report available-for-sale investments at fair value as of each balance sheet date and include any unrealized gains and, to the extent deemed temporary, unrealized losses in stockholders’ equity. Realized gains and losses are determined using the specific identification method and are included in other income (expense) in the statement of operations. Certain of our marketable securities are classified as trading securities and any changes in the fair value of those securities are recorded as other income (expense) in the statement of operations.

We conduct quarterly reviews to determine the fair value of our investment portfolio and to identify and evaluate each investment that has an unrealized loss, in accordance with the meaning of other-than-temporary impairment and its application to certain investments. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. In the event that the cost basis of a security exceeds its fair value, we evaluate, among other factors, the duration of the period that, and extent to which, the fair value is less than cost basis, the financial health of and business outlook for the issuer, including industry and sector performance, and operational and financing cash flow factors, overall market conditions and trends, our intent to sell the investment and if it is more likely than not that we would be required to sell the investment before its anticipated recovery. Unrealized losses on available-for-sale securities that are determined to be temporary, and not related to credit loss, are recorded in accumulated other comprehensive income (loss).

For available-for-sale debt securities with unrealized losses, we perform an analysis to assess whether we intend to sell or whether we would more likely than not be required to sell the security before the expected recovery of the amortized cost basis. Where we intend to sell a security, or may be required to do so, the security’s decline in fair value is deemed to be other-than-temporary and the full amount of the unrealized loss is reflected in the consolidated statement of operations as an impairment loss.

Regardless of our intent to sell a security, we perform additional analysis on all securities with unrealized losses to evaluate losses associated with the creditworthiness of the security. Credit losses are identified where we do not expect to receive cash flows sufficient to recover the amortized cost basis of a security.

We invest our available cash primarily in U.S. Treasury bill funds, money market funds, commercial paper, and U.S. federal and state agency backed certificates, including auction rate securities that have investment grade ratings. Auction rate securities are structured with short-term interest reset dates of generally less than 90 days, but with contractual maturities that can be well in excess of ten years. At the end of each reset period, which occurs every seven to twenty-eight days, investors can sell or continue to hold the securities at par value. If auction rate securities fail an auction, due to sell orders exceeding buy orders, the funds associated with a failed auction would not be accessible until a successful auction occurred, a buyer was found outside the auction process, the underlying securities matured or a settlement with the underwriter is reached.  ArQule’s marketable securities portfolio includes auction rate securities of $2.3 million (at cost) at June 30, 2011 and $2.6 million (at cost) at December 31, 2010. These auction rate securities failed at auction due to sell orders exceeding buy orders.

The following is a summary of the fair value of available-for-sale marketable securities we held at June 30, 2011 and December 31, 2010:

June 30, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
U.S. Federal Treasury and U.S. government agencies securities-short term	$	8,680	$	4	$	—		$	8,684
Corporate debt securities-short term		47,546		24		(8	)		47,562
		56,226		28		(8	)		56,246
U.S. Federal Treasury and U.S. government agencies securities -long term		41,217		37		—			41,254
Total available-for-sale marketable securities	$	97,443	$	65	$	(8	)	$	97,500

December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
U.S. Federal Treasury and U.S. government agencies securities	$	12,184	$	2	$	(1	)	$	12,185
Corporate debt securities-short term		48,061		12		(20	)		48,053
Total available-for-sale marketable securities	$	60,245	$	14	$	(21	)	$	60,238

The Company’s available-for-sale marketable securities in a loss position at June 30, 2011 and December 31, 2010 were in a continuous unrealized loss position for less than 12 months.

The following is a summary of the fair value of trading securities we held at June 30, 2011 and December 31, 2010:

June 30, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
Auction rate securities	$	2,300	$	—	$	(396	)	$	1,904
Total trading securities	$	2,300	$	—	$	(396	)	$	1,904

December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
Auction rate securities	$	2,600	$	—	$	(446	)	$	2,154
Total trading securities	$	2,600	$	—	$	(446	)	$	2,154

The underlying collateral of our auction rate securities consists of student loans, supported by the federal government as part of the Federal Family Education Loan Program (FFELP).

At June 30, 2011 and December 31, 2010, the Company’s auction rate securities are included in marketable securities-long term and total $1,904 and $2,154, respectively. The net increase in fair value of our auction rate securities of $31 and $47 in the three and six months ended June 30, 2011, respectively was recorded as a gain in other income (expense) in the statement of operations.

In January 2011, we adopted a newly issued accounting standard which requires additional disclosure about the amounts of and reasons for significant transfers in and out of Level 1 and Level 2 fair value measurements. This standard also clarified existing disclosure requirements related to the level of disaggregation of fair value measurements for each class of assets and liabilities and requires disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring Level 2 and Level 3 measurements. In addition, effective for interim and annual periods beginning after December 15, 2010, this standard further requires an entity to present disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. As this accounting standard only requires enhanced disclosure, the adoption of this standard did not impact our financial position or results of operations and will not affect them in the future.

The following tables present information about our assets that are measured at fair value on a recurring basis for the periods presented and indicates the fair value hierarchy of the valuation techniques we utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. We value our level 2 investments using quoted prices for identical assets in the markets where they are traded, although such trades may not occur daily. These quoted prices are based on observable inputs, primarily interest rates. Fair values determined by Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. There were no transfers in or out of Level 1 or Level 2 measurements for the periods presented:

	June 30, 2011		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	23,133	$	23,133	$	—	$	—
Marketable securities—short term		56,246		—		56,246		—
Marketable securities—long term		43,158		—		41,254		1,904
Total	$	122,537	$	23,133	$	97,500	$	1,904

	December 31, 2010		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	16,871	$	16,871	$	—	$	—
Marketable securities—short term		60,238		—		60,238		—
Marketable securities—long term		2,154		—		—		2,154
Total	$	79,263	$	16,871	$	60,238	$	2,154

Due to the lack of market quotes relating to our auction rate securities, the fair value measurements for our auction rate securities have been estimated using an income approach model (discounted cash flow analysis), which is exclusively based on Level 3 inputs. The model considers factors that reflect assumptions market participants would use in pricing including, among others, the collateralization underlying the investments, the creditworthiness of the counterparty, the expected future cash flows, liquidity premiums, the probability of successful auctions in the future, and interest rates. The assumptions used are subject to volatility and may change as the underlying sources of these assumptions and markets conditions change.

Due to the lack of market quotes relating to our auction rate put option, the fair value measurements for our put option at June 30, 2010 were estimated using a valuation approach commonly used for forward contracts in which one party agrees to sell a financial instrument (generating cash flows) to another party at a particular time for a predetermined price, which is based on Level 3 inputs. In this approach the present value of all expected future cash flows is subtracted from the current fair value of the security, and the resulting value is calculated as a future value at an interest rate reflective of counterparty risk. On June 30, 2010, the company exercised the auction rate put option and in July 2010, UBS AG redeemed at par value all of the Company’s auction rate securities held by UBS AG that were outstanding at June 30, 2010.

The following tables roll forward the fair value of our auction rate securities and put option, whose fair values are determined by Level 3 inputs for the periods presented:

	Amount
Balance at December 31, 2010	$	2,154
Gain on auction rate securities	47
Settlements	(297)
Balance at June 30, 2011	$	1,904

	Amount
Balance at March 31, 2011	$	2,072
Gain on auction rate securities	31
Settlements	(199		)
Balance at June 30, 2011	$	1,904

	Amount
Balance at December 31, 2009	$	59,791
Loss on auction rate securities and put option	(615		)
Settlements	(33,850		)
Balance at June 30, 2010	$	25,326

	Amount
Balance at March 31, 2010	$	53,074
Loss on auction rate securities and put option	(123		)
Settlements	(27,625		)
Balance at June 30, 2010	$	25,326

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RECENT ACCOUNTING PRONOUNCEMENTS

6 Months Ended

Jun. 30, 2011

Recent Accounting Pronouncements [Abstract]

RECENT ACCOUNTING PRONOUNCEMENTS

9.    RECENT ACCOUNTING PRONOUNCEMENTS

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption.

Recently Issued and Adopted Accounting Standards

In October 2009, the FASB issued an accounting standards update (“ASU”) on Multiple-Deliverable Revenue Arrangements. This standards update amends existing revenue recognition accounting pronouncements and provides accounting principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated, and the consideration allocated. Among other provisions, this guidance eliminates the requirement to have objective evidence for undelivered products and services and instead provides for separate revenue recognition based upon management’s best estimate of the selling price for an undelivered item when there is no other means to determine the fair value of that undelivered item. Previous accounting principles required that the fair value of the undelivered item be the price of the item either sold in a separate transaction between unrelated third parties or the price charged for each item when the item is sold separately. Revenue from our existing multiple-deliverable arrangements is recognized over the estimated development period using the contingency adjusted performance model. Under the new approach, revenue for new agreements or material modifications of existing agreements will be recognized based upon the relative selling price of each element in the arrangement. The Company adopted this guidance prospectively on January 1, 2011 and the adoption of this standard did not have a material impact on our financial position and results of operations; however, the new guidance will impact any new collaboration agreements or material modifications to any existing agreements.

In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition—Milestone Method” . This ASU provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. Under the milestone method of revenue recognition, consideration that is contingent upon achievement of a milestone in its entirety can be recognized as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. This standard provides the criteria to be met for a milestone to be considered substantive which includes that: a) performance consideration earned by achieving the milestone be commensurate with either performance to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from performance to achieve the milestone; and b) relate to past performance and be reasonable relative to all deliverables and payment terms in the arrangement. The Company adopted this guidance on a prospective basis for milestones on or after January 1, 2011 and the adoption of this standard did not have a material impact on our financial position and results of operations; however, the new guidance will impact any new collaboration agreements or material modifications to any existing agreements.

In January 2011, we adopted ASU No. 2010-06, ”Improving Disclosures About Fair Value Measurements” which requires additional disclosure about the amounts of and reasons for significant transfers in and out of Level 1 and Level 2 fair value measurements. In addition, effective for interim and annual periods beginning after December 15, 2010, which for us is January 1, 2011, this standard further requires an entity to present disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. As this accounting standard only requires enhanced disclosure, the adoption of this newly issued accounting standard did not impact our financial position or results of operations.

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs ”. This newly issued accounting standard clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This ASU is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011, which for us is January 1, 2012. We do not expect that adoption of this standard will have a material impact on our financial position or results of operations.

In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220) ”. This newly issued accounting standard (1) eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity; (2) requires the consecutive presentation of the statement of net income and other comprehensive income; and (3) requires an entity to present reclassification adjustments on the face of the financial statements from other comprehensive income to net income. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income nor do the amendments affect how earnings per share is calculated or presented. This ASU is required to be applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011, which for us is January 1, 2012. As this accounting standard only requires enhanced disclosure, the adoption of this standard will not impact our financial position or results of operations.

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INCOME TAXES

6 Months Ended

Jun. 30, 2011

Income Tax Disclosure [Abstract]

INCOME TAXES

10.    INCOME TAXES

The Company recorded a $0.6 million income tax benefit in the quarter ended June 30, 2010 attributable to an election it made in the second quarter of 2010 under revised legislation that allowed net operating losses to offset 100% of alternative minimum tax (“AMT”).  Prior to this legislation, only 90% of AMT could be offset by net operating losses.  The Company received a refund in July 2010 of the $0.6 million AMT paid in 2009.

As of December 31, 2010, we had federal net operating loss (“NOL”), state NOL, and research and development credit carryforwards of approximately $219,187, $159,727 and $22,816 respectively, which can be used to offset future federal and state income tax liabilities and expire at various dates through 2030. Federal net capital loss carryforwards of approximately $571 can be used to offset future federal capital gains and expire in 2015. Approximately $15,004 of our federal NOL and $1,568 of our state NOL were generated from excess tax deductions from share- based awards, the tax benefit of which will be credited to additional paid-in-capital when the deductions reduce current taxes payable.

At June 30, 2011, and December 31, 2010 we had no unrecognized tax benefits. We do not expect that the total amount of unrecognized tax benefits will significantly increase in the next twelve months. We recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2011 and December 31, 2010, we had no accrued interest or penalties related to uncertain tax positions. The tax years 2007 through 2010 remain open to examination by the major taxing jurisdictions to which we are subject, which is primarily the U.S. Prior tax years remain open to the extent of net operating loss and tax credit carryforwards.

Utilization of NOL and research and development credit carryforwards may be subject to a substantial annual limitation in the event of an ownership change that has occurred previously or could occur in the future pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, as well as similar state provisions. An ownership change may limit the amount of NOL and research and development credit carryforwards that can be utilized annually to offset future taxable income and tax, and may, in turn, result in the expiration of a portion of those carryforwards before utilization. In general, an ownership change, as defined by Section 382, results from transactions that increase the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three year period. We undertook a detailed study of our NOL and research and development credit carryforwards in the fourth quarter of 2009 to determine whether such amounts are likely to be limited by Section 382. As a result of this analysis, and a detailed review of ownership changes through 2010, we currently do not believe Sections 382’s limitations will significantly impact our ability to offset income with available NOL and research and development credit carryforwards. However, future ownership changes under Section 382 may limit our ability to fully utilize these tax benefits.

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STOCK OFFERING

6 Months Ended

Jun. 30, 2011

Stock Offering [Abstract]

STOCK OFFERING

8.    STOCK OFFERING

On January 25, 2011, we sold 8,050,000 shares of common stock at $6.15 per share for aggregate net proceeds of approximately $46.8 million after commissions and other offering expenses.

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NATURE OF OPERATIONS AND BASIS OF PRESENTATION

6 Months Ended

Jun. 30, 2011

Nature Of Operations and Basis Of Presentation [Abstract]

NATURE OF OPERATIONS AND BASIS OF PRESENTATION

1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION

We are a clinical-stage biotechnology company organized as a Delaware corporation in 1993 and engaged in the research and development of innovative cancer therapeutics. Our mission is to produce novel medicines with differentiated mechanisms of action that target specific biological pathways implicated in a wide range of cancers.

Our lead product candidate is tivantinib (ARQ 197), an orally administered, small molecule inhibitor of the c-Met receptor tyrosine kinase that is currently being evaluated in Phase 2 and Phase 3 clinical trials in a number of indications. In January 2011, we enrolled the first patient in the Phase 3 trial of tivantinib in non-small cell lung cancer (“NSCLC”) in combination with erlotinib, and in February 2011, we received a $25 million payment from Daiichi Sankyo Co., Ltd. (“Daiichi Sankyo”) resulting from the achievement of this clinical milestone. We have licensed commercial rights to tivantinib for human cancer indications to Daiichi Sankyo in the U.S., Europe, South America and the rest of the world, excluding Japan and certain other Asian countries, where we have licensed commercial rights to Kyowa Hakko Kirin Co., Ltd. (“Kyowa Hakko Kirin”).  We expect that Kyowa Hakko Kirin will independently initiate the recruitment of a Phase 3 trial in Asia of tivantinib and erlotinib in non-squamous NSCLC patients with wild type EGFR in the near future.

Our proprietary pipeline is directed toward molecular targets and biological processes with demonstrated roles in the development of human cancers. The most advanced candidates in this pipeline are ARQ 621, an inhibitor of the Eg5 kinesin motor protein, and ARQ 736, an inhibitor of the RAF kinases, both of which are in Phase 1 clinical testing. A third pipeline program, focused on small molecule inhibitors of fibroblast growth factor receptor, is in pre-clinical development. Our drug discovery efforts are focused primarily on the ArQule Kinase Inhibitor Platform (“AKIP™”), which we are using to generate compounds designed to inhibit kinases without competing with adenosine triphosphate (“ATP”) for binding to the target kinase, as well as other types of kinase inhibitors. We have assessed the potential of AKIP™ to target multiple kinases in oncology and other therapeutic areas, and we are generating and validating compounds that inhibit these kinase targets.

We have prepared the accompanying condensed consolidated financial statements pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to these rules and regulations.  These condensed consolidated financial statements should be read in conjunction with our audited financial statements and footnotes related thereto for the year ended December 31, 2010 included in our annual report on Form 10-K filed with the SEC on March 2, 2011.

The unaudited condensed consolidated financial statements include, in our opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of our financial position as of June 30, 2011, the results of our operations for the three and six months ended June 30, 2011and June 30, 2010, and cash flows for the six months ended June 30, 2011 and June 30, 2010. The results of operations for such interim periods are not necessarily indicative of the results to be achieved for the full year.

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COMPREHENSIVE LOSS

6 Months Ended

Jun. 30, 2011

Comprehensive Loss [Abstract]

COMPREHENSIVE LOSS

4.    COMPREHENSIVE LOSS

Comprehensive loss is comprised of net loss and other comprehensive gain (loss). Other comprehensive income (loss) includes unrealized losses on our available-for-sale securities that are excluded from net loss. Total comprehensive loss for the three and six months ended June 30, 2011 and 2010 was as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Net loss	$	(10,804	)	$	(8,227	)	$	(12,270	)	$	(17,979	)
Unrealized gain (loss) on marketable securities		101			(7	)		64			(36	)
Comprehensive loss	$	(10,703	)	$	(8,234	)	$	(12,206	)	$	(18,015	)

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ACCOUNTS PAYABLE AND ACCRUED EXPENSES

6 Months Ended

Jun. 30, 2011

Payables and Accruals [Abstract]

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

5.    ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses include the following at June 30, 2011 and December 31, 2010:

	June 30, 2011		December 31, 2010
Accounts payable	$	454	$	1,260
Accrued payroll		2,116		3,450
Accrued outsourced pre-clinical and clinical fees		21,960		10,375
Accrued professional fees		690		785
Other accrued expenses		978		966
	$	26,198	$	16,836

Accrued outsourced pre-clinical and clinical fees include amounts payable for our share of tivantinib collaboration costs that are netted against revenue as contra-revenue.

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NET LOSS PER SHARE

6 Months Ended

Jun. 30, 2011

Earnings Per Share [Abstract]

NET LOSS PER SHARE

6.    NET LOSS PER SHARE

Net loss per share is computed using the weighted average number of common shares outstanding. Basic and diluted net loss per share amounts are equivalent for the periods presented as the inclusion of potential common shares in the number of shares used for the diluted computation would be anti-dilutive to loss per share. Unvested restricted stock, although legally issued and outstanding, are not considered outstanding for purposes of calculating basic net income per share. The weighted average number of common shares outstanding excludes 206,653 and 334,214 unvested shares of restricted stock for the three and six months ended June 30, 2011 and 2010, respectively and 390,000 performance-based stock units for the three and six months ended June 30, 2011.  There were no performance-based stock units outstanding at June 30, 2010. Potential common shares, the shares that would be issued upon the exercise of outstanding stock options, were 6,965,518 and 6,238,332 for the three and six months ended June 30, 2011 and 2010, respectively.

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $) In Thousands	6 Months Ended
	Jun. 30, 2011	Jun. 30, 2010
Cash flows from operating activities:
Net loss	$ (12,270)	$ (17,979)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	598	744
Amortization of premium/discount on marketable securities	570	522
Amortization of deferred gain on sale leaseback	(277)	(277)
Non-cash stock compensation	2,301	1,906
Loss on auction rate securities put option		5,074
Gain on auction rate securities	(47)	(4,459)
Changes in operating assets and liabilities:
Prepaid expenses and other current assets	(4,497)	993
Other long-term assets	(24)	(5)
Accounts payable and accrued expenses	9,362	2,107
Deferred revenue	(1,103)	(9,622)
Net cash used in operating activities	(5,387)	(20,996)
Cash flows from investing activities:
Purchases of marketable securities	(95,131)	(36,821)
Proceeds from sale or maturity of marketable securities	57,660	76,998
Purchases of property and equipment	(324)	(144)
Net cash provided by (used in) investing activities	(37,795)	40,033
Cash flows from financing activities:
Payment of notes payable		(29,900)
Proceeds from stock offering, net	46,761
Proceeds from stock option exercises	3,808	460
Net cash provided by (used in) financing activities	50,569	(29,440)
Net increase (decrease) in cash and cash equivalents	7,387	(10,403)
Cash and cash equivalents, beginning of period	20,457	36,551
Cash and cash equivalents, end of period	$ 27,844	$ 26,148

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COLLABORATIONS AND ALLIANCES

6 Months Ended

Jun. 30, 2011

Organization, Consolidation and Presentation Of Financial Statements [Abstract]

COLLABORATIONS AND ALLIANCES

2. COLLABORATIONS AND ALLIANCES

Daiichi Sankyo Kinase Inhibitor Discovery Agreement

On November 7, 2008, we entered into a research collaboration, exclusive license and co-commercialization agreement with Daiichi Sankyo under which we are applying our proprietary technology and know-how using our AKIP™ technology for the discovery of therapeutic compounds that selectively inhibit certain kinases in the field of oncology. The agreement defines two such kinase targets, and Daiichi Sankyo will have an option to license compounds directed to these targets following the completion of certain pre-clinical studies. The agreement provides for a $15 million upfront payment, which we received in November 2008, research support payments for the first and second years of the collaboration, licensing fees for compounds discovered as a result of this research, milestone payments related to clinical development, regulatory review and sales, and royalty payments on net sales of compounds from the collaboration. We retain the option to co-commercialize licensed products developed under this agreement in the U.S. In May 2009, we entered into an agreement with Daiichi Sankyo related to potential future milestones and royalties for our AKIP™ collaboration, under which we could receive up to $265 million in potential development and sales milestone payments for each product selected for clinical development. Upon commercialization of a licensed product, we would also receive tiered, double-digit royalties on its net sales. On October 12, 2010, we and Daiichi Sankyo announced the expansion of this agreement, establishing a third target, with an option for a fourth, in oncology, and including a two-year extension through November 2012.

The duration and termination of the agreement are tied to future events. Unless earlier terminated due to breach, insolvency or upon 90 days notice by Daiichi Sankyo, the agreement terminates on the later of (i) the expiration of the research collaboration period, or (ii) various periods specified in the agreement for development and commercialization of products. If Daiichi Sankyo has commercialized a licensed product or products, the agreement will continue in force until such time as all royalty terms for all licensed products have ended. The royalty term, on a country-by-country basis for a product, ends as of the later of (i) the expiration of the last valid claim under a patent covering the manufacture, use, or sale of a licensed product or (ii) a certain number of years from the date of the commercial sale of the licensed product in such country.

Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated performance period through November 2012. For the three and six months ended June 30, 2011 and 2010, $3.2 million and $5.6 million, and $2.8 million and $5.3 million, respectively were recognized as revenue. At June 30, 2011, $13.2 million remains in deferred revenue.

Daiichi Sankyo Tivantinib Agreement

On December 18, 2008, we entered into a license, co-development and co-commercialization agreement with Daiichi Sankyo to conduct research, clinical trials and the commercialization of tivantinib in human cancer indications in the U.S., Europe, South America and the rest of the world, excluding Japan, China (including Hong Kong), South Korea and Taiwan, where Kyowa Hakko Kirin has exclusive rights for development and commercialization.

The agreement provides for a $60 million cash upfront licensing payment from Daiichi Sankyo to us, which we received in December 2008, and an additional $560 million in potential development and sales milestone payments. Upon commercialization, we will receive tiered, double-digit royalties from Daiichi Sankyo on net sales of tivantinib commensurate with the magnitude of the transaction. We retain the option to participate in the commercialization of tivantinib in the U.S. We and Daiichi Sankyo will share equally the costs of Phase 2 and Phase 3 clinical studies, with our share of Phase 3 costs payable solely from milestone and royalty payments by Daiichi Sankyo.

In each quarter the tivantinib collaboration costs that we incur are compared with those of Daiichi Sankyo. If our costs for the quarter exceed Daiichi Sankyo’s, we recognize revenue on the amounts due to us under the contingency adjusted performance model. Revenue is calculated on a pro-rata basis using the time elapsed from inception of the agreement over the estimated duration of the development period under the agreement. If our costs for the quarter are less than those of Daiichi Sankyo’s, we report the amount due to Daiichi Sankyo as contra-revenue in that quarter. For the three and six months ended June 30, 2011 and 2010 our tivantinib collaboration costs incurred were less than those of Daiichi Sankyo’s by $3.7 million and  $8.7 million, and $0.1 million and $0.8 million, respectively.  Accordingly those amounts were recognized as contra-revenue and were netted against our tivantinib Daiichi Sankyo research and development revenue. For the three and six month’s ended June 30, 2011 our  non-refundable share of advance drug purchases for the tivantinib trial was $4.8 million.  These costs will be recognized as contra-revenue as the related drugs are administered to patients.  For the three and six month’s ended June 30, 2011 $0.3 million was recognized as contra-revenue and at June 30, 2011 $4.5 million remains deferred and is reported in prepaid and other assets.

The dosing of the first patient in a Phase 3 clinical trial of tivantinib in NSCLC, announced in January 2011, triggered the payment of a $25 million development milestone from Daiichi Sankyo that was received in February 2011. We determined that the milestone is not considered substantive under FASB guidance related to multiple element arrangements. Accordingly, the milestone payment was recorded as deferred revenue and is being recognized as revenue using the contingency-adjusted performance model with an estimated development period through December 2013. For the three and six months ended June 30, 2011, $1.3 million and $12.7 million, respectively was recognized as revenue from the milestone.

The duration and termination of the agreement are tied to future events. Unless earlier terminated due to breach, insolvency or upon 90 days notice if prior to phase 3 clinical trials or 180 days notice if on or after the beginning of phase 3 clinical trials by Daiichi Sankyo, the agreement shall continue until the later of (i) such time as Daiichi Sankyo is no longer developing at least one licensed product or (ii) if Daiichi Sankyo has commercialized a licensed product or products, such time as all royalty terms for all licensed products have ended. The royalty term, on a country-by-country basis for a product, ends as of the later of (i) the expiration of the last valid claim under a patent covering the manufacture, use, or sale of a licensed product or (ii) a certain number of years from the date of the commercial sale of the licensed product in such country.

Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated development period through December 2013. For the three and six months ended June 30, 2011 and 2010, $1.0 million and $10.9 million, and $3.4 million and $6.2 million, respectively were recognized as net revenue. At June 30, 2011, $46.4 million remains in deferred revenue.

Kyowa Hakko Kirin Licensing Agreement

On April 27, 2007, we entered into an exclusive license agreement with Kyowa Hakko Kirin to develop and commercialize tivantinib in Japan and parts of Asia. A $3 million portion of an upfront licensing fee was received by the Company under this agreement in the first quarter of 2007, and an additional $27 million in upfront licensing fees was received on May 7, 2007. The agreement includes $123 million in upfront and potential development milestone payments from Kyowa Hakko Kirin to ArQule, including the $30 million cash upfront licensing payments. In February 2008, we received a $3 million milestone payment from Kyowa Hakko Kirin. Upon commercialization, ArQule will receive tiered royalties in the mid-teen to low-twenty percent range from Kyowa Hakko Kirin on net sales of tivantinib. Kyowa Hakko Kirin will be responsible for all clinical development costs and commercialization of the compound in certain Asian countries, consisting of Japan, China (including Hong Kong), South Korea and Taiwan. In July 2010, we announced the initiation of a Phase 2 trial with tivantinib by Kyowa Hakko Kirin in gastric cancer, for which we received a $5 million milestone payment in September 2010. The milestone payment was recorded as deferred revenue and is being recognized as revenue using the contingency-adjusted performance model with an estimated development period through April 2016. We expect that Kyowa Hakko Kirin will independently initiate the recruitment of a Phase 3 trial in Asia of tivantinib and erlotinib in non-squamous NSCLC patients with wild type EGFR in the near future.

In addition to the upfront and possible regulatory milestone payments totaling $123 million, the Company will be eligible for future milestone payments based on the achievement of certain levels of net sales. The Company will recognize the payments, if any, as revenue in accordance with its revenue recognition policies. As of June 30, 2011, the Company had not recognized any revenue from these sales milestone payments, and there can be no assurance that it will do so in the future.

The duration and termination of the agreement are tied to future events. Unless earlier terminated due to breach, insolvency or upon 90 days notice by Kyowa Hakko Kirin, the agreement terminates on the date that the last royalty term expires in all countries in the territory. The royalty term ends as of the later of (i) the expiration of the last pending patent application or expiration of the patent in the country covering the manufacture, use, or sale of a licensed product or (ii) a certain number of years from the date of the commercial launch in such country of such license product.

Revenue for this agreement is recognized using the contingency-adjusted performance model with an estimated development period through April 2016. For the three and six months ended June 30, 2011 and 2010 $1.2 million and $2.3 million, and $1.0 million and $1.9 million, respectively were recognized as revenue. At June 30, 2011 $21.8 million remains in deferred revenue.

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NOTES PAYABLE

6 Months Ended

Jun. 30, 2011

Notes Payable Note [Abstract]

NOTES PAYABLE

11.    NOTES PAYABLE

On July 8, 2008, we entered into a collateralized, revolving credit line agreement for up to $47.5 million with UBS Bank USA, secured by a first priority lien and security interest in the auction rate securities held by us in an account with UBS Financial Services Inc. On June 30, 2010, the company exercised its UBS auction rate put option and in July 2010, UBS AG redeemed at par value all of the Company’s auction rate securities held by them that were outstanding at June 30, 2010. The Company used a portion of the 2010 redemptions to retire the notes payable to UBS AG and the credit line at UBS AG was cancelled in July 2010.

In October 2008, we entered into a margin loan agreement with another financial institution collateralized by $2.9 million of our auction rate securities and borrowed $1.7 million which is the maximum amount allowed under this facility. The amount outstanding under this facility of $1.7 million at June 30, 2011 is due on demand and is collateralized by $2.3 million of auction rate securities.

Interest expense was $6 and $12 for the three and six months ended June 30, 2011, respectively.  Interest expense was $133 and $255 for the three and six months ended June 30, 2010, respectively.

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CONDENSED CONSOLIDATED BALANCE SHEETS (USD $) In Thousands	Jun. 30, 2011	Dec. 31, 2010
Current assets:
Cash and cash equivalents	$ 27,844	$ 20,457
Marketable securities-short term	56,246	60,238
Prepaid expenses and other current assets	5,616	1,119
Total current assets	89,706	81,814
Marketable securities-long term	43,158	2,154
Property and equipment, net	3,243	3,517
Other assets	1,405	1,381
Total assets	137,512	88,866
Current liabilities:
Accounts payable and accrued expenses	26,198	16,836
Note payable	1,700	1,700
Current portion of deferred revenue	33,170	27,825
Current portion of deferred gain on sale leaseback	552	552
Total current liabilities	61,620	46,913
Deferred revenue, net of current portion	48,179	54,627
Deferred gain on sale leaseback, net of current portion	1,611	1,888
Total liabilities	111,410	103,428
Commitments and contingencies
Stockholders' equity (deficit) :
Preferred stock, $0.01 par value; 1,000,000 shares authorized; no shares issued or outstanding
Common stock, $0.01 par value; 100,000,000 shares authorized; 53,700,171 and 44,973,335 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively	537	450
Additional paid-in capital	436,496	383,713
Accumulated other comprehensive income (loss)	57	(7)
Accumulated deficit	(410,988)	(398,718)
Total stockholders' equity (deficit)	26,102	(14,562)
Total liabilities and stockholders' equity (deficit)	$ 137,512	$ 88,866