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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended September 30, 2007

OR



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

For the transition period from  to

Commission File Number: 000-51472



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COLEY
PHARMACEUTICAL GROUP, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 06-1506689                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

93 WORCESTER STREET, SUITE 101

WELLESLEY, MA 02481

(Address of principal executive offices, including zip
code)

(781) 431-9000

(Registrants telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)



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

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

Large accelerated filer ̈Accelerated filer  x    Non-accelerated filer ̈

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

As of October 26, 2007, there were 26,604,496 shares of the Registrants Common Stock issued and outstanding.



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##### Table of Contents

Coley Pharmaceutical Group, Inc.

Form 10-Q Index

For the Quarter Ended September 30, 2007



|                             |  |                                                                                                                                                                                                                             |  |     
|---------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                             |  |                                                                                                                                                                                                                             |  | Page
|PART IFINANCIAL INFORMATION |  |                                                                                                                                                                                                                            
|                             |  |                                                                                                                                                                                                                            
|ITEM 1                       |  | FINANCIAL STATEMENTS (Unaudited)                                                                                                                                                                                            |  |     
|                             |  |                                                                                                                                                                                                                            
|                             |  | Condensed Consolidated Balance Sheets (Unaudited) as of September 30, 2007 and December 31, 2006                                                                                                                            |  | 3   
|                             |  |                                                                                                                                                                                                                            
|                             |  | Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited) for the three months ended September 30, 2007 and September 30, 2006 and the nine months ended September 30, 2007 and September 30,
2006 |  | 4   
|                             |  |                                                                                                                                                                                                                            
|                             |  | Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2007 and September 30, 2006                                                                                             |  | 5   
|                             |  |                                                                                                                                                                                                                            
|                             |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                                                                                                                              |  | 6   
|                             |  |                                                                                                                                                                                                                            
|ITEM 2.                      |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                                                                                                                       |  | 13  
|                             |  |                                                                                                                                                                                                                            
|ITEM 3.                      |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                                                                                                  |  | 23  
|                             |  |                                                                                                                                                                                                                            
|ITEM 4.                      |  | CONTROLS AND PROCEDURES                                                                                                                                                                                                     |  | 23  
|                             | 
|PART IIOTHER INFORMATION    |  |                                                                                                                                                                                                                            
|                             |  |                                                                                                                                                                                                                            
|ITEM 1.                      |  | LEGAL PROCEEDINGS                                                                                                                                                                                                           |  | 23  
|                             |  |                                                                                                                                                                                                                            
|ITEM 1A.                     |  | RISK FACTORS                                                                                                                                                                                                                |  | 23  
|                             |  |                                                                                                                                                                                                                            
|ITEM 2.                      |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                                                                                                                                 |  | 24  
|                             |  |                                                                                                                                                                                                                            
|ITEM 3.                      |  | DEFAULTS UPON SENIOR SECURITIES                                                                                                                                                                                             |  | 25  
|                             |  |                                                                                                                                                                                                                            
|ITEM 4.                      |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                                                                                                         |  | 25  
|                             |  |                                                                                                                                                                                                                            
|ITEM 5.                      |  | OTHER INFORMATION                                                                                                                                                                                                           |  | 25  
|                             |  |                                                                                                                                                                                                                            
|ITEM 6.                      |  | EXHIBITS                                                                                                                                                                                                                    |  | 25  



2



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##### Table of Contents

PART IFINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

Coley Pharmaceutical Group, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)



|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | - | ----------------- | - | -------- | -
|(in thousands, except share and per share data)                                                                                                                                                                         |  | September 30, 2007 |          |   | December 31, 2006 |  
|Assets                                                                                                                                                                                                                  |  |                    |          |   |                   |   |          |  
|Current assets                                                                                                                                                                                                          |  |                    |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                                                                               |  | $                  | 69,985   |   |                   | $ | 52,505   |  
|Marketable securities                                                                                                                                                                                                   |  |                    | 17,794   |   |                   |   | 54,541   |  
|Accounts receivable                                                                                                                                                                                                     |  |                    | 875      |   |                   |   | 448      |  
|Prepaid expenses and other current assets                                                                                                                                                                               |  |                    | 2,006    |   |                   |   | 1,833    |  
|Deferred royalty fees                                                                                                                                                                                                   |  |                    | 2,094    |   |                   |   | 2,022    |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Total current assets                                                                                                                                                                                                    |  |                    | 92,754   |   |                   |   | 111,349  |  
|Property and equipment, net                                                                                                                                                                                             |  |                    | 5,418    |   |                   |   | 4,597    |  
|Deferred royalty fees                                                                                                                                                                                                   |  |                    | 2,873    |   |                   |   | 4,236    |  
|Other noncurrent assets                                                                                                                                                                                                 |  |                    | 2,026    |   |                   |   | 2,093    |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Total assets                                                                                                                                                                                                            |  | $                  | 103,071  |   |                   | $ | 122,275  |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|                                                                                                                                                                                                                        |  |                   
|Liabilities and Shareholders Equity                                                                                                                                                                                    |  |                    |          |   |                   |   |          |  
|Current liabilities                                                                                                                                                                                                     |  |                    |          |   |                   |   |          |  
|Accounts payable                                                                                                                                                                                                        |  | $                  | 1,337    |   |                   | $ | 1,874    |  
|Accrued expenses                                                                                                                                                                                                        |  |                    | 5,333    |   |                   |   | 4,332    |  
|Current portion of payable due to 3M                                                                                                                                                                                    |  |                    | 4,602    |   |                   |   |         |  
|Current portion of note payable                                                                                                                                                                                         |  |                    | 3,439    |   |                   |   | 2,024    |  
|Deferred revenue                                                                                                                                                                                                        |  |                    | 16,893   |   |                   |   | 15,873   |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                                                                               |  |                    | 31,604   |   |                   |   | 24,103   |  
|Deferred revenue                                                                                                                                                                                                        |  |                    | 14,480   |   |                   |   | 25,596   |  
|Payable due to 3M, net of current portion                                                                                                                                                                               |  |                    | 7,653    |   |                   |   |         |  
|Note payable, net of current portion                                                                                                                                                                                    |  |                    |         |   |                   |   | 1,093    |  
|Other noncurrent liabilities                                                                                                                                                                                            |  |                    | 922      |   |                   |   | 841      |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Total liabilities                                                                                                                                                                                                       |  |                    | 54,659   |   |                   |   | 51,633   |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Commitments and contingencies                                                                                                                                                                                           |  |                    |          |   |                   |   |          |  
|Shareholders equity                                                                                                                                                                                                    |  |                    |          |   |                   |   |          |  
|Preferred stock, $0.01 par value:                                                                                                                                                                                       |  |                    |          |   |                   |   |          |  
|Authorized shares5,000,000 shares at September 30, 2007 and December 31, 2006, respectively; no shares outstanding at
September 30, 2007 and December 31, 2006, respectively                                           |  |                    |          |   |                   |   |          |  
|Common stock, $0.01 par value:                                                                                                                                                                                          |  |                    |          |   |                   |   |          |  
|Authorized shares50,000,000 shares at September 30, 2007 and December 31, 2006, respectively; issued and outstanding
shares26,601,376 and 26,382,432 shares at September 30, 2007 and December 31, 2006, respectively |  |                    | 265      |   |                   |   | 264      |  
|Additional paid-in capital                                                                                                                                                                                              |  |                    | 295,175  |   |                   |   | 293,032  |  
|Accumulated other comprehensive income                                                                                                                                                                                  |  |                    | 1,590    |   |                   |   | 619      |  
|Deferred compensation                                                                                                                                                                                                   |  |                    | (2,626   | ) |                   |   | (5,438   | )
|Accumulated deficit                                                                                                                                                                                                     |  |                    | (245,992 | ) |                   |   | (217,835 | )
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Total shareholders equity                                                                                                                                                                                              |  |                    | 48,412   |   |                   |   | 70,642   |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Total liabilities and shareholders equity                                                                                                                                                                              |  | $                  | 103,071  |   |                   | $ | 122,275  |  
|                                                                                                                                                                                                                        |  |                    |          |   |                   |   |          |  

The accompanying notes are an integral part of these condensed consolidated financial statements.



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##### Table of Contents

Coley Pharmaceutical Group, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)



|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                         |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|(in thousands, except per share amounts)                                 |  | 2007                            |        |   | 2006                           |   |        | 2007 |  |   | 2006    |  
|Revenue                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Collaborative agreements                                                 |  | $                               | 4,155  |   |                                | $ | 4,387  |      |  | $ | 22,769  |   |  | $ | 12,395  |  
|Government contracts and grants                                          |  |                                 | 957    |   |                                |   | 701    |      |  |   | 3,223   |   |  |   | 2,619   |  
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total revenue                                                            |  |                                 | 5,112  |   |                                |   | 5,088  |      |  |   | 25,992  |   |  |   | 15,014  |  
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                                         |  |                                 |        |  
|Operating expenses                                                       |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Research and development                                                 |  |                                 | 8,633  |   |                                |   | 10,966 |      |  |   | 27,372  |   |  |   | 32,685  |  
|Purchased technology                                                     |  |                                 |       |   |                                |   |       |      |  |   | 16,757  |   |  |   |        |  
|General and administrative                                               |  |                                 | 2,799  |   |                                |   | 3,413  |      |  |   | 9,614   |   |  |   | 9,385   |  
|Royalty expense                                                          |  |                                 | 507    |   |                                |   | 539    |      |  |   | 2,964   |   |  |   | 1,599   |  
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                 |  |                                 | 11,939 |   |                                |   | 14,918 |      |  |   | 56,707  |   |  |   | 43,669  |  
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Loss from operations                                                     |  |                                 | (6,827 | ) |                                |   | (9,830 | )    |  |   | (30,715 | ) |  |   | (28,655 | )
|                                                                         |  |                                 |        |  
|Other income and expense                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Interest income                                                          |  |                                 | 1,150  |   |                                |   | 1,453  |      |  |   | 3,637   |   |  |   | 4,386   |  
|Interest expense                                                         |  |                                 | (572   | ) |                                |   | (67    | )    |  |   | (709    | ) |  |   | (197    | )
|Foreign currency loss                                                    |  |                                 | (124   | ) |                                |   | (18    | )    |  |   | (267    | ) |  |   | (72     | )
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total other income                                                       |  |                                 | 454    |   |                                |   | 1,368  |      |  |   | 2,661   |   |  |   | 4,117   |  
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Loss before income taxes                                                 |  |                                 | (6,373 | ) |                                |   | (8,462 | )    |  |   | (28,054 | ) |  |   | (24,538 | )
|                                                                         |  |                                 |        |  
|Income tax expense                                                       |  |                                 | (48    | ) |                                |   | (22    | )    |  |   | (103    | ) |  |   | (66     | )
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                                 |  | $                               | (6,421 | ) |                                | $ | (8,484 | )    |  | $ | (28,157 | ) |  |   | (24,604 | )
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                                         |  |                                 |        |  
|Comprehensive loss                                                       |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                                 |  | $                               | (6,421 | ) |                                | $ | (8,484 | )    |  | $ | (28,157 | ) |  | $ | (24,604 | )
|Other comprehensive income (loss):                                       |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Foreign currency translation adjustments                                 |  |                                 | 487    |   |                                |   | 58     |      |  |   | 967     |   |  |   | 396     |  
|Unrealized gain (loss) on investments, net                               |  |                                 |       |   |                                |   | 64     |      |  |   | 4       |   |  |   | (16     | )
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Comprehensive loss                                                       |  | $                               | (5,934 | ) |                                | $ | (8,362 | )    |  | $ | (27,186 | ) |  | $ | (24,224 | )
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                                         |  |                                 |        |  
|Basic and diluted net loss per share                                     |  | $                               | (0.24  | ) |                                | $ | (0.32  | )    |  | $ | (1.06   | ) |  | $ | (0.94   | )
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Weighted average shares used to compute basic and diluted loss per share |  |                                 | 26,566 |   |                                |   | 26,314 |      |  |   | 26,503  |   |  |   | 26,203  |  
|                                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  

The accompanying notes are an integral part of these condensed consolidated financial statements.



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Coley Pharmaceutical Group, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)



|                                                                       |  |                                |         |   |      |   |         |  
|---------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                       |  | Nine Months EndedSeptember 30, |        
|(in thousands)                                                         |  | 2007                           |         |   | 2006 |  
|Cash flows from operating activities                                   |  |                                |         |   |      |   |         |  
|Net cash used in operating activities                                  |  | $                              | (13,409 | ) |      | $ | (28,335 | )
|                                                                       |  |                                |         |   |      |   |         |  
|                                                                       |  |                               
|Cash flows from investing activities                                   |  |                                |         |   |      |   |         |  
|Purchases of marketable securities                                     |  |                                | (53,254 | ) |      |   | (46,762 | )
|Maturities of marketable securities                                    |  |                                | 90,005  |   |      |   | 49,840  |  
|First annual payment for purchased technology                          |  |                                | (5,000  | ) |      |   |        |  
|(Deposits) releases of restricted cash                                 |  |                                | (111    | ) |      |   | 46      |  
|Purchases of property and equipment                                    |  |                                | (1,532  | ) |      |   | (672    | )
|                                                                       |  |                                |         |   |      |   |         |  
|Net cash provided by investing activities                              |  |                                | 30,108  |   |      |   | 2,452   |  
|                                                                       |  |                                |         |   |      |   |         |  
|                                                                       |  |                               
|Cash flows from financing activities                                   |  |                                |         |   |      |   |         |  
|Principal payments of capital lease obligations                        |  |                                | (129    | ) |      |   | (714    | )
|Proceeds from stock option exercises                                   |  |                                | 205     |   |      |   | 537     |  
|Proceeds from repayment of shareholder note                            |  |                                |        |   |      |   | 44      |  
|                                                                       |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                    |  |                                | 76      |   |      |   | (133    | )
|                                                                       |  |                                |         |   |      |   |         |  
|Exchange rate effect on cash and cash equivalents                      |  |                                | 705     |   |      |   | 442     |  
|                                                                       |  |                                |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                   |  |                                | 17,480  |   |      |   | (25,574 | )
|Cash and cash equivalents, beginning of period                         |  |                                | 52,505  |   |      |   | 85,911  |  
|                                                                       |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of period                               |  | $                              | 69,985  |   |      | $ | 60,337  |  
|                                                                       |  |                                |         |   |      |   |         |  
|                                                                       |  |                               
|Supplemental disclosure of noncash investing and financing activities: |  |                                |         |   |      |   |         |  
|Payable to 3M for purchased technology                                 |  | $                              | 11,757  |   |      | $ |        |  
|Repayment of shareholder note                                          |  | $                              |        |   |      | $ | 353     |  
|Capital lease obligation incurred                                      |  | $                              |        |   |      | $ | 412     |  

The accompanying notes are an integral part of these condensed consolidated financial statements.



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##### Table of Contents

Coley Pharmaceutical Group, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

(in thousands, except share data)

1. Nature of the Business, Basis of Presentation and Significant Accounting Policies

Nature of the Business

Coley Pharmaceutical Group, Inc. (the Company) is focused on discovering and developing a novel class of drug candidates for several disease
indications including cancers, allergy and asthma and to enhance the effectiveness of vaccines. The Companys proprietary TLR Therapeutics act by stimulating a specific class of targets, called Toll-like receptors, or TLRs, found on
immune system cells which direct the immune system to fight disease.

Basis of Presentation and Principles of Consolidation

The condensed consolidated financial statements reflect the operations of the Company and its wholly-owned subsidiaries, Coley Pharmaceutical GmbH, Coley
Pharmaceutical Group, Ltd. and Coley Pharmaceutical Security Corporation. All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying condensed consolidated financial statements of Coley Pharmaceutical Group, Inc. have been prepared in accordance with generally accepted accounting principles and the rules and regulations of the
Securities and Exchange Commission, or SEC, for interim financial information. Accordingly, these financial statements do not include all the information and footnotes required by generally accepted accounting principles for complete financial
statements and should be read in conjunction with the Companys consolidated financial statements included in the Companys Annual Report on Form 10-K for the year ended December 31, 2006. The financial information as of
September 30, 2007 and for the three and nine months ended September 30, 2007 and September 30, 2006 is unaudited, but in the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary
for a fair statement of the results of these interim periods have been included. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles
generally accepted in the United States of America.

The results of the Companys operations for any interim period are not
necessarily indicative of the results that may be expected for any other interim period or for a full fiscal year.

Cash, Cash Equivalents and
Marketable Securities

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be
cash equivalents. Marketable securities are classified as available-for-sale and are carried at market value with unrealized gains and losses reported as other comprehensive income or loss, which is a separate component of
shareholders equity.

Marketable securities as of September 30, 2007 consist of the following:



|                            |  |                |        |                  |   |                             |  |   |       
|--------------------------- |  | -------------- | ------ | ---------------- | - | --------------------------- |  | - | ------
|                            |  | Amortized cost |        | Unrealized gains |   | Estimated Fair Market Value
|Certificates of deposit     |  | $              | 2,000  |                  | $ | 1                           |  | $ | 2,001 
|U.S. government agencies    |  |                | 4,491  |                  |   | 2                           |  |   | 4,493 
|Auction rate securities     |  |                | 11,300 |                  |   |                            |  |   | 11,300
|                            |  |                |        |                  |   |                             |  |   |       
|Total marketable securities |  | $              | 17,791 |                  | $ | 3                           |  | $ | 17,794
|                            |  |                |        |                  |   |                             |  |   |       

Deferred Royalty Fees

Royalty fees represent payments for in-licensed technology from third parties (licensors) where the Company generally obtains rights to develop and commercialize products covered by the licensed
technology. These licensors are primarily the University of Iowa Research Foundation (UIRF) and the Ottawa Health Research Institute (OHRI).

The Companys license agreements generally require royalty payments to the licensor based on the sale of products covered by the licensed technology. The Company also has the right to sublicense the technology to
third parties and is required to pay the licensor part of any sublicense fees the Company receives. Deferred royalty fees represent payments to licensors that have been deferred and will be recognized as expense as the Company recognizes the related
revenue under its collaborative research and development agreements.



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##### Table of Contents

Deferred royalty fees included in the condensed consolidated balance sheet totaled $4,967 and $6,258 at
September 30, 2007 and December 31, 2006, respectively.

2. Stock-Based Compensation

The Company currently has one equity-based compensation plan from which stock-based compensation awards can be granted to employees and directors. At the
Companys annual meeting of stockholders held on June 14, 2007, the Companys stockholders approved the amendment and restatement of the 2005 Stock Plan to increase the number of shares available to be granted under the Plan by
1,500,000 shares. A total of 1,682,234 shares were available to be granted under the Plan as of September 30, 2007. In addition, the Company has another equity-based compensation plan that has been terminated as to future grants, but under
which options are currently outstanding. The equity incentive plans are described more fully in Note 2 to the consolidated financial statements included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31,
2006.

The table below illustrates the fair value per share and Black-Scholes option pricing model with the following assumptions used for
grants issued during the three and nine months ended September 30, 2007 and 2006:



|                                                                 |  |                                 |      |   |                                 |   |      |      |  |   |              |   |  |   |              |  
|---------------------------------------------------------------- |  | ------------------------------- | ---- | - | ------------------------------- | - | ---- | ---- |  | - | ------------ | - |  | - | ------------ | -
|                                                                 |  | Three Months EndedSeptember 30, |      |   | Nine Months Ended September 30, |  
|                                                                 |  | 2007                            |      |   | 2006                            |   |      | 2007 |  |   | 2006         |  
|Weighted average fair value of options granted during the period |  | $                               | 2.03 |   |                                 | $ | 7.56 |      |  | $ | 4.17         |   |  | $ | 8.45         |  
|Risk-free interest rate                                          |  |                                 | 4.31 | % |                                 |   | 5.0  | %    |  |   | 4.31% - 4.94 | % |  |   | 4.80% - 5.10 | %
|Expected dividend yield                                          |  |                                 | 0    | % |                                 |   | 0    | %    |  |   | 0            | % |  |   | 0            | %
|Expected option life, in years                                   |  |                                 | 6.25 |   |                                 |   | 6.25 |      |  |   | 6.25         |   |  |   | 6.25         |  
|Expected stock price volatility                                  |  |                                 | 67   | % |                                 |   | 75   | %    |  |   | 67           | % |  |   | 75           | %

The Company, due to its limited history as a public company, bases its expected volatility upon
the expected stock price volatility of similar companies that are in the same industry, stage of life cycle, size and financial leverage and whose stock prices are publicly available.

The following table shows stock-based compensation expense included in the condensed consolidated statements of operations for the three and nine months
ended September 30, 2007 and 2006:



|                                       |  |                                 |       |                                |   |       |  |      |       |  |   |      
|-------------------------------------- |  | ------------------------------- | ----- | ------------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                       |  | Three Months EndedSeptember 30, |       | Nine Months EndedSeptember 30,
|                                       |  | 2007                            |       | 2006                           |   | 2007  |  | 2006
|Research and development               |  | $                               | 672   |                                | $ | 627   |  | $    | 2,170 |  | $ | 1,880
|General and administrative             |  |                                 | 800   |                                |   | 731   |  |      | 2,581 |  |   | 2,102
|                                       |  |                                 |       |                                |   |       |  |      |       |  |   |      
|Total stock-based compensation expense |  | $                               | 1,472 |                                | $ | 1,358 |  | $    | 4,751 |  | $ | 3,982
|                                       |  |                                 |       |                                |   |       |  |      |       |  |   |      

For the nine months ended
September 30, 2007, $289 of non-cash stock compensation expense was recognized for the re-measurement of stock options related to the modification of options that was undertaken for three employees terminated as a result of the decision to
suspend further development of ACTILON in January 2007. For stock options accounted for under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB No. 25), $564 of deferred compensation was reclassified against additional paid-in-capital to account for the terminations.

A summary of stock option activity under the Companys 1997 Employee, Director and Consultant Stock Option Plan and 2005 Stock Option Plan for the nine months ended September 30, 2007 is as follows:



|                                          |  |                  |   |  |                                           |      |                                                        |     |                           |   |       
|----------------------------------------- |  | ---------------- | - |  | ----------------------------------------- | ---- | ------------------------------------------------------ | --- | ------------------------- | - | ------
|                                          |  | Number of Shares |   |  | Weighted Average Exercise Price per
Share |      | Weighted Average Remaining Contractual
Life (in Years) |     | Aggregate Intrinsic Value
|Options outstanding at December 31, 2006  |  | 3,154,389        |   |  | $                                         | 5.87 |                                                        | 7.7 |                           | $ | 17,570
|Granted                                   |  | 1,586,236        |   |  | $                                         | 6.39 |                                                        |     |                           |   |       
|Cancelled                                 |  | (207,435         | ) |  | $                                         | 9.37 |                                                        |     |                           |   |       
|Exercised                                 |  | (174,530         | ) |  | $                                         | 1.18 |                                                        |     |                           |   |       
|                                          |  |                  |   |  |                                           |      |                                                        |     |                           |   |       
|Options outstanding at September 30, 2007 |  | 4,358,660        |   |  | $                                         | 6.08 |                                                        | 7.9 |                           | $ | 3,499 
|Options vested at September 30, 2007      |  | 2,123,735        |   |  | $                                         | 4.86 |                                                        | 6.7 |                           | $ | 2,989 



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As of September 30, 2007, there remained approximately $12,393 of compensation costs, net of
forfeitures, related to unvested stock options to be recognized as expense over a weighted average period of approximately 2.54 years.

3. Net Loss Per
Common Share

The Company accounts for and discloses net loss per common share in accordance with SFAS No. 128, Earnings Per
Share (SFAS No. 128). Under the provisions of SFAS No. 128, basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding. Diluted net loss per share is
computed by dividing net loss by the weighted-average number of common shares and other potential common shares then outstanding. Other potential common shares consist of shares issuable upon the exercise of stock options and common stock warrants.
Diluted net loss per share is identical to basic net loss per share for all periods presented since other potential common shares are excluded from the calculation as their effect is anti-dilutive.

The following table shows potentially dilutive common shares outstanding which are not included in the historical calculations of net loss per common
share as the effect of their inclusion is anti-dilutive during each period:



|                      |  |                     |  |          
|--------------------- |  | ------------------- |  | ---------
|                      |  | As of September 30,
|                      |  | 2007                |  | 2006     
|Options               |  | 4,358,660           |  | 3,225,153
|Common stock warrants |  | 1,925,561           |  | 2,038,205
|                      |  |                     |  |          
|                      |  | 6,284,221           |  | 5,263,358
|                      |  |                     |  |          

4. Significant Research and Development and Licensing Agreements

3M Company

In June 2007, the Company entered into an
agreement with 3M Company (3M) to acquire the majority of 3Ms therapeutic Toll-like receptor cancer programs. The acquisition included a pipeline of clinical and preclinical small molecule candidates targeting TLR7 and TLR8, as
well as an intellectual property estate of more than two hundred issued and several hundred pending patents and a library in excess of ten thousand small molecule compounds that stimulate TLR7 and TLR8.

Under the terms of the agreement, 3M will receive guaranteed cash payments totaling $20,000 over a three year period, including a payment of $5,000 that
was made in June 2007. In addition, 3M could potentially receive future milestone payments, as well as royalties from the sale of any products that are developed and commercialized in association with this acquisition.

The Company expensed the net present value of the 3M assets, totaling $16,757, upon execution of the agreement in the second quarter of 2007. The
purchase price was expensed based on the Companys evaluation that the incomplete early stage technology had no alternative future use. The present value was based on an effective interest rate of 12.5%. Interest expense of $3,243 will be
accreted from July 2007 through July 2010 to reflect the total purchase price of $20,000 and be recorded as a component of interest expense on the income statement. As of September 30, 2007, $498 of interest expense has been recorded. After
consideration of the $5,000 that was paid during the second quarter of 2007, there is $4,602 classified as a short term obligation and $7,653 as a long-term obligation in the condensed consolidated September 30, 2007 balance sheet.

Either party may terminate the agreement upon customary terms included in the agreement, including upon an uncured material breach by the other party,
as defined in the agreement. This license extends through the later to occur of (i) the expiration of all patent rights licensed or assigned under the agreement, or (ii) the Companys obligation to make payments pursuant to the
agreement.

Dynavax Technologies Corporation

In June 2007, the Company entered into an agreement with Dynavax Technologies Corporation (Dynavax). Under the terms of the agreement, Dynavax received a non-exclusive license under the Companys immunostimulatory
oligonucleotide patent estate for the commercialization of HEPLISAV, a hepatitis B prophylactic vaccine, currently in Phase III clinical trials. In the second quarter of 2007, the Company received a $5,000 payment which was recognized as
revenue in the 2007 period due to the absence of future obligations required to be performed by the Company. The Company is also eligible to receive up to an additional $5,000 if regulatory approvals of HEPLISAV are obtained, as well as royalty
payments on future sale, if any, of HEPLISAV.



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Either party may terminate the agreement upon customary terms included in the agreement, including upon
an uncured material breach by the other party, as defined in the agreement. This license will extend through the expiration of the last valid patent claim in a country covered by the agreement.

Merck & Co., Inc.

In April 2007, the
Company entered into an agreement with Merck & Co., Inc. (Merck) that granted a worldwide, non-exclusive license for the Companys VaxImmune vaccine adjuvant for incorporation into vaccines being developed by Merck for
certain infectious diseases and Alzheimers disease, as well as the option to add additional fields to the license. Under the terms of the agreement, Merck paid the Company a license fee of $4,000. The $4,000 payment was recognized as revenue
in the second quarter of 2007 due to the absence of future obligations required to be performed by the Company. The Company is also eligible to receive milestone payments of up to $33,000 as well as royalties from the sale of any products that are
commercialized under the agreement.

Either party may terminate the agreement upon customary terms included in the agreement, including
upon an uncured material breach by the other party, as defined in the agreement, and upon Mercks sale of any remaining inventory. This license will extend through the expiration of all royalty obligations included in the agreement.

GlaxoSmithKline

The Company has a non-exclusive license agreement with GlaxoSmithKline to develop and commercialize vaccines for three cancer indications. In the second quarter of 2007, GlaxoSmithKline announced that it had finalized
plans to evaluate the Companys vaccine adjuvant, VaxImmuneTM, in a Phase III clinical trial as part of GlaxoSmithKlines MAGE-A3 cancer
immunotherapeutic in patients with early stage, completely resected non-small cell lung cancer. As a result of these plans to initiate a Phase III trial, $2,000 of milestone payments became due under the terms of the collaboration. Of the $2,000 in
milestone payments, GlaxoSmithKline paid $1,000 in cash in the second quarter of 2007 and applied $1,000 from a previous payment recorded as deferred revenue because it was creditable against future milestones. These milestone payments of $2,000 are
recognized over 20 years, the expected period of the Companys performance obligations, using the retrospective approach and accordingly, $492 was recognized as revenue in the nine months ended September 30, 2007 for these milestone
payments. Refer to Note 9 in the Companys unaudited financial statements accompanying this Report for discussion of the $3,000 milestone payment received in October 2007 triggered by the initiation of a Phase III trial with VaxImmune.

Because the Companys license agreement for cancer indications grants GlaxoSmithKline rights to present and future know-how related
to the Companys TLR Therapeutic product candidates, the Company defers nonrefundable payments and amortizes them and related expense over the lives of these agreements, estimated to be twenty years. Accordingly, for the three months ended
September 30, 2007 and 2006, the Company recognized option, license and milestone revenue of $100 and $75, respectively. For the nine months ended September 30, 2007 and 2006, the Company recognized revenue of $1,007 and $225,
respectively. As of September 30, 2007, there is $5,783 of deferred revenue from previous option, license and milestone payments that will be recognized over the remaining 15 years of the performance period.

Under the terms of these agreements, the Company is entitled to receive up to approximately $44,000 for cancer vaccines representing upfront and various
option payments, development and regulatory milestones, as well as royalties based on any future product sales. The Company has received payments from GlaxoSmithKline aggregating $9,023 for cancer vaccines related to upfront license fees, option
fees and patent milestones as of September 30, 2007. GlaxoSmithKline has initiated four clinical studies combining TLR9 agonists with their vaccines. These trials consist of two clinical trials in breast cancer, as well as clinical trials in
prostate and lung cancer.

GlaxoSmithKline may terminate the collaboration relationship without cause upon 90 days written notice to
the Company and upon payment of all accrued research and development funding and milestone obligations. Either GlaxoSmithKline or the Company may terminate the collaboration relationship under customary terms included in the agreement, including if
the other party commits an uncured material default, as defined in the license agreements. The cancer vaccine license agreement extends until December 2021.

Pfizer Inc.

In March 2005, the Company entered into a series of agreements with Pfizer Inc. (Pfizer) under
which it has granted Pfizer development and worldwide marketing rights to CPG 7909, now referred to as PF-3512676 by Pfizer, for the treatment, control and prevention of multiple cancers, including the treatment of advanced non-small cell lung
cancer, or NSCLC.

Pfizer had initiated and enrolled 800 patients in two pivotal international Phase III clinical trials of PF-3512676 in
first-line treatment of advanced NSCLC patients. In June 2007, Pfizer discontinued its development program in advanced lung cancer with PF-3512676 in combination with cytotoxic chemotherapy. This included two Phase III clinical trials and two



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Phase II clinical trials. Pfizers decision to discontinue these clinical trials was based on a scheduled interim analysis of the Phase III clinical
trials by an independent Data Safety Monitoring Committee (DSMC). The analysis showed that there was no evidence that PF-3512676 produced additional clinical efficacy over that achieved with the standard cytotoxic chemotherapy regimen alone. The
DSMC concluded that the risk-benefit profile did not justify continuation of the trials.

Pfizer continues to investigate PF-3512676 as a potential treatment for lung and other cancers with two ongoing clinical trials. These two trials include a Phase II clinical trial evaluating PF-3512676 in combination with Tarceva® as a potential treatment for refractory NSCLC, as well as a Phase I clinical trial evaluating PF-3512676 combined with their anti-CTLA-4 (cytotoxicT lymphocyte antigen-4) targeted monoclonal
antibody in patients with advanced malignant melanoma.

Pursuant to a separate screening agreement, Pfizer is also providing the Company
with funding for the discovery and development of next-generation TLR9 agonists for cancer, which, if successful, would be licensed to Pfizer and could result in milestone payments and royalties to the Company.

Under the license agreement, the Company received a $50,000 upfront license fee in 2005 and may receive up to $455,000 in milestone payments, a
significant majority of which relates to potential development and regulatory approval milestones, as well as royalties on any future product sales. The Company also entered into a stock purchase agreement with Pfizer pursuant to which Pfizer
purchased $10,000 of the Companys common stock in a private placement concurrent with the Companys initial public offering.

In
connection with the $50,000 upfront license payment from Pfizer, the Company is recognizing this initial fee over 44 months, the expected period of the Companys performance obligations. Accordingly, for the three months ended
September 30, 2007 and 2006, the Company recognized license, sponsored research revenue and expense reimbursements of $3,902 and $4,059, respectively. For the nine months ended September 30, 2007 and 2006, the Company recognized revenue of
$12,582 and $11,498, respectively. To date, the Company has received or invoiced $57,243 for upfront license, sponsored research and expense reimbursement under the Pfizer agreement. As of September 30, 2007, there is $19,512 of deferred
revenue that will be recognized over the remaining 15 months of the performance period.

Under the terms of the license agreement, the
license extends until the later to occur of the expiration of the last of the licensed patents which covers the sale of PF-3512676 or any next generation TLR9 agonist licensed by the Company to Pfizer and the emergence of generic competition for
such products, in each case, as determined on a country-by-country basis. Currently, the latest to expire of the Companys patents covering PF-3512676 is scheduled to expire in 2014. The Company has patent applications pending which, if issued,
may provide patent protection for PF-3512676 through 2017.

Pfizer may terminate the collaboration relationship without cause upon not less
than 120 days prior written notice. Either Pfizer or the Company may terminate the collaboration relationship upon the bankruptcy of the other party or the commitment by the other party of an uncured material default, as defined in the license
agreement.

Upon a change of control of the Company, as defined in the license agreement, the agreement would remain in effect, although
Pfizer would have the right to terminate certain provisions.

Government Contracts and Grants

U.S. National Institute of Allergy and Infectious Diseases (NIAID), part of the National Institutes of Health

The Company has a $6,250 grant with the NIAID to perform research and preclinical development in the area of pulmonary innate immune activation for
bio-terror defense. NIAID has approved the Companys request to extend the expiration of the grant one year until February 2008. The Company has recognized revenues under this grant of $106 and $73 for the three months ended September 30,
2007 and 2006, respectively. For the nine months ended September 30, 2007 and 2006, the Company has recognized revenue under this grant of $328 and $648, respectively.

In 2004, the Company was awarded a $16,902 five-year contract from the NIAID to perform research in the area of innate immune receptors and vaccine
adjuvant discovery for defense against bio-terror agents. The Company recognized revenues under this contract of $851 and $627 for the three months ended September 30, 2007 and 2006, respectively. For the nine months ended September 30,
2007 and 2006, the Company recognized revenue under this contract of $2,895 and $1,971, respectively.

Funding of the above mentioned
government contracts and grants beyond the U.S. governments current fiscal year is subject to Congressional appropriations.



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Technology In-Licenses

Ottawa Health Research Institute

The Company has an exclusive worldwide license agreement with the
OHRI to develop and commercialize products using technology developed by OHRI in vaccines. In conjunction with an amendment to this license in 2001, the Company issued OHRI 8,734 shares of its common stock. The agreement requires royalty payments on
the sale of products covered by the licensed technology. The Company has the right to grant sublicenses to third parties and is required to pay OHRI part of any sublicense proceeds received.

During the nine months ended September 30, 2007, the Company paid OHRI $300 for royalties related to the $5,000 license payment received from
Dynavax, the $4,000 license payment received from Merck and the $1,000 milestone payment received from GlaxoSmithKline. The payments to OHRI are expensed to match the recognition of revenue for the license and milestone payments described above.

University of Iowa Research Foundation

The Company has an exclusive worldwide license agreement with the UIRF to develop and commercialize products covered by certain technology patented by UIRF. This technology was developed by the Companys
scientific co-founder, while he was at the University of Iowa, among others. The agreement requires minimum annual license maintenance fees of $150 beginning in 2003. The Company is obligated to pay UIRF royalty payments on net sales of its products
incorporating the licensed technology. The Company has the right to grant sublicenses to third parties and is required to pay UIRF a royalty on any sublicense proceeds received.

During the nine months ended September 30, 2007, the Company paid UIRF $1,300 for royalties related to the $5,000 license payment received from
Dynavax, the $4,000 license payment received from Merck and the $1,000 milestone payment received from GlaxoSmithKline. The payments to UIRF are expensed to match the recognition of revenue for the license and milestone payments described above.

5. Suspension of ACTILON Clinical Development

In January 2007, the Company suspended its independent development of ACTILON, the Companys product candidate for the treatment of Hepatitis C virus (HCV) infection. In accordance with this program decision, the Company reduced its
headcount by approximately 22 percent, or 32 employees. Under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the Company has recognized $1,176 of expense related to the severance and outplacement support
offered to employees affected by this program decision. For the nine months ended September 30, 2007, $767 was recorded as research and development expense and $409 as general and administrative expense. As of September 30, 2007, the
Company has paid $1,071 and has $105 accrued for severance expenses, which are expected to be fully paid by December 2007.

In addition,
the Company has recognized $289 of non-cash stock compensation expense for the re-measurement of stock options related to the modification of options that was undertaken for three employees impacted by this program decision in compliance with their
severance agreements. For stock options accounted for under APB No. 25, $564 of deferred compensation was reclassified against additional paid-in-capital to account for the terminations. Refer to Note 2 in the Companys unaudited financial
statements accompanying this Report for further discussion on stock compensation expense.

6. Abandoned Lease Facility

In June 2007, the Company abandoned a lease for office and laboratory space in Langenfeld, Germany in order to move into a larger location in Dusseldorf,
Germany that would accommodate the Companys research and development requirements. In the second quarter of 2007, the Company entered into a sublease agreement for the space covering approximately 60% of its costs through 2010, the date at
which the Companys lease obligations cease. The Company accounts for abandoned lease facilities in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. A facility is considered abandoned
on the date that the Company ceases to use it. On this date, the Company records expense for the present value of the total remaining costs for the abandoned facility reduced by any actual or probable sublease income. In June 2007, the Company
recorded an accrual for the abandoned facility, reduced by the sublease income, of 202, of which 171 ($242 as of September 30, 2007) remains as of September 30, 2007. There is $81 classified as a short term obligation and $161
as a long term obligation in the condensed consolidated balance sheet at September 30, 2007. The Company also disposed of fully depreciated assets of 304 ($429 as of September 30, 2007) and also recognized 93 ($128 as of
September 30, 2007) of loss related to disposals of leasehold improvements, furniture, and lab equipment in the abandoned lease facility. We do not expect any future charges related to this abandonment.



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7. Accounting for the Uncertainty of Income Taxes

On January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (FIN 48). FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition issues.

The Company has an uncertain tax position of approximately
$5,000 which did not change significantly during the three and nine months ended September 30, 2007. The uncertain tax position results in a decrease of the Companys net operating loss deferred tax asset, which is offset by a valuation
allowance. Accordingly, there was no impact on the Companys consolidated financial position, results of operations and cash flows as a result of the adoption of FIN 48.

Interest and penalties related to income taxes will be recorded as a component of the tax provision. As of September 30, 2007, we have not accrued
any amounts for interest or penalties.

The Company files United States federal income tax returns as well as income tax returns in various
state, local, and foreign jurisdictions. In the United States, the Company is no longer subject to any tax assessment from an income tax examination in major taxing jurisdictions for years before 2003, except to the extent that in the future it
utilizes net operating losses or tax credit carryforwards that originated before 2003. In Canada and Germany, the Company is subject to any tax assessment from an income tax examination for years from 2001 through 2006. The Company currently is not
under examination by the Internal Revenue Service or other jurisdictions for any tax years.

As discussed in Note 9 to the consolidated
financial statements included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2006, the Company has a valuation allowance for the majority of its net deferred tax asset. The Company currently provides a
valuation allowance against deferred tax assets when it is more likely than not that some portion, or all of its deferred tax assets, will not be realized.

8. Subsequent Event  Stockholder Rights Plan

On October 5, 2007, the Board of Directors adopted a Stockholder
Rights Plan that was designed to protect the Companys stockholders against abusive or coercive takeover tactics in the context of an unsolicited offer or takeover attempt. Under the plan, the Board of Directors declared a dividend of one
preferred stock purchase right (a Right) for each outstanding share of common stock held by stockholders of record on October 15, 2007. Each Right may be exercised, under certain circumstances, to purchase one one-hundredth of a
share of Series A Junior Participating Preferred Stock, par value $.01 per share, at an exercise price of $25.00, subject to adjustment. The Rights may be exercised ten days after a public announcement that a person or group has acquired beneficial
ownership of 15 percent or more of the Companys common stock, or ten days after the commencement of a tender or exchange offer for the Companys common stock that would result in the acquisition of 15 percent or more of common stock,
except pursuant to an offer for all outstanding shares of common stock which the Board of Directors determines to be fair to, and otherwise in the best interests of, the Company and its stockholders. Upon exercise of the Right, each holder will
receive the number of shares of common stock which equals the exercise price of the Right divided by one-half of the current market price of the common stock. The Rights will expire on October 5, 2017, unless redeemed or exchanged earlier by
the Company. The Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right at any time prior to the acquisition of 15 percent or more of the common stock.

9. Subsequent Event  GlaxoSmithKline Milestone

In October 2007, GlaxoSmithKline initiated a
Phase III trial with VaxImmune as part of GlaxoSmithKlines MAGE-A3 cancer immunotherapeutic in patients with early stage, completely resected NSCLC under the Companys non-exclusive license agreement with GlaxoSmithKline to develop and
commercialize vaccines for cancer. Refer to Note 4 in the Companys unaudited financial statements accompanying this Report for further discussion of the collaboration agreement with GlaxoSmithKline. The initiation of the trial triggered a
$3,000 milestone payment that was received from GlaxoSmithKline on October 25, 2007. The milestone payment will be recognized over 20 years, the expected period of the Companys performance obligations, using the retrospective approach and
accordingly, the Company will recognize $775 of revenue in the fourth quarter of 2007 in connection with this milestone payment.

10. Recent Accounting
Pronouncements

In June 2007, the FASB issued Emerging Issues Task Force (EITF) Issue No. 07-3, Accounting for
Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities, or EITF 07-3. The consensus requires that nonrefundable advance payments made for goods or services to be used in future
research and development activities should be deferred and capitalized until such time as the related goods or services are delivered or are performed. If an entity does not expect the goods to be delivered or services to be rendered, the
capitalized advance payment should be charged to expense. EITF 07-3 is effective for new contracts entered into after January 1, 2008. The initial adjustment to reflect the effect of applying the consensus as a change in accounting principle
would be accounted for as a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is in the process of evaluating whether EITF 07-3 will have a material effect on its financial position or results
of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities (SFAS No. 159). SFAS No. 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been
elected are reported in



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earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating whether this
standard will have a material effect on its financial position or results of operations.

In September 2006, the FASB issued SFAS
No. 157, Fair Value Measurement. This standard addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles
(GAAP). This standard is effective for all financial statements issued for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating whether this standard will have a material effect on its
financial position or results of operations.



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

Various statements in this Quarterly Report on Form 10-Q are forward-looking statements concerning our future products, revenues, expenses, liquidity
and cash needs, as well as our plans and strategies. Forward-looking statements give managements current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historic or
current events. They use words such as anticipate, estimate, expect, project, intend, plan, believe, should, may, will, and other
words and terms of similar meaning. These forward-looking statements are based upon current expectations and we assume no obligation to update this information. Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q may
turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks or uncertainties. Consequently, no forward-looking statement can be guaranteed. Actual results may vary materially from those set forth
in the forward-looking statements. Forward-looking statements, therefore, should be considered in light of all of the information included or referred to in this Quarterly Report on Form 10-Q, including the cautionary information set forth under
Part II, Item 1A., Risk Factors.

You should read the following discussion and analysis of financial condition and results of
operations together with our condensed consolidated financial statements and related notes included elsewhere in this report.

Overview

We are a biopharmaceutical company focused on discovering and developing TLR
Therapeutics, a novel class of drug candidates, for several disease indications including cancers, asthma and allergic disorders, and to enhance the effectiveness of vaccines. We began
operations in 1998. We and our collaborators currently have three drug candidates in clinical trials, all of which agonize, or stimulate, one specific Toll-like receptor (TLR), TLR9.

Our most advanced clinical compound is VaxImmune, our proprietary vaccine adjuvant. In October 2007, GlaxoSmithKline (GSK) initiated a Phase III clinical trial with VaxImmune as part of GSKs MAGE-A3 cancer immunotherapeutic in patients with early
stage, completely resected non-small cell lung cancer or NSCLC (stage IB, II or IIIA NSCLC). The randomized, double-blind, and placebo-controlled MAGRIT trial (MAGE-A3 as Adjuvant NSCLC Immunotherapy) is expected to enroll approximately 2,270
patients with stage IB, II or IIIA resectable NSCLC. The primary endpoint of the trial is disease-free survival.

We have an exclusive
license with Pfizer Inc. (Pfizer) for the development and commercialization of our lead TLR9 agonist compound in cancer, PF-3512676. In June 2007, we announced that Pfizer discontinued its development program in advanced lung
cancer with PF-3512676 in combination with cytotoxic chemotherapy. This included two Phase III clinical trials and two Phase II clinical trials.

Pfizers decision to discontinue these clinical trials was based on a scheduled interim analysis of the Phase III clinical trials by an independent Data Safety Monitoring Committee (DSMC). The analysis showed that there was no evidence
that PF-3512676 produced additional clinical efficacy over that achieved with the standard cytotoxic chemotherapy regimen alone. The DSMC concluded that the risk-benefit profile did not justify continuation of the trials.

Pfizer continues to investigate PF-3512676 as a potential treatment for lung and other cancers
with two ongoing clinical trials. These two trials include a Phase II clinical trial evaluating PF-3512676 in combination with Tarceva® as a potential treatment for refractory NSCLC, as
well as a Phase I clinical trial evaluating PF-3512676 combined with Pfizers anti-CTLA-4 (cytotoxicT lymphocyte antigen-4) targeted monoclonal antibody in patients with advanced malignant melanoma. Pfizer is currently planning additional
clinical trials with PF-3512676 to evaluate its safety and potential efficacy in other cancer indications.

We have a collaboration with
sanofi-aventis in the area of asthma and allergic disorders. We also have license agreements with various vaccine developers in addition to GSK, including Merck & Co., Inc. (Merck) and Novartis AG, to improve the performance and
efficacy of their vaccines with VaxImmune.

In June 2007, we entered into an agreement with 3M Company (3M) to acquire the
majority of their therapeutic Toll-like receptor cancer programs. 3M will receive guaranteed cash payments totaling $20.0 million over a three-year period, including $5.0 million which we paid them in June 2007. The acquisition includes a pipeline
of clinical and preclinical small



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molecule candidates targeting TLR7 and TLR8, as well as an intellectual property estate of more than two hundred issued and several hundred pending patents.

In 2006 and 2005, we explored the development of ACTILONTMfor the treatment of HCV in treatment-experienced patients. Based on interim results from two ongoing clinical trials in the treatment-experienced HCV patient
population, we made a strategic program decision in January 2007 to suspend our independent development of ACTILON. We believe that the commercial potential for ACTILON may be fully realized by pursuing clinical development in the
treatment-naïve patient population or by using ACTILON in combination with newer therapies currently in clinical development by other biotechnology and pharmaceutical companies. We believe these opportunities are better explored with a partner
which will share the development costs or at such time when the market opportunity and development path for a second-generation immunomodulating agent for the treatment of HCV becomes clearer.

In accordance with the decision to suspend our independent development of ACTILON, we reduced our headcount, predominately in the area of clinical
development staff, by approximately 22 percent, or 32 employees. This reduction was completed in the second quarter of 2007. At September 30, 2007, we had 116 full time employees. As a result of this reduction in headcount and based upon our
current operating plan, we anticipate achieving approximately $3.0 million in cost savings in 2007.

For the nine months ended
September 30, 2007, we have recognized $1.2 million of expense related to the severance and outplacement support offered to employees affected by this program decision and have $0.1 million accrued for severance expenses, which are expected to
be fully paid by December 2007. In addition, we have recognized $0.3 million of non-cash stock compensation expense for the re-measurement of stock options related to the modification of options that was undertaken for three employees impacted by
this program decision in compliance with their severance agreements.

As a result of our decision to suspend our independent development of
ACTILON, we will focus our resources towards discovering and developing new TLR Therapeutics, including other synthetic agonists and antagonists targeting TLRs 7, 8 and 9, as well as synthetic RNA-based drugs designed to stimulate TLRs 7 and 8. This
change will result in a shift in the components of our research and development spending in 2007 compared to 2006. Based on our current operating plan, we expect spending in discovery research and preclinical expense to increase by approximately
$4.0 million in 2007 from 2006 and spending in clinical trials and drug development to decrease by approximately $8.5 million in 2007 from 2006. Overall spending in research and development is expected to decrease by approximately $4.0 million in
2007 from 2006 to approximately $37.0 million. At this time, we do not anticipate that the acquisition of the cancer program from 3M will have a material impact on our 2007 research and development spending.

Since our inception, we have generated significant losses while we or our collaborators have advanced our products into clinical trials. As of
September 30, 2007, we had accumulated a deficit of $246.0 million.

United States Government Contracts and Grants

As of September 30, 2007, gross proceeds of $8.0 million remain to be received under our various government contracts and grants, which include
amounts for reimbursement to our subcontractors, as well as potential reimbursement for our employees time and benefits and other expenses related to performance under the various contracts. Funding of these government contracts and grants
beyond the United States governments current fiscal year is subject to annual Congressional appropriations.

The status of our United
States government contracts and grants, in millions, is as follows:



|                                                          |  |        |     |  |               |      |                                           |   |                                                          |  |                            |     |  |     
|--------------------------------------------------------- |  | ------ | --- |  | ------------- | ---- | ----------------------------------------- | - | -------------------------------------------------------- |  | -------------------------- | --- |  | ----
|Program Title                                             |  | Agency |     |  | Program Total |      | Total Received Through September 30, 2007 |   | RemainingAmounts to be Received as of September 30, 2007 |  | Contract/ Grant Expiration
|Pulmonary Innate Immune Activation for Bio-terror Defense |  | NIAID  | (1) |  | $             | 6.3  |                                           | $ | 6.3                                                      |  | $                          |    |  | 2008
|Innate Immune Receptors and Adjuvant Discovery            |  | NIAID  | (1) |  |               | 16.9 |                                           |   | 8.9                                                      |  |                            | 8.0 |  | 2009
|                                                          |  |        |     |  |               |      |                                           |   |                                                          |  |                            |     |  |     
|Total                                                     |  |        |     |  | $             | 23.2 |                                           | $ | 15.2                                                     |  | $                          | 8.0 |  |     
|                                                          |  |        |     |  |               |      |                                           |   |                                                          |  |                            |     |  |     

---

|(1) | National Institute of Allergy and Infectious Diseases, part of the U.S. National Institutes of Health
|--- | -----------------------------------------------------------------------------------------------------

Research and Development

Risks and Uncertainties Associated with Research and Development Activities

Substantially all of our product development programs are at an early stage; therefore, the successful development of our product
candidates is highly uncertain and may not result in approved products. Completion dates and completion costs can vary significantly for each product candidate and are difficult to predict. Product candidates that may appear promising at early
stages of development may not reach the market for a number of reasons. We and our collaborators may decide to discontinue clinical trials involving our product candidates. Product candidates may be found ineffective, may cause harmful



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side effects during clinical trials, may take longer to progress through clinical trials than anticipated, may fail to receive necessary regulatory approvals
and may prove impracticable to manufacture in commercial quantities at reasonable cost and with acceptable quality. The lengthy process of seeking United States Food and Drug Administration, or FDA, approvals requires the expenditure of substantial
resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals could materially adversely affect our product development efforts. Because of these risks and uncertainties, we cannot predict when or whether we will
successfully complete the development of our product candidates or the ultimate product development cost or whether we will obtain any approval required by the FDA on a timely basis, if at all.

Critical Accounting Policies and Estimates

The
preparation of our condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of our
financial statements as well as the reported revenues and expenses during the reported periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in the notes to our consolidated financial statements included in our Annual Report on Form 10-K filed
with the Securities and Exchange Commission for the year ended December 31, 2006 and in Note 1 to our unaudited financial statements accompanying this Report. However, we believe that the following critical accounting policy related to income
taxes, which we adopted in the first quarter of 2007, is important to understanding and evaluating our reported financial results.

Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) prescribes a recognition threshold that a tax position is required to meet before being recognized in
the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues.

We have an uncertain tax position of approximately $5.0 million which did not change significantly during the three and nine months ended
September 30, 2007. The uncertain tax position results in a decrease of our net operating loss deferred tax asset, which is offset by a valuation allowance. Accordingly, there was no impact on our consolidated financial position, results of
operations and cash flows as a result of the adoption of FIN 48.

Results of Operations

Three Months Ended September 30, 2007 and 2006

Revenue: Revenue of $5.1 million was substantially unchanged in the three months ended September 30, 2007 as compared to the same period in 2006.



|                                                |  |                                  |       |                      |   |       |  |   |      |  
|----------------------------------------------- |  | -------------------------------- | ----- | -------------------- | - | ----- |  | - | ---- | -
|                                                |  | Three months ended September 30, |       | Increase/ (Decrease) |  
|Revenue                                         |  | 2007                             |       | 2006                 |  
|                                                |  | (in thousands)                   |      
|Collaborator:                                   |  |                                  |       |                      |   |       |  |   |      |  
|License fees recognized over performance period |  | $                                | 3,605 |                      | $ | 3,601 |  | $ | 4    |  
|Milestones recognized over performance period   |  |                                  | 25    |                      |   |      |  |   | 25   |  
|Cost reimbursement and other                    |  |                                  | 525   |                      |   | 786   |  |   | (261 | )
|                                                |  |                                  |       |                      |   |       |  |   |      |  
|Total collaborator revenue                      |  |                                  | 4,155 |                      |   | 4,387 |  |   | (232 | )
|Government                                      |  |                                  | 957   |                      |   | 701   |  |   | 256  |  
|                                                |  |                                  |       |                      |   |       |  |   |      |  
|Total revenue                                   |  | $                                | 5,112 |                      | $ | 5,088 |  | $ | 24   |  
|                                                |  |                                  |       |                      |   |       |  |   |      |  

Collaborator revenue decreased $0.2 million in the three months ended September 30, 2007
compared to the same period in 2006. This decrease was primarily due to a reduction in reimbursement expenses from Pfizer for development services incurred on their behalf under our license agreement with them.

Government revenue increased by $0.3 million in the three months ended September 30, 2007 compared to the same period in 2006. This increase was due
primarily to higher expenses relating to our Innate Immune Receptors and Adjuvant Discovery contract with NIAID.



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Research and development expenses:Research and development expenses decreased by $2.3 million to
$8.6 million in the three months ended September 30, 2007 from $11.0 million in the same period in 2006, a decrease of 21%.



|                                             |  |                                  |       |           |   |            |  |   |        |  
|-------------------------------------------- |  | -------------------------------- | ----- | --------- | - | ---------- |  | - | ------ | -
|                                             |  | Three months ended September 30, |       | Increase/ |  
|Research and Development Expenses            |  | 2007                             |       | 2006      |   | (Decrease) | 
|                                             |  | (in thousands)                   |      
|Discovery research and preclinical expense   |  | $                                | 5,021 |           | $ | 4,268      |  | $ | 753    |  
|Clinical trials and drug development expense |  |                                  | 1,713 |           |   | 5,153      |  |   | (3,440 | )
|Government program expense                   |  |                                  | 765   |           |   | 554        |  |   | 211    |  
|Stock-based compensation expense             |  |                                  | 672   |           |   | 627        |  |   | 45     |  
|Depreciation and amortization expense        |  |                                  | 462   |           |   | 364        |  |   | 98     |  
|                                             |  |                                  |       |           |   |            |  |   |        |  
|Total research and development expenses      |  | $                                | 8,633 |           | $ | 10,966     |  | $ | (2,333 | )
|                                             |  |                                  |       |           |   |            |  |   |        |  

Discovery research and preclinical expense increased by $0.8 million in the three months ended
September 30, 2007 as compared to the same period in 2006. This increase was primarily due to higher patent related legal costs of $0.8 million, $0.4 million for patent maintenance costs for the recently acquired 3M portfolio and $0.2 million
of higher compensation costs mainly due to severance. These increases were partially offset by a decrease in toxicology expenses of $0.6 million for our early preclinical programs. Discovery research and preclinical expense includes basic research,
chemical development, pharmacology, product development and patent related legal costs related to our internal research programs.

Clinical
trials and drug development expense decreased by $3.4 million in the three months ended September 30, 2007 as compared to the same period in 2006. This decrease was comprised of a $1.4 million decrease in internal expenses and a $2.0 million
decrease in external expenses. Our internal resources, employees and infrastructure are not directly tied to any individual project. Only external costs are tracked by product candidate. External expenses by product candidate are as follows:



|                                                  |  |                                  |       |           |   |            |  |   |        |  
|------------------------------------------------- |  | -------------------------------- | ----- | --------- | - | ---------- |  | - | ------ | -
|                                                  |  | Three months ended September 30, |       | Increase/ |  
|                                                  |  | 2007                             |       | 2006      |   | (Decrease) | 
|                                                  |  | (in thousands)                   |      
|Internal expenses (non-program specific)          |  | $                                | 1,538 |           | $ | 2,960      |  | $ | (1,422 | )
|External expenses:                                |  |                                  |       |           |   |            |  |   |        |  
|PF-3512676                                        |  |                                  |      |           |   | 127        |  |   | (127   | )
|ACTILON                                           |  |                                  | 175   |           |   | 2,066      |  |   | (1,891 | )
|                                                  |  |                                  |       |           |   |            |  |   |        |  
|Total external expenses                           |  |                                  | 175   |           |   | 2,193      |  |   | (2,018 | )
|                                                  |  |                                  |       |           |   |            |  |   |        |  
|Total clinical trial and drug development expense |  | $                                | 1,713 |           | $ | 5,153      |  | $ | (3,440 | )
|                                                  |  |                                  |       |           |   |            |  |   |        |  

The $1.4 million decrease in internal expenses in the three months ended September 30, 2007
was due primarily to the reduction in drug development staff resulting from the suspension of our ACTILON development program.

There were
no external expenses for our PF-3512676 program in the three months ended September 30, 2007, a decrease of $0.1 million over the same period in 2006. This decrease was due to the completion of our Phase II clinical trials in NSCLC and advanced
melanoma.

External expenses for our ACTILON program were $0.2 million for the three months ended September 30, 2007, a decrease of
$1.9 million over the same period in 2006. This decrease was due primarily to $1.0 million in lower manufacturing expenses and $0.7 million in lower clinical trial expenses resulting from our decision to suspend further development of ACTILON. The
expenses that were incurred in the three months ended September 30, 2007 consist primarily of finalizing reports and documentation for toxicology studies and clinical trials.

Clinical trials and drug development expense includes external costs of manufacturing TLR Therapeutics and of conducting clinical trials, as well as
internal costs for clinical development, regulatory compliance, quality assurance, pharmaceutical development and operating our clinical immunology laboratory.

Government program expense increased by $0.2 million to $0.8 million in the three months ended September 30, 2007 compared to the same period in 2006 due primarily to higher expenses relating to our Innate Immune
Receptors and Adjuvant Discovery contract with NIAID. Government program expense includes amounts incurred for our labor, external consulting and manufacturing costs, as well as sub-contractor costs attributable to our government contracts and
grants.



16



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Stock compensation expense of $0.7 million was substantially unchanged as compared to the same period in
2006.

Depreciation and amortization expense for laboratory equipment and leasehold improvements at our research facilities increased $0.1
million to $0.5 million in the three months ended September 30, 2007 as compared to the same period in 2006. The increase was due to additional depreciation for assets in our new research and development facility in Dusseldorf, Germany.

General and administrative expenses: General and administrative expenses decreased by $0.6 million to $2.8 million in the three
months ended September 30, 2007 from $3.4 million in the same period in 2006, a decrease of 18%.



|                                           |  |                                  |       |           |   |            |  |   |      |  
|------------------------------------------ |  | -------------------------------- | ----- | --------- | - | ---------- |  | - | ---- | -
|                                           |  | Three months ended September 30, |       | Increase/ |  
|General and Administrative Expenses        |  | 2007                             |       | 2006      |   | (Decrease) | 
|                                           |  | (in thousands)                   |      
|Compensation and personnel related expense |  | $                                | 1,057 |           | $ | 1,260      |  | $ | (203 | )
|Professional services                      |  |                                  | 589   |           |   | 1,136      |  |   | (547 | )
|Insurance                                  |  |                                  | 208   |           |   | 190        |  |   | 18   |  
|Facility costs                             |  |                                  | 123   |           |   | 75         |  |   | 48   |  
|Stock-based compensation expense           |  |                                  | 800   |           |   | 731        |  |   | 69   |  
|Depreciation and amortization expense      |  |                                  | 22    |           |   | 21         |  |   | 1    |  
|                                           |  |                                  |       |           |   |            |  |   |      |  
|Total general and administrative expenses  |  | $                                | 2,799 |           | $ | 3,413      |  | $ | (614 | )
|                                           |  |                                  |       |           |   |            |  |   |      |  

The $0.6 million decrease in general and administrative expenses in the three months ended
September 30, 2007 compared to the same period in 2006 was primarily attributed to a $0.5 million decrease in professional expenses due to a reduction in external consulting services. Compensation expenses decreased $0.2 million due to a
reduction in staff resulting from the suspension of our ACTILON development program.

Royalty expense: Royalty expense results from
the amortization of royalties paid to the UIRF and the OHRI related to revenues from collaboration agreements. Royalty expense of $0.5 million was substantially unchanged as compared to the same period in 2006.

Other income: Interest income decreased by $0.3 million to $1.2 million in the three months ended September 30, 2007 compared to the same
period in 2006, reflecting lower average cash and investment balances. Interest expense increased $0.5 million to $0.6 million in the three months ended September 30, 2007 compared to the same period in 2006 due to interest accreted on the
present value of the purchase price to acquire the majority of 3Ms therapeutic Toll-like receptor cancer programs.

Net loss:
For the reasons stated above, net loss decreased by $2.1 million to $6.4 million in the three months ended September 30, 2007 from a net loss of $8.5 million in the same period in 2006.

Nine Months Ended September 30, 2007 and 2006

Revenue: Revenue increased by $11.0 million to $26.0 million in the nine months ended September 30, 2007 from $15.0 million in the same period in 2006, an increase of 73%.



|                                                |  |                                 |        |      |   |          |  |   |       
|----------------------------------------------- |  | ------------------------------- | ------ | ---- | - | -------- |  | - | ------
|                                                |  | Nine months ended September 30, |        |     
|Revenue                                         |  | 2007                            |        | 2006 |   | Increase
|                                                |  | (in thousands)                 
|Collaborator:                                   |  |                                 |        |      |   |          |  |   |       
|License fees recognized over performance period |  | $                               | 10,815 |      | $ | 10,805   |  | $ | 10    
|License fees recognized when earned             |  |                                 | 9,000  |      |   | 100      |  |   | 8,900 
|Milestones recognized over performance period   |  |                                 | 492    |      |   |         |  |   | 492   
|Cost reimbursement and other                    |  |                                 | 2,462  |      |   | 1,490    |  |   | 972   
|                                                |  |                                 |        |      |   |          |  |   |       
|Total collaborator revenue                      |  |                                 | 22,769 |      |   | 12,395   |  |   | 10,374
|Government                                      |  |                                 | 3,223  |      |   | 2,619    |  |   | 604   
|                                                |  |                                 |        |      |   |          |  |   |       
|Total revenue                                   |  | $                               | 25,992 |      | $ | 15,014   |  | $ | 10,978
|                                                |  |                                 |        |      |   |          |  |   |       



17



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##### Table of Contents

Collaborator revenue increased by $10.4 million in the nine months ended September 30, 2007 compared
to the same period in 2006. This increase was primarily due to an increase in license fees resulting from a $5.0 million license fee from Dynavax Technologies Corporation (Dynavax) and a $4.0 million license fee from Merck recognized in
the second quarter of 2007 due to the absence of future obligations required to be performed by us. Revenue earned from cost reimbursement increased by $1.0 million due to an increase of reimbursable expenses from Pfizer for development services
incurred on their behalf under our license agreement with them. Milestone revenue increased by $0.5 million due to a milestone payment received in the second quarter of 2007 from GSK which is recognized over our performance period. The milestone
became due under the terms of the collaboration when GSK finalized its plan to initiate a Phase III trial including VaxImmune.

Government
revenue increased by $0.6 million in the nine months ended September 30, 2007 compared to the same period in 2006. This increase was due primarily to a $0.9 million increase in expenses relating to our Innate Immune Receptors and Adjuvant
Discovery contract with NIAID offset by a $0.3 million decrease in our Pulmonary Innate Immune Activation for Bio-Terror Defense grant with NIAID which ends in February 2008.

Research and development expenses:Research and development expenses decreased by $5.3 million to $27.4 million in the nine months ended
September 30, 2007 from $32.7 million in the same period in 2006, a decrease of 16%.



|                                             |  |                                 |        |           |   |            |  |   |        |  
|-------------------------------------------- |  | ------------------------------- | ------ | --------- | - | ---------- |  | - | ------ | -
|                                             |  | Nine months ended September 30, |        | Increase/ |  
|Research and Development Expenses            |  | 2007                            |        | 2006      |   | (Decrease) | 
|                                             |  | (in thousands)                  |       
|Discovery research and preclinical expense   |  | $                               | 15,100 |           | $ | 12,875     |  | $ | 2,225  |  
|Clinical trials and drug development expense |  |                                 | 6,200  |           |   | 14,629     |  |   | (8,429 | )
|Government program expense                   |  |                                 | 2,687  |           |   | 2,223      |  |   | 464    |  
|Stock-based compensation expense             |  |                                 | 2,170  |           |   | 1,880      |  |   | 290    |  
|Depreciation and amortization expense        |  |                                 | 1,215  |           |   | 1,078      |  |   | 137    |  
|                                             |  |                                 |        |           |   |            |  |   |        |  
|Total research and development expenses      |  | $                               | 27,372 |           | $ | 32,685     |  | $ | (5,313 | )
|                                             |  |                                 |        |           |   |            |  |   |        |  

Discovery research and preclinical expense increased by $2.2 million in the nine months ended
September 30, 2007 as compared to the same period in 2006. The increase was primarily a result of $1.2 million in higher patent costs mainly related to a patent interference proceeding with a competitor at the United States Patent and Trademark
Office and $0.5 million for patent maintenance costs for the recently acquired 3M portfolio. During the nine months ended September 30, 2007, the U.S. dollar depreciated against the Euro by 7% and the Canadian dollar by 16%, which resulted
in a $0.7 million increase in expenses when our foreign subsidiary results were translated from the local currency into U.S. dollars. In addition, we incurred $0.5 million in higher lab expenses and $0.3 million in higher compensation expenses
mainly due to severance. The remaining increase was due to $0.4 million in costs associated with our abandoned lease and asset disposal at our former research and development facility in Langenfeld, Germany. These increases were partially offset by
a decrease of $1.5 million for expenses related to our lead preclinical program. Discovery research and preclinical expense includes basic research, chemical development, pharmacology, product development and patent related legal costs related to
our internal research programs.

Clinical trials and drug development expense decreased by $8.4 million in the nine months ended
September 30, 2007 as compared to the same period in 2006. This decrease was comprised of a $2.9 million decrease in internal expenses and a $5.6 million decrease in external expenses. Our internal resources, employees and infrastructure are
not directly tied to any individual project. Only external costs are tracked by product candidate. External expenses by product candidate are as follows:



|                                                  |  |                                 |       |           |   |            |  |   |        |  
|------------------------------------------------- |  | ------------------------------- | ----- | --------- | - | ---------- |  | - | ------ | -
|                                                  |  | Nine months ended September 30, |       | Increase/ |  
|                                                  |  | 2007                            |       | 2006      |   | (Decrease) | 
|                                                  |  | (in thousands)                  |      
|Internal expenses (non-program specific)          |  | $                               | 5,712 |           | $ | 8,566      |  | $ | (2,854 | )
|External expenses:                                |  |                                 |       |           |   |            |  |   |        |  
|PF-3512676                                        |  |                                 | 2     |           |   | 291        |  |   | (289   | )
|ACTILON                                           |  |                                 | 486   |           |   | 5,772      |  |   | (5,286 | )
|                                                  |  |                                 |       |           |   |            |  |   |        |  
|Total external expenses                           |  |                                 | 488   |           |   | 6,063      |  |   | (5,575 | )
|                                                  |  |                                 |       |           |   |            |  |   |        |  
|Total clinical trial and drug development expense |  | $                               | 6,200 |           | $ | 14,629     |  | $ | (8,429 | )
|                                                  |  |                                 |       |           |   |            |  |   |        |  



18



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The $2.9 million decrease in internal expenses in the nine months ended September 30, 2007 was due
primarily to the reduction in drug development staff resulting from the suspension of our ACTILON development program.

External expenses
for our PF-3512676 program decreased by $0.3 million in the nine months ended September 30, 2007 over the same period in 2006. This decrease was due to the completion of our Phase II clinical trials in NSCLC and advanced melanoma.

External expenses for our ACTILON program were $0.5 million for the nine months ended September 30, 2007, a decrease of $5.3 million over the
same period in 2006. This decrease was due primarily to $2.4 million in lower manufacturing expenses, $1.7 million in lower clinical trial expenses and $0.7 million in lower toxicology expenses resulting from our decision to suspend further
development of ACTILON. We also received a $0.3 million refund in 2007 from one of our manufacturing partners for a down payment on a production run of ACTILON material that we suspended in 2006, as our partner was able to re-use the start up
material originally intended for ACTILON.

Clinical trials and drug development expense includes external costs of manufacturing TLR
Therapeutics and of conducting clinical trials, as well as internal costs for clinical development, regulatory compliance, quality assurance, pharmaceutical development and operating our clinical immunology laboratory.

Government program expense increased by $0.5 million to $2.7 million in the nine months ended September 30, 2007 compared to the same period in 2006
due primarily to higher expenses relating to our Innate Immune Receptors and Adjuvant Discovery contract with NIAID. Government program expense includes amounts incurred for our labor, external consulting and manufacturing costs, as well as
sub-contractor costs attributable to our government contracts and grants.

Stock compensation expense increased $0.3 million to $2.2
million for the nine months ended September 30, 2007 compared to the same period in 2006. The increase in stock compensation expense was due primarily to $0.6 million in expense related to stock options granted to research and development
employees in the first quarter of 2007 offset by a $0.3 reduction in amortization of deferred compensation relating to stock awards issued to employees prior to April 20, 2005 (the date the Company filed its initial Registration Statement on
form S-1 with the SEC).

Depreciation and amortization expense for laboratory equipment and leasehold improvements at our research
facilities increased $0.1 million to $1.2 million in the nine months ended September 30, 2007 as compared to the same period in 2006. The increase was due to additional depreciation for assets in the new research and development facility in
Dusseldorf, Germany.

Purchased technology: In June 2007, we entered into an agreement with 3M to acquire the majority of 3Ms
therapeutic Toll-like receptor cancer programs. The asset acquisition included a pipeline of clinical and preclinical small molecule candidates targeting TLR7 and TLR8, as well as an intellectual property estate of more than two hundred issued and
several hundred pending patents and a library in excess of ten thousand small molecule compounds that stimulate TLR7 and TLR8. In the nine months ended September 30, 2007, we recorded a $16.8 million expense for the assets purchased from 3M.
The $16.8 million charge represents the present value of the $20.0 million purchase price.

General and administrative expenses:
General and administrative expenses increased by $0.2 million to $9.6 million in the nine months ended September 30, 2007 from $9.4 million in the same period in 2006, an increase of 2%.



|                                           |  |                                 |       |           |   |            |  |   |      |  
|------------------------------------------ |  | ------------------------------- | ----- | --------- | - | ---------- |  | - | ---- | -
|                                           |  | Nine months ended September 30, |       | Increase/ |  
|General and Administrative Expenses        |  | 2007                            |       | 2006      |   | (Decrease) | 
|                                           |  | (in thousands)                  |      
|Compensation and personnel related expense |  | $                               | 4,231 |           | $ | 3,952      |  | $ | 279  |  
|Professional services                      |  |                                 | 1,832 |           |   | 2,466      |  |   | (634 | )
|Insurance                                  |  |                                 | 623   |           |   | 586        |  |   | 37   |  
|Facility costs                             |  |                                 | 281   |           |   | 215        |  |   | 66   |  
|Stock-based compensation expense           |  |                                 | 2,581 |           |   | 2,102      |  |   | 479  |  
|Depreciation and amortization expense      |  |                                 | 66    |           |   | 64         |  |   | 2    |  
|                                           |  |                                 |       |           |   |            |  |   |      |  
|Total general and administrative expenses  |  | $                               | 9,614 |           | $ | 9,385      |  | $ | 229  |  
|                                           |  |                                 |       |           |   |            |  |   |      |  

The $0.2 million increase in general and administrative expenses in the nine months ended
September 30, 2007 was primarily attributed to a $0.5 million increase in stock compensation expense and a $0.3 million increase in compensation expense, primarily severance, offset by a decrease of $0.6 million in professional services due to
a reduction in external consulting services. The increase in stock compensation expense was mainly due to $0.4 million for stock options granted to



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general and administrative employees in the first quarter of 2007 and $0.2 million for the re-measurement of stock options related to the modification of
options that was undertaken for two employees impacted by the decision to suspend further development of ACTILON.

Royalty expense:
Royalty expense results from the amortization of royalties paid to the UIRF and the OHRI related to revenues from collaboration agreements. Royalty expense increased by $1.4 million to $3.0 million in the nine months ended September 30, 2007
from $1.6 million in the same period in 2006. This increase resulted primarily from royalties paid to the UIRF and OHRI that were related to the $4.0 million license payment received from Merck and the $5.0 million license payment received from
Dynavax in the second quarter of 2007.

Other income: Interest income decreased by $0.8 million to $3.6 million in the nine months
ended September 30, 2007 compared to the same period in 2006, reflecting lower average cash and investment balances. Interest expense increased $0.5 million to $0.7 million in the nine months ended September 30, 2007 compared to the same
period in 2006 due to interest accreted on the present value of the purchase price to acquire the majority of 3Ms therapeutic Toll-like receptor cancer programs.

Net loss: For the reasons stated above, net loss increased by $3.6 million to $28.2 million in the nine months ended September 30, 2007 from a net loss of $24.6 million in the same period in 2006.

Liquidity and Capital Resources

Sources of
Liquidity

Since our inception in 1998, we have funded our operations primarily through:



| |  |  | proceeds of $145.6 million from private placements of preferred stock and warrants;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | proceeds of $110.8 million from our initial public offering and concurrent private placement of common stock to Pfizer;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | cash receipts of $104.0 million from our commercial collaborations;
| | - |  | -------------------------------------------------------------------



| |  |  | cash receipts of $26.9 million from United States government contracts and grants;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | $7.2 million borrowed for leasehold improvements and equipment financing under a capital lease facility; and
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | $2.1 million in debt to fund our initial research and development activities.
| | - |  | -----------------------------------------------------------------------------

Included in the amounts above is $67.2 million from Pfizer that we have received in upfront license fees, sales of common stock, sponsored research fees
and expense reimbursements.

At September 30, 2007, we had unrestricted cash, cash equivalents and marketable securities of $87.8
million, compared to $107.0 million as of December 31, 2006.

We invest in cash equivalents, U.S. government obligations, high-grade
municipal notes, and auction rate securities. Our investment objectives are, primarily, to assure liquidity and preservation of capital and, secondarily, to obtain investment income.



|                                                                 |  |                                 |         |   |                      |   |         |               |  |   |         |  
|---------------------------------------------------------------- |  | ------------------------------- | ------- | - | -------------------- | - | ------- | ------------- |  | - | ------- | -
|                                                                 |  | Nine Months Ended September 30, |         |   | Increase/ (Decrease) |  
|Summary Cash Flow Information                                    |  | 2007                            |         |   | 2006                 |   |         | 2007 vs. 2006 | 
|                                                                 |  | (in thousands)                  |        
|Net cash (used in) provided by:                                  |  |                                 |         |   |                      |   |         |               |  |   |         |  
|Operating activities                                             |  | $                               | (13,409 | ) |                      | $ | (28,335 | )             |  | $ | 14,926  |  
|Investing activities                                             |  |                                 | 30,108  |   |                      |   | 2,452   |               |  |   | 27,656  |  
|Financing activities                                             |  |                                 | 76      |   |                      |   | (133    | )             |  |   | 209     |  
|Exchange rate effect on cash and cash equivalents                |  |                                 | 705     |   |                      |   | 442     |               |  |   | 263     |  
|                                                                 |  |                                 |         |   |                      |   |         |               |  |   |         |  
|Net increase (decrease) in cash and cash equivalents             |  |                                 | 17,480  |   |                      |   | (25,574 | )             |  |   | 43,054  |  
|                                                                 |  |                                 |         |   |                      |   |         |               |  |   |         |  
|Cash and cash equivalents at September 30                        |  |                                 | 69,985  |   |                      |   | 60,337  |               |  |   | 9,648   |  
|Marketable securities at September 30                            |  |                                 | 17,794  |   |                      |   | 53,571  |               |  |   | (35,777 | )
|                                                                 |  |                                 |         |   |                      |   |         |               |  |   |         |  
|Cash, cash equivalents and marketable securities at September 30 |  | $                               | 87,779  |   |                      | $ | 113,908 |               |  | $ | (26,129 | )
|                                                                 |  |                                 |         |   |                      |   |         |               |  |   |         |  



20



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##### Table of Contents

Nine months ended September 30, 2007 and 2006

For the nine months ended September 30, 2007, net cash used in operating activities decreased by $14.9 million to $13.4 million as compared to the
same period in 2006 due primarily to a $10.0 million increase in cash received from collaborators and $3.7 million in lower operating expenses, excluding the charge for purchased technology.

Net cash provided by investing activities increased by $27.7 million to $30.1 million in the nine months ended September 30, 2007 as compared to the
same period in 2006 due primarily to an increase in net maturities of marketable securities used to fund operations and to fund the payment of $5.0 million to 3M for the acquisition of 3Ms therapeutic Toll-like receptor cancer programs.

Net cash provided by financing activities increased by $0.2 million in the nine months ended September 30, 2007 as compared to the
same period in 2006 due primarily to a reduction in payments made on capital leases, as our lease agreement with GE Capital expired in 2006.

Our foreign currency cash balances at our subsidiary in Germany expose us to fluctuations in currency exchange rates. During the nine months ended September 30, 2007, the U.S. dollar depreciated approximately 7% against the Euro,
which resulted in a $0.4 million favorable translation adjustment when converting our Euro cash balances to U.S. dollars for financial reporting purposes.

Contractual Obligations and Commitments

The following summarizes our long-term contractual cash obligations as of
September 30, 2007:



|                       |  |                             |        |                  |   |           |  |           |        |                   |   |       |  |   |    
|---------------------- |  | --------------------------- | ------ | ---------------- | - | --------- |  | --------- | ------ | ----------------- | - | ----- |  | - | ---
|                       |  | Cash Payments Due by Period
|                       |  | Total                       |        | Less than 1 year |   | 1-3 years |  | 4-5 years |        | More than 5 years
|                       |  | (in thousands)             
|Operating leases       |  |                             | 5,385  |                  |   | 1,832     |  |           | 2,327  |                   |   | 1,122 |  |   | 104
|Capital leases         |  |                             | 385    |                  |   | 203       |  |           | 182    |                   |   |      |  |   |   
|Note payable           |  |                             | 3,439  |                  |   | 3,439     |  |           |       |                   |   |      |  |   |   
|Payable to 3M          |  |                             | 15,000 |                  |   | 5,000     |  |           | 10,000 |                   |   |      |  |   |   
|In-licensed technology |  |                             | 750    |                  |   | 150       |  |           | 300    |                   |   | 300   |  |   | *  
|Other liabilities      |  |                             | 583    |                  |   |          |  |           |       |                   |   |      |  |   | 583
|                       |  |                             |        |                  |   |           |  |           |        |                   |   |       |  |   |    
|                       |  | $                           | 25,542 |                  | $ | 10,624    |  | $         | 12,809 |                   | $ | 1,422 |  | $ | 687
|                       |  |                             |        |                  |   |           |  |           |        |                   |   |       |  |   |    

---

|* | Minimum annual license fees of $0.2 million are required through the date of the last patent expiration. As a result of pending patent applications, we are currently unable to
determine the length of this period.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Operating Leases

Our commitments under operating leases shown above consist of payments relating to our real estate lease in Wellesley, Massachusetts, expiring in 2008, our lease in Ottawa, Canada, expiring in 2012, our lease in
Langenfeld, Germany, expiring in 2010, and our lease in Düsseldorf, Germany, expiring in 2010. In June 2007, we abandoned our lease for office and laboratory space in Langenfeld, Germany in order to move into a larger location in Dusseldorf,
Germany that would accommodate our research and development requirements. We have entered into a sublease agreement for the space covering approximately 60% of our costs through 2010, the date at which our lease obligations cease. As of
September 30, 2007, we have accrued 0.2 million ($0.2 million as of September 30, 2007) for the abandoned facility, reduced by the sublease income. We do not expect any future charges related to this abandonment.

Capital Leases

In August 2006, we entered into a
0.3 million ($0.5 million at September 30, 2007) capital lease agreement for the purchase of a piece of laboratory equipment. The lease extends for a period of 36 months with an annual interest rate of 7.33%. As of September 30,
2007, we have principal and interest obligations of 0.2 million ($0.3 million at September 30, 2007) remaining.

Note Payable

In 1998, our foreign subsidiary, Coley Pharmaceutical GmbH (Coley GmbH), obtained a research and development loan from
Technologie-Beteiligungs-Gesellschaft (Tbg). The loan of 1.5 million ($2.2 million at September 30, 2007) was



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to fund the early research and development of our product candidates. The loan bears interest at 6% annually, with principal payable by December 31,
2007 and interest payable semi-annually on March 31 and September 30. An additional fee of 6% annually of the loan principal is payable when the loan is due. We and Tbg revised the payment terms of this additional fee during 2006, delaying
the payments of $1.2 million due in 2007 until March and June of 2008.

Payable to 3M

In June 2007, we entered into an agreement with 3M to acquire the majority of their therapeutic Toll-like receptor cancer programs. The acquisition
included a pipeline of clinical and preclinical small molecule candidates targeting TLR7 and TLR8, as well as an intellectual property estate of more than two hundred issued and several hundred pending patents and a library in excess of ten thousand
small molecule compounds that stimulate TLR7 and TLR8. Under the terms of the agreement, 3M will receive guaranteed cash payments totaling $20.0 million over a three year period, including a payment of $5.0 million made in June 2007.

In-Licensed Technology

We have also entered into
technology in-license agreements with UIRF and OHRI that require us to pay annual license maintenance fees and royalty payments based on license fees, milestones and product royalties received by us from third parties, as well as on products that
are sold by us.

Income Taxes

No
payments related to uncertain tax positions are expected to be made in the next twelve months.

Funding Requirements

We expect to devote substantial resources to continue our research and development efforts. Our funding requirements will depend on a number of
forward-looking factors. These factors include, but are not limited to, the following:



| |  |  | the advancement of additional product candidates into clinical development;
| | - |  | ---------------------------------------------------------------------------



| |  |  | the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other patent-related costs, including litigation or interference
costs and the results of such litigation or interference; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to maintain collaborative arrangements and obtain milestone, royalties and other payments from our collaborators.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------

All of our drug candidates are currently in preclinical or clinical development. To commercialize our drug candidates, we will be required to
successfully complete preclinical studies and clinical trials to obtain required regulatory approvals.

Based on our current operating
plan, we believe that our cash and cash equivalent balance at September 30, 2007 will be sufficient to finance our working capital and capital requirements for approximately 2.5 years. Changes in our research and development plans or other
changes affecting our operating expenses may affect our cash burn and existing cash resources. We expect our sources of funding for the next several years to include potential milestone payments relating to VaxImmune, sanofi-aventis drug
candidates and Pfizer, proceeds from our government programs and other collaborative license agreements we may enter into. In addition, we may incur expenses from time to time in connection with any acquisitions or other in-licenses of technology or
other assets.

Although we have no specific plans to raise additional capital in the next two years, we will continue to review our
financing options, and if opportunities arise to raise capital on favorable terms, we may avail ourselves of these opportunities.

If we
need to raise funds in the future, we may be required to raise those funds through public or private financings, strategic relationships or other arrangements. We cannot assure you that the funding, if needed, will be available on terms attractive
to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants. Our failure to raise capital as and when needed could have a negative impact on our
financial condition and our ability to pursue our business strategy.

Recent Accounting Pronouncements

In June 2007, the FASB issued Emerging Issues Task Force (EITF) Issue No. 07-3, Accounting for Nonrefundable Advance Payments for
Goods or Services Received for Use in Future Research and Development Activities, or EITF 07-3. The consensus requires that nonrefundable advance payments made for goods or services to be used in future research and development activities should
be deferred and capitalized until such time as the related goods or services are delivered or are performed. If an entity does not expect the goods to be delivered or services to be rendered, the capitalized advance payment should be charged to
expense. EITF 07-3 is effective for new contracts entered into after January 1, 2008. The initial adjustment to reflect the effect of applying the consensus as a change in accounting principle would be accounted for as a cumulative-effect
adjustment to retained earnings as of the beginning of the year of adoption. We are currently evaluating whether EITF 07-3 will have a material effect on our financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS
No. 159). SFAS No. 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in
earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are currently assessing the impact of SFAS No. 159 on our consolidated financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement. This standard addresses how companies should measure fair value when
they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (GAAP). This standard is effective for all financial statements



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issued for fiscal years beginning after November 15, 2007. We are in the process of evaluating whether this standard will have a material effect on our
financial position or results of operations.

Off-Balance Sheet Arrangements

Since inception, we have not engaged in any material off-balance sheet activities, including the use of structured finance, special purpose entities or
variable interest entities.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

Market Risks

The primary objective of our investment activities is to preserve principal while at the same time maximizing
the income we receive from our marketable securities without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the
marketable securities to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and marketable securities in a variety of securities, including commercial paper, money market funds, government and
non-government debt securities and corporate obligations. Because of the short-term maturities of our cash equivalents and marketable securities, we do not believe that an increase in market rates would have any significant impact on the realized
value of our marketable securities.

The costs and expenses of our international subsidiaries are denominated in the Canadian dollar and
the Euro. If exchange rates change 5%, the impact on our 2007 net loss and cash burn would be $2.2 million.



|Item 4. | Controls and Procedures
|------- | -----------------------

(a) Evaluation of
Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, the Companys management, under the
supervision and with the participation of the Companys Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of the design and operation of the Companys disclosure controls and procedures as of
the end of the period covered by this report. Based upon that evaluation, these officers have concluded that, as of September 30, 2007, our disclosure controls and procedures were effective.

(b) Changes in Internal Controls

There have been no changes in our internal controls over financial reporting, identified in connection with the evaluation of such internal controls that have occurred during our most recent fiscal quarter that have materially affected, or
are reasonably likely to materially affect, our internal controls over financial reporting.

PART IIOTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

None.



|Item 1A. | Risk Factors
|-------- | ------------

The following risk factors represent
those in which updates or changes to the information set forth in our prior risk factors descriptions have been made.

We depend heavily
on the continued clinical development of our lead product candidate, PF-3512676. If Pfizer is unable or decides not to further develop or commercialize PF-3512676, or experiences significant delays in doing so, our business will be materially
harmed.

In March 2005, we entered into a series of agreements with Pfizer under which we have granted Pfizer development and worldwide
marketing rights to CPG 7909, now referred to as PF-3512676 by Pfizer, for the treatment, control and prevention of multiple cancers, including the treatment of advanced non-small cell lung cancer, or NSCLC.

Pfizer had initiated and enrolled 800 patients in two pivotal international Phase III clinical trials of PF-3512676 in the first-line treatment of
advanced NSCLC patients in the first quarter of 2007. In June 2007, Pfizer discontinued the development program in NSCLC for PF-3512676 in combination with cytotoxic chemotherapy in response to interim data from a scheduled interim analysis which
showed that there was no evidence that PF-3512676 produced additional clinical efficacy over that achieved with the standard cytotoxic chemotherapy regimen alone. The independent Data Safety Monitoring Committee (DSMC) that performed the interim
analysis concluded that the risk-benefit profile did not justify continuation of the two Phase III clinical trials.



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Although it has not indicated its intention to do so, Pfizer has the right to terminate our collaboration
relationship without cause upon not less than 120 days prior written notice. Either party may terminate the collaboration pursuant to an uncured material default, as defined in the license agreement. Any loss of Pfizer as a collaborator in the
development or commercialization of PF-3512676, and any dispute over the terms of, or decisions regarding, the collaboration or other adverse developments in our relationship with Pfizer would materially harm our business and may accelerate our
need for additional capital, impose significant additional costs on us, diminish any competitive advantages that we or Pfizer might otherwise have attained, and limit our ability to receive milestone payments or royalties and generate revenue and
profits which could result in our inability to fund any of our other development programs including the TLR Therapeutic candidates acquired from 3M.

In June 2007, we agreed to acquire the majority of 3Ms therapeutic Toll-like receptor cancer programs, which are all at an early stage of development, for the price of $20 million. If we are unable to develop
and commercialize this acquired technology successfully, we may be forced to abandon this asset and would not obtain any meaningful value for this significant investment.

The therapeutic Toll-like receptor cancer programs that we acquired from 3M are all at an early stage of development, and we cannot assure you that any
of the product candidates that we acquired from 3M will ever receive regulatory approval or be successfully commercialized. We will need to expend substantial resources, in addition to the $20 million that we committed to pay to acquire the
portfolio from 3M, on the preclinical and clinical development of these product candidates. Because the development of early-stage product candidates is lengthy, expensive and uncertain, and failures can occur at any stage of preclinical or clinical
development, we are not currently able to determine whether these substantial expenditures will ever result in product candidates that are able to proceed through clinical development and reach the market. If the assets that we acquired from 3M do
not result in clinically viable product candidates, we may abandon the substantial investment that we have made and will continue to make in these assets, which could significantly harm our business.

Our stockholder rights plan may prevent an acquisition of us or may make an acquisition of us more complicated or uneconomical.

On October 5, 2007, our Board of Directors adopted our stockholder rights plan. Under the plan, we declared a dividend distribution of one
Right for each outstanding share of our common stock to stockholders of record at the close of business on October 15, 2007. Since that time, we have issued one Right with each newly issued share of common stock. Each Right, when
exercisable, entitles the holder to purchase from us one one-hundredth of a share of our Series A Junior Participating Preferred Stock, par value $.01 per share, at a purchase price of $25.00. In general, under the plan, if a person or affiliated
group acquires beneficial ownership of 15% or more of our shares of common stock, then each Right (other than those held by such acquiring person or affiliated group) will entitle the holder to receive, upon exercise, shares of common stock (or,
under certain circumstances, a combination of securities or other assets) having a value of twice the underlying purchase price of the Right. In addition, if following the announcement of the existence of an acquiring person or affiliated group we
are involved in a business combination or sale of 50% or more of our assets or earning power, each Right (other than those held by the acquiring person or affiliated group) will entitle the holder to receive, upon exercise, shares of common stock of
the acquiring entity having a value of twice the underlying purchase price of the Right. The Board of Directors also has the right, after an acquiring person or affiliated group is identified, to cause each Right to be exchanged for common stock or
substitute consideration. We may redeem the Rights at a price of $0.01 per Right prior to the identification of an acquiring person or affiliated group. The Rights expire on October 5, 2017.

We also may be subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15%
or more of our common stock for three years unless the holders acquisition of our stock was approved in advance by our Board of Directors. Although we believe these provisions collectively provide for an opportunity to receive higher bids by
requiring potential acquirors to negotiate with our Board of Directors, they would apply even if the offer may be considered beneficial by some stockholders. In any event, these provisions may delay or prevent a third party from acquiring us or make
it uneconomical for a third party to acquire us. Any such delay or prevention could cause the market price of our common stock to decline.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

Use
of Proceeds from Registered Securities

We registered shares of our common stock in connection with our initial public offering under the Securities Act
of 1933, as amended. Our Registration Statement on Form S-1 (Reg. No. 333-124176) in connection with our initial public offering was declared effective by the SEC on August 9, 2005.



24



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In the final prospectus of our initial public offering, we noted under the caption Use of Proceeds that we
would devote a substantial amount of the proceeds of that offering to fund the clinical development of ACTILON. As discussed elsewhere in this Quarterly Report on Form 10-Q, in the first quarter of 2007 we decided to suspend our independent
development of ACTILON. Accordingly, remaining proceeds from the offering will be invested in other programs.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

None.



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

No matters
were submitted to a vote of security holders during the quarter covered by this Quarterly Report.



|Item 5. | Other Information
|------- | -----------------

None.



|Item 6. | Exhibits
|------- | --------



|      |  |                                                                                                                                                                                   
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   |  | Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock                                                                               
|      | 
|4.1   |  | Shareholder Rights Plan dated October 5, 2007 (incorporated herein by reference to Exhibit 99.1 to Current Report on Form 8-K filed October 9, 2007)                              
|      | 
|31.1  |  | Certification of the Principal Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.                                                                   
|      | 
|31.2  |  | Certification of the Principal Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.                                                                   
|      | 
|32(1) |  | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

---

|(1) | The certification attached as Exhibit 32 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be
incorporated by reference into any filing of Coley Pharmaceutical Group, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form
10-Q, irrespective of any general incorporation language contained in such filing.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES

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



|                 |  |                                             
|---------------- |  | --------------------------------------------
|                 |  | COLEY PHARMACEUTICAL GROUP, INC.            
|                 | 
|November 2, 2007 |  | /S/ ROBERT L. BRATZLER, PH.D.               
|                 |  | Robert L. Bratzler, Ph.D.                   
|                 |  | President and Chief Executive Officer       
|                 |  | (Principal Executive Officer)               
|                 | 
|November 2, 2007 |  | /S/ CHARLES H. ABDALIAN, JR.                
|                 |  | Charles H. Abdalian, Jr.                    
|                 |  | Chief Financial Officer                     
|                 |  | (Principal Financial and Accounting Officer)



26



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##### Table of Contents

COLEY PHARMACEUTICAL GROUP, INC.

EXHIBIT INDEX



|      |  |                                                                                                                                                                                   
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   |  | Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock                                                                               
|      | 
|4.1   |  | Shareholder Rights Plan dated October 5, 2007 (incorporated herein by reference to Exhibit 99.1 to Current Report on Form 8-K filed October 9, 2007)                              
|      | 
|31.1  |  | Certification of the Principal Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.                                                                   
|      | 
|31.2  |  | Certification of the Principal Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.                                                                   
|      | 
|32(1) |  | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.

---

|(1) | The certification attached as Exhibit 32 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be
incorporated by reference into any filing of Coley Pharmaceutical Group, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form
10-Q, irrespective of any general incorporation language contained in such filing.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



27