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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 March 31, 2006

OR



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

For the transition period fromto

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 ̈Non-accelerated
filer   x

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 May 11, 2006, there were 26,205,704 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 March 31, 2006



|                               |  |                                                                                                                                                 |  |     
|------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                               |  |                                                                                                                                                 |  | Page
|PART I  FINANCIAL INFORMATION |  | 3                                                                                                                                              
|                               |  |                                                                                                                                                
|ITEM 1.                        |  | FINANCIAL STATEMENTS                                                                                                                            |  | 3   
|                               |  |                                                                                                                                                
|                               |  | Condensed Consolidated Balance Sheets (Unaudited) as of March 31, 2006 and December 31, 2005                                                    |  | 3   
|                               |  |                                                                                                                                                
|                               |  | Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited) for the three months ended March 31, 2006 and March 31, 2005 |  | 4   
|                               |  |                                                                                                                                                
|                               |  | Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2006 and March 31, 2005                        |  | 5   
|                               |  |                                                                                                                                                
|                               |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                                                  |  | 6   
|                               |  |                                                                                                                                                
|ITEM 2.                        |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                                           |  | 11  
|                               |  |                                                                                                                                                
|ITEM 3.                        |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                      |  | 19  
|                               |  |                                                                                                                                                
|ITEM 4.                        |  | CONTROLS AND PROCEDURES                                                                                                                         |  | 19  
|                               | 
|PART II  OTHER INFORMATION    |  | 20                                                                                                                                             
|                               |  |                                                                                                                                                
|ITEM 1A.                       |  | RISK FACTORS                                                                                                                                    |  | 20  
|                               |  |                                                                                                                                                
|ITEM 2.                        |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                                                     |  | 23  
|                               |  |                                                                                                                                                
|ITEM 6.                        |  | EXHIBITS                                                                                                                                        |  | 23  



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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)                                                                       |  | March 31, 2006 |          |   | December 31, 2005 |  
|Assets                                                                                                                |  |                |          |   |                   |   |          |  
|Current assets                                                                                                        |  |                |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                             |  | $              | 63,686   |   |                   | $ | 85,911   |  
|Marketable securities                                                                                                 |  |                | 70,431   |   |                   |   | 57,075   |  
|Accounts receivable                                                                                                   |  |                | 861      |   |                   |   | 2,100    |  
|Prepaid expenses and other current assets                                                                             |  |                | 1,236    |   |                   |   | 1,199    |  
|Deferred royalty fees                                                                                                 |  |                | 2,019    |   |                   |   | 2,020    |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total current assets                                                                                                  |  |                | 138,233  |   |                   |   | 148,305  |  
|Property and equipment, net                                                                                           |  |                | 4,393    |   |                   |   | 4,532    |  
|Acquired intangible assets, net                                                                                       |  |                | 1,077    |   |                   |   | 1,117    |  
|Deferred royalty fees                                                                                                 |  |                | 5,729    |   |                   |   | 6,234    |  
|Other noncurrent assets                                                                                               |  |                | 979      |   |                   |   | 1,036    |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total assets                                                                                                          |  | $              | 150,411  |   |                   | $ | 161,224  |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Liabilities and Shareholders Equity                                                                                  |  |                |          |   |                   |   |          |  
|Current liabilities                                                                                                   |  |                |          |   |                   |   |          |  
|Accounts payable                                                                                                      |  | $              | 2,819    |   |                   | $ | 3,087    |  
|Accrued expenses                                                                                                      |  |                | 4,654    |   |                   |   | 5,819    |  
|Current portion of capital lease obligations                                                                          |  |                | 352      |   |                   |   | 726      |  
|Deferred revenue                                                                                                      |  |                | 15,269   |   |                   |   | 15,014   |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total current liabilities                                                                                             |  |                | 23,094   |   |                   |   | 24,646   |  
|Deferred revenue                                                                                                      |  |                | 36,321   |   |                   |   | 39,628   |  
|Note payable                                                                                                          |  |                | 2,769    |   |                   |   | 2,689    |  
|Other noncurrent liabilities                                                                                          |  |                | 383      |   |                   |   | 375      |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total liabilities                                                                                                     |  |                | 62,567   |   |                   |   | 67,338   |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Commitments and contingencies                                                                                         |  |                |          |   |                   |   |          |  
|Shareholders equity                                                                                                  |  |                |          |   |                   |   |          |  
|Common stock, $0.01 par value:                                                                                        |  |                |          |   |                   |   |          |  
|Authorized shares50,000,000 shares at March 31, 2006 and December 31, 2005                                           |  |                |          |   |                   |   |          |  
|Issued and outstanding shares 26,201,005 and 25,931,428 shares at March 31, 2006 and December 31, 2005,
respectively |  |                | 262      |   |                   |   | 259      |  
|Additional paid-in capital                                                                                            |  |                | 291,475  |   |                   |   | 291,458  |  
|Note receivable from shareholder                                                                                      |  |                | (351     | ) |                   |   | (391     | )
|Accumulated other comprehensive income                                                                                |  |                | 226      |   |                   |   | 250      |  
|Deferred compensation                                                                                                 |  |                | (7,917   | ) |                   |   | (9,630   | )
|Accumulated deficit                                                                                                   |  |                | (195,851 | ) |                   |   | (188,060 | )
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total shareholders equity                                                                                            |  |                | 87,844   |   |                   |   | 93,886   |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total liabilities and shareholders equity                                                                            |  | $              | 150,411  |   |                   | $ | 161,224  |  
|                                                                                                                      |  |                |          |   |                   |   |          |  

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 Operations and Comprehensive Loss

(Unaudited)



|                                                                                                             |  |                              |        |   |      |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | ---------------------------- | ------ | - | ---- | - | ------- | -
|                                                                                                             |  | Three Months Ended March 31, |       
|(in thousands, except per share amounts)                                                                     |  | 2006                         |        |   | 2005 |  
|Revenue                                                                                                      |  |                              |        |   |      |   |         |  
|Collaborative agreements                                                                                     |  | $                            | 4,024  |   |      | $ | 295     |  
|Government contracts and grants                                                                              |  |                              | 1,025  |   |      |   | 1,495   |  
|                                                                                                             |  |                              |        |   |      |   |         |  
|Total revenue                                                                                                |  |                              | 5,049  |   |      |   | 1,790   |  
|                                                                                                             |  |                              |        |   |      |   |         |  
|Operating expenses                                                                                           |  |                              |        |   |      |   |         |  
|Research and development                                                                                     |  |                              | 10,817 |   |      |   | 10,764  |  
|General and administrative                                                                                   |  |                              | 2,863  |   |      |   | 3,550   |  
|Royalty expense                                                                                              |  |                              | 505    |   |      |   | 76      |  
|                                                                                                             |  |                              |        |   |      |   |         |  
|Total operating expenses                                                                                     |  |                              | 14,185 |   |      |   | 14,390  |  
|                                                                                                             |  |                              |        |   |      |   |         |  
|Loss from operations                                                                                         |  |                              | (9,136 | ) |      |   | (12,600 | )
|Other income (expense)                                                                                       |  |                              |        |   |      |   |         |  
|Interest income                                                                                              |  |                              | 1,469  |   |      |   | 104     |  
|Interest expense                                                                                             |  |                              | (67    | ) |      |   | (139    | )
|Other expense, net                                                                                           |  |                              | (35    | ) |      |   | (23     | )
|                                                                                                             |  |                              |        |   |      |   |         |  
|Total other income (expense)                                                                                 |  |                              | 1,367  |   |      |   | (58     | )
|                                                                                                             |  |                              |        |   |      |   |         |  
|Loss before income taxes                                                                                     |  |                              | (7,769 | ) |      |   | (12,658 | )
|                                                                                                             |  |                             
|Income tax expense                                                                                           |  |                              | (21    | ) |      |   |        |  
|                                                                                                             |  |                              |        |   |      |   |         |  
|Net loss                                                                                                     |  |                              | (7,790 | ) |      |   | (12,658 | )
|Accretion of redeemable convertible preferred stock                                                          |  |                              |       |   |      |   | (807    | )
|                                                                                                             |  |                              |        |   |      |   |         |  
|Net loss attributable to common shareholders                                                                 |  | $                            | (7,790 | ) |      | $ | (13,465 | )
|                                                                                                             |  |                              |        |   |      |   |         |  
|Comprehensive loss                                                                                           |  |                              |        |   |      |   |         |  
|Net loss                                                                                                     |  | $                            | (7,790 | ) |      | $ | (12,658 | )
|Other comprehensive income (loss):                                                                           |  |                              |        |   |      |   |         |  
|Foreign currency translation adjustments                                                                     |  |                              | 53     |   |      |   | 1,362   |  
|Unrealized loss on investments                                                                               |  |                              | (77    | ) |      |   |        |  
|                                                                                                             |  |                              |        |   |      |   |         |  
|Comprehensive loss                                                                                           |  | $                            | (7,814 | ) |      | $ | (11,296 | )
|                                                                                                             |  |                              |        |   |      |   |         |  
|Net loss per share attributable to common shareholders                                                       |  |                              |        |   |      |   |         |  
|Basic and diluted net loss per share attributable to common shareholders                                     |  | $                            | (0.30  | ) |      | $ | (12.88  | )
|                                                                                                             |  |                              |        |   |      |   |         |  
|Weighted average shares used to compute basic and diluted loss per share attributable to common shareholders |  |                              | 26,063 |   |      |   | 1,045   |  

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)



|                                                                           |  |                              |         |   |      |   |         |  
|-------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------- | -
|                                                                           |  | Three Months Ended March 31, |        
|(in thousands)                                                             |  | 2006                         |         |   | 2005 |  
|Cash flows from operating activities                                       |  |                              |         |   |      |   |         |  
|Net loss                                                                   |  | $                            | (7,790  | ) |      | $ | (12,658 | )
|Adjustments to reconcile net loss to net cash used in operating activities |  |                              |         |   |      |   |         |  
|Depreciation and amortization                                              |  |                              | 339     |   |      |   | 401     |  
|Amortization of acquired intangible assets                                 |  |                              | 40      |   |      |   | 40      |  
|Noncash stock compensation expense                                         |  |                              | 1,361   |   |      |   | 4,911   |  
|Changes in operating assets and liabilities:                               |  |                              |         |   |      |   |         |  
|Accounts receivable                                                        |  |                              | 1,239   |   |      |   | (116    | )
|Prepaid expenses and other assets                                          |  |                              | (388    | ) |      |   | 115     |  
|Deferred royalty fees                                                      |  |                              | 505     |   |      |   | (29     | )
|Accounts payable                                                           |  |                              | (348    | ) |      |   | (1,088  | )
|Accrued expenses and other liabilities                                     |  |                              | (687    | ) |      |   | 215     |  
|Deferred revenue                                                           |  |                              | (3,051  | ) |      |   | 237     |  
|                                                                           |  |                              |         |   |      |   |         |  
|Net cash used in operating activities                                      |  |                              | (8,780  | ) |      |   | (7,972  | )
|                                                                           |  |                              |         |   |      |   |         |  
|Cash flows from investing activities                                       |  |                              |         |   |      |   |         |  
|Purchases of marketable securities                                         |  |                              | (21,543 | ) |      |   | (21,000 | )
|Maturities of marketable securities                                        |  |                              | 8,110   |   |      |   | 29,013  |  
|Release of restricted cash                                                 |  |                              | 46      |   |      |   | 56      |  
|Purchases of property and equipment                                        |  |                              | (187    | ) |      |   | (21     | )
|                                                                           |  |                              |         |   |      |   |         |  
|Net cash (used in) provided by investing activities                        |  |                              | (13,574 | ) |      |   | 8,048   |  
|                                                                           |  |                              |         |   |      |   |         |  
|Cash flows from financing activities                                       |  |                              |         |   |      |   |         |  
|Principal payments of capital lease obligations                            |  |                              | (381    | ) |      |   | (493    | )
|Proceeds from stock option exercises                                       |  |                              | 372     |   |      |   | 47      |  
|Proceeds from repayment of shareholder note                                |  |                              | 40      |   |      |   |        |  
|                                                                           |  |                              |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                        |  |                              | 31      |   |      |   | (446    | )
|                                                                           |  |                              |         |   |      |   |         |  
|Exchange rate effect on cash and cash equivalents                          |  |                              | 98      |   |      |   | (283    | )
|                                                                           |  |                              |         |   |      |   |         |  
|Net decrease in cash and cash equivalents                                  |  |                              | (22,225 | ) |      |   | (653    | )
|Cash and cash equivalents, beginning of period                             |  |                              | 85,911  |   |      |   | 13,190  |  
|                                                                           |  |                              |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                   |  | $                            | 63,686  |   |      | $ | 12,537  |  
|                                                                           |  |                              |         |   |      |   |         |  
|Supplemental disclosure of cash flow information                           |  |                              |         |   |      |   |         |  
|Cash paid for interest                                                     |  | $                            | 66      |   |      | $ | 77      |  

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



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Coley Pharmaceutical Group, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

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

Nature of the Business

Coley Pharmaceutical Group,
Inc. (the Company) is an international biopharmaceutical company focused on discovering and developing TLR Therapeutics, a new class of investigational drug candidates that direct the human immune system to fight cancers, infectious diseases, asthma and allergy. The
Company has established a pipeline of four TLR Therapeutic product candidates currently advancing through clinical development either independently or with partners, and additional product candidates in preclinical development.

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.

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 Form 10-K for the year ended December 31, 2005. The financial information as of March 31, 2006 and for the three months ended March 31, 2006 and March 31, 2005 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 this interim period 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 March 31, 2006 consists of the following:



|                            |  |                |            |                  |   |                   |  |                             |         |  |   |           
|--------------------------- |  | -------------- | ---------- | ---------------- | - | ----------------- |  | --------------------------- | ------- |  | - | ----------
|                            |  | Amortized cost |            | Unrealized gains |   | Unrealized losses |  | Estimated Fair Market Value
|Certificates of deposit     |  | $              | 2,031,659  |                  | $ | 427               |  | $                           |        |  | $ | 2,032,086 
|U.S. government obligations |  |                | 45,964,785 |                  |   |                  |  |                             | 76,395  |  |   | 45,888,390
|Corporate bonds             |  |                | 22,543,640 |                  |   | 184               |  |                             | 33,241  |  |   | 22,510,583
|                            |  |                |            |                  |   |                   |  |                             |         |  |   |           
|Total marketable securities |  | $              | 70,540,084 |                  | $ | 611               |  | $                           | 109,636 |  | $ | 70,431,059
|                            |  |                |            |                  |   |                   |  |                             |         |  |   |           

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 or accruals 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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Deferred royalty fees included in the condensed consolidated balance sheet totaled $7,748,315 and
$8,253,198 at March 31, 2006 and December 31, 2005, respectively.

2. Stock-Based Compensation

Upon the effectiveness of the initial public offering, the 2005 Stock Plan (2005 Plan) was adopted. The 2005 Plan provides for the grant of
incentive stock options, nonqualified stock options, restricted and unrestricted stock awards and other stock-based awards. The stock options typically vest over a period of up to four years. The stock options typically expire ten years from the
date granted. When an optionee ceases to be an employee, director, or consultant of the Company, such options terminate either upon or shortly after termination of employment or the provision of services.

In 1997, the Company adopted the 1997 Stock Option Plan (1997 Plan). The terms of the 1997 Plan are similar to the 2005 Plan. Upon the
completion of the Companys initial public offering, the 1997 Plan was terminated and no new options can be granted under this plan. All outstanding stock options granted under the 1997 Plan as of the date of the termination remain outstanding
and subject to their terms and the terms of the 1997 Plan. At March 31, 2006, 2,482,420 options were outstanding under the 1997 Plan.

In
December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), Share-Based Payment (SFAS No. 123(R)), which amends SFAS No. 123, Accounting for Stock-Based Compensation (SFAS
No. 123). The Company adopted SFAS No. 123(R) on January 1, 2006 effective with the beginning of the Companys first quarter. The standard set forth in SFAS No. 123(R) requires the Company to measure the cost of
employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award using an option pricing model. That cost is recognized over the period during which an employee is required to provide service
in exchange for the award. The Company elected to adopt the modified prospective transition method as provided by SFAS No. 123(R) and, accordingly, financial statement amounts for the periods prior to adoption presented in this Form 10-Q have
not been restated to reflect the fair value method of expensing prescribed by SFAS No. 123(R). The Company recognizes stock-based compensation expense using the straight-line attribution method. The net cumulative effect of the adoption of SFAS
No. 123(R) did not have a material impact on the financial statements at March 31, 2006.

Prior to January 1, 2006, the
Company applied the intrinsic value method set forth in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), in accounting for employee stock options. Under APB No. 25,
when the exercise price of options granted to employees under these plans is less than the market price of the common stock on the date of grant, compensation expense is recognized over the vesting period.

For stock options granted to non-employees, including members of its Scientific Advisory Board, the Company recognizes compensation expense in accordance
with the provisions of SFAS No. 123, as amended by SFAS No. 148, and Emerging Issues Task Force, or EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction
with Selling, Goods or Services, which require such equity instruments to be recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments
vest. The Company amortizes compensation expense related to non-employee stock options in accordance with FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans(FIN
28). For the three months ended March 31, 2006 and 2005, the Company recognized $32,534 and $169,647, respectively, of stock-based compensation expense related to these options.

Upon the adoption of SFAS No. 123(R), $775,901 of the Companys deferred stock-based compensation balance of $9,630,022 as of December 31,
2005, which was accounted for under APB No. 25, was reclassified against additional paid-in-capital. The remaining portion of the deferred stock-based compensation balance at March 31, 2006 is comprised of the intrinsic value of stock
options granted prior to April 20, 2005 (the date the Company filed its Registration Statement on Form S-1 with the United States Securities and Exchange Commission) at an exercise price below fair market value that were accounted for under the
minimum value method since the Companys stock was not publicly traded.



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The fair value of options at the date of grant, based upon certain assumptions, was calculated using the
Black-Scholes option pricing model. Given its limited history as a public company, the Companys expected stock price volatility was based upon the expected stock price volatility of companies whose stock prices are publicly available and are
similar in size and development stage to the Company. Given the nature of the Companys awards in 2005 and 2006, the simplified method was used to estimate the expected term for the three months ended March 31, 2006. The dividend yield of
zero is based upon the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. The risk-free interest rate used for each grant is equal to the U.S. Treasury yield curve in effect at the time of the
grant for instruments with a similar expected life.

The table below illustrates the Black-Scholes option pricing model with the following
assumptions used for grants issued during the quarters ended March 31, 2006 and 2005:



|                                |  |                              |  |        
|------------------------------- |  | ---------------------------- |  | -------
|                                |  | Three Months Ended March 31,
|                                |  | 2006                         |  | 2005   
|Risk-free interest rate         |  | 4.83 %                       |  | 4.5 %  
|Expected dividend yield         |  | 0 %                          |  | 0 %    
|Expected option life            |  | 6.25 years                   |  | 7 years
|Expected stock price volatility |  | 75 %                         |  | 0%     

SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised in
subsequent periods, if necessary, if actual forfeiture rates differ from those estimates. The Company will record additional expense if the actual forfeitures are less than the estimated and will record a recovery of expense if actual forfeitures
are greater than the estimated. No amounts related to stock-based compensation have been capitalized.

The adoption of SFAS No. 123(R)
increased the Companys stock-based compensation expense by approximately $434,000 (a $0.02 impact to basic and diluted net loss per share) in the first quarter of 2006. The following table shows stock-based compensation expense included in the
condensed consolidated statements of operations for the three months ended March 31, 2006 and 2005:



|                                       |  |                              |           |      |   |          
|-------------------------------------- |  | ---------------------------- | --------- | ---- | - | ---------
|                                       |  | Three Months Ended March 31,
|                                       |  | 2006                         |           | 2005
|Research and development               |  | $                            | 689,807   |      | $ | 2,669,789
|General and administrative             |  |                              | 671,137   |      |   | 2,241,385
|                                       |  |                              |           |      |   |          
|Total stock-based compensation expense |  | $                            | 1,360,944 |      | $ | 4,911,174
|                                       |  |                              |           |      |   |          

As of March 31, 2006, there remained approximately $13,908,880 of compensation costs, net of
estimated forfeitures, related to unvested stock options to be recognized as expense over a weighted average period of approximately 2.97 years.

A summary of stock option activity under the Companys 1997 Stock Option and 2005 Stock Option Plans for the period ended March 31, 2006 is as follows:



|                                                           |  |                  |   |  |                                           |       |                                             |           |                           |   |           
|---------------------------------------------------------- |  | ---------------- | - |  | ----------------------------------------- | ----- | ------------------------------------------- | --------- | ------------------------- | - | ----------
|                                                           |  | Number of Shares |   |  | Weighted Average Exercise Price per Share |       | Weighted Average Remaining Contractual
Life |           | Aggregate Intrinsic Value
|Options outstanding at December 31, 2005                   |  | 3,385,384        |   |  | $                                         | 4.86  |                                             |           |                           |   |           
|Granted                                                    |  | 29,000           |   |  | $                                         | 15.49 |                                             |           |                           |   |           
|Cancelled                                                  |  | (22,657          | ) |  | $                                         | 3.97  |                                             |           |                           |   |           
|Exercised                                                  |  | (254,773         | ) |  | $                                         | 1.45  |                                             |           |                           | $ | 3,423,415 
|                                                           |  |                  |   |  |                                           |       |                                             |           |                           |   |           
|Options outstanding at March 31, 2006                      |  | 3,136,954        |   |  | $                                         | 5.25  |                                             | 8.2 years |                           | $ | 32,075,276
|Options vested at March 31, 2006                           |  | 1,373,338        |   |  | $                                         | 3.41  |                                             | 7.5 years |                           | $ | 16,592,258
|Options vested and expected to vest at March 31, 2006      |  | 3,037,630        |   |  | $                                         | 5.16  |                                             | 8.2 years |                           | $ | 31,309,961
|Weighted average fair value of options granted during 2006 |  |                  |   |  | $                                         | 10.85 |                                             |           |                           |   |           
|Weighted average fair value of options granted during 2005 |  |                  |   |  | $                                         | 11.68 |                                             |           |                           |   |           



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##### Table of Contents

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 the incremental common shares issuable upon the conversion of preferred stock, shares issuable upon the exercise of stock options and the conversion of preferred stock upon the
exercise of 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:



|                |  |                              |  |           
|--------------- |  | ---------------------------- |  | ----------
|                |  | Three Months Ended March 31,
|                |  | 2006                         |  | 2005      
|Options         |  | 2,334,011                    |  | 2,929,397 
|Warrants        |  | 2,038,205                    |  | 2,124,074 
|Preferred Stock |  |                             |  | 17,003,547
|                |  |                              |  |           
|                |  | 4,372,216                    |  | 22,057,018
|                |  |                              |  |           

The Company became a public company on August 9, 2005. At that time all preferred stock
outstanding converted into an aggregate of 17,003,547 shares of common stock, including shares of common stock issuable in connection with a guaranteed paid-in-kind dividend on the Companys Series F Preferred Stock.

4. Significant Research and Development and Licensing Agreements

Pfizer Inc.

In March 2005, the Company entered into a series of agreements with Pfizer Inc. under which it has granted
Pfizer development and worldwide marketing rights to ProMune (also known as CPG 7909 and now referred to as PF-3512676 by Pfizer). Under the license agreement, the Company received a $50,000,000 upfront license fee and may receive up to $455,000,000
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 $10,000,000 of the Companys common stock in a private placement concurrent with the Companys initial public offering.

A primary focus of the agreements with Pfizer is the development and commercialization of ProMune (PF-3512676) for the treatment, control and prevention of multiple cancers, including the treatment of advanced
non-small cell lung cancer, or NSCLC. Pfizer will fund virtually all future development of ProMune (PF-3512676) including Phase III clinical trials for the treatment of NSCLC, breast cancer and other cancer indications. Pfizer has initiated two
pivotal international Phase III clinical trials of ProMune (PF-3512676) in the first-line treatment of advanced NSCLC patients.

Pursuant
to a separate screening agreement, Pfizer is 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 additional milestone
payments and additional royalties to the Company.

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 ProMune (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 ProMune (PF-3512676) is scheduled to expire in 2014. The Company has patent applications pending which, if issued, may provide patent
protection for ProMune (PF-3512676) through 2017.



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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.

In connection with the $50,000,000 upfront license payment from Pfizer, the Company will recognize this
initial fee over 44 months, the expected period of the Companys performance obligations. Accordingly, for the three months ended March 31, 2006, the Company recognized license, sponsored research revenue and expense reimbursements of
$3,795,097. To date, the Company has received or invoiced $53,162,696 for upfront license, sponsored research and expense reimbursement under the Pfizer agreement.

During 2005, the Company paid UIRF $6,500,000 and the OHRI $150,000 for royalties related to the $50,000,000 upfront license payment received from Pfizer. These amounts were included in deferred royalty fees and are
being recognized as expense over 44 months to match the recognition as revenue of the $50,000,000 upfront payment.

Government Contracts and Grants

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

The Company has a $6,250,000 grant with the NIAID to perform research and preclinical development in the area of pulmonary innate
immune activation for bio-terror defense. This grant extends through February 2007. The Company has recognized revenues under this grant of $440,932 and $520,792 for the three months ended March 31, 2006 and 2005, respectively.

In 2004, the Company was awarded a $16,902,000 five-year contract 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 $583,674 and $654,616 for the three months ended March 31, 2006 and 2005, respectively.

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

5. Related Party Transactions

In 2001, the Company loaned its co-founder and Chief Scientific Officer, Dr. Arthur Krieg, $500,000 evidenced by a promissory note bearing interest of 7% and payable in full on May 8, 2006. The loan was in connection with
Dr. Kriegs purchase of a home in Massachusetts. The loan is collateralized by the Companys common stock held by Dr. Krieg equal to at least 150% of the outstanding balance of the loan, but in no case greater than 184,061 shares
and a second mortgage on Dr. Kriegs home.

In 2005, Dr. Krieg remitted $310,000 to the Company as a partial pre-payment of
his loan. On May 8, 2006, Dr. Krieg settled the remaining balance, including interest, of approximately $351,000 by tendering Coley common stock to the Company.

6. Recent Accounting Pronouncements

The Company does not believe there exists any recent accounting
pronouncements that will have a material impact on its results of operations or financial position.



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##### Table of Contents

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

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 cancers, infectious diseases and respiratory disorders. We began operations in 1998. Independently and with our collaborators, we currently have four drug
candidates in clinical trials, including our lead product candidate, PF-3512676 for cancers, which is currently in pivotal international Phase III clinical trials, ACTILON for Hepatitis C virus, which is currently in Phase Ib and Phase II clinical
trials, and two product candidates being developed by our collaborators.

Our strategy has been to advance our cancer drug development
program to a point where we could enter into a collaboration with a third party and then focus our financial and development resources on advancing our infectious disease program. Since our inception, we have generated significant losses while we or
our collaborators have advanced our products into clinical trials. As of March 31, 2006, we had accumulated a deficit of $195.9 million.

Our most advanced product candidate, PF-3512676, was licensed to Pfizer Inc. in March 2005. Pfizer will fund virtually all future development, regulatory and commercialization costs for PF-3512676. Subsequent to this license, we expect to
continue to spend significant amounts on the discovery and development of TLR Therapeutics for infectious diseases and expand our research and development programs for new TLR Therapeutics for additional disease indications and advance new product
candidates into clinical development from our existing research programs.

Our research and development and financial focus since inception
have been in the areas of cancer and infectious diseases. In other areas, such as respiratory diseases and vaccines, we have entered into collaborations to supplement our own resources in the development and commercialization of our drug candidates
and to fund the continued development of our technology. In addition, our government sponsored programs have allowed us to further develop and expand our research and development capabilities in areas of interest to us, with the added advantage of
reducing our financing needs.

Most of our expenditures to date have been to discover and develop our pipeline of product candidates, to
develop our product technology platform and to seek or obtain patents for our intellectual property. Research and development expenditures through March 31, 2006 were related primarily to the development of our lead product candidates,
PF-3512676 and ACTILON, and to filing patent applications on our inventions. Our patent estate, on a worldwide basis, includes 16 patents issued in the United States, 63 patents issued in the rest of the world and more than 422 pending patent
applications.

On-going Clinical Programs

Cancer

At March 31, 2006, substantially all PF-3512676 clinical trials conducted by us have been completed.

We have been reimbursed $1.3 million by Pfizer for the external costs associated with the conduct of PF-3512676 trials from the inception
of the Pfizer relationship through March 31, 2006.

Infectious Disease

As a result of licensing PF-3512676 to Pfizer, we have shifted our internal product development focus from oncology to concentrate on our on-going work in
infectious diseases. Our lead product candidate for the treatment of Hepatitis C virus is ACTILON.

The status of ACTILON clinical trials
as of March 31, 2006 is as follows:



|                               |  |             |  |                  
|------------------------------ |  | ----------- |  | -----------------
|Trial                          |  | Indication  |  | Enrollment Status
|Phase Ib combination therapies |  | Hepatitis C |  | Fully enrolled   
|Phase II combination therapies |  | Hepatitis C |  | Enrolling        

In the quarter ended March 31, 2006, we started a Phase II study of ACTILON in combination
with pegylated interferon plus ribavirin in treatment-refractory chronic HCV patients who were previously treated with pegylated interferon plus ribavirin but failed to respond. Initial results from this trial are expected in the second half of
2006.



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##### Table of Contents

Consistent with our ProMune clinical development strategy, we plan to use the results of our Phase Ib and
Phase II clinical trials to determine our ACTILON clinical development strategy in HCV before proceeding into large scale efficacy clinical trials.

We have incurred $1.4 million in external costs to date on the Phase Ib study, including $0.3 million of external costs in the quarter ended March 31, 2006. We expect to incur an additional $0.4 million in external costs for this
study. For the Phase II study, we have incurred $0.3 million in external costs to date, including $0.2 million of external costs in the quarter ended March 31, 2006. We expect to incur an additional $2.0 million in external costs for this
study.

We are independently developing and funding ACTILONs clinical development, with Schering-Plough supplying pegylated
interferon and ribavirin at no cost for the above clinical trials.

United States Government Contracts and Grants

As of March 31, 2006 gross proceeds of $13.6 million remained 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 are 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 |      | TotalReceivedThroughMarch 31, 2006 |   | RemainingAmounts tobe Received March 31, 2006 |  | Contract/ GrantExpiration
|Pulmonary Innate Immune Activation for Bio-terror Defense |  | NIAID  | (1) |  | $             | 6.3  |                                    | $ | 5.3                                           |  | $                         | 1.0  |  | 2007
|Innate Immune Receptors and Adjuvant Discovery            |  | NIAID  | (1) |  |               | 16.9 |                                    |   | 4.3                                           |  |                           | 12.6 |  | 2009
|                                                          |  |        |     |  |               |      |                                    |   |                                               |  |                           |      |  |     
|Total                                                     |  |        |     |  | $             | 23.2 |                                    | $ | 9.6                                           |  | $                         | 13.6 |  |     
|                                                          |  |        |     |  |               |      |                                    |   |                                               |  |                           |      |  |     

---

|(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

Most 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. Product candidates may be found ineffective, may cause harmful 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 Form
10-K filed with the Securities and Exchange Commission for the year ended December 31, 2005. However, we believe that there has been one significant change to our critical accounting policies and estimates regarding stock-based compensation
expense that is important in understanding and evaluating our reported financial results.



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Stock-Based Compensation Expense

Stock-based compensation expense, which is a non-cash charge, results from estimating the fair value of stock options on the date they were granted and recognizing the related expense over the expected vesting period.

We adopted SFAS No. 123(R) on January 1, 2006 effective with the beginning of our first quarter of 2006. The standard set forth
in SFAS No. 123(R) requires us to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award using an option pricing model. That cost is recognized over the
period during which an employee is required to provide service in exchange for the award. We elected to adopt the modified prospective transition method as provided by SFAS No. 123(R) and, accordingly, financial statement amounts for the
periods prior to adoption presented in this Form 10-Q have not been restated to reflect the fair value method of expensing prescribed by SFAS No. 123(R). The net cumulative effect of the adoption of SFAS No. 123(R) did not have a material
impact on the financial statements for the three months ended March 31, 2006.

Prior to January 1, 2006, the Company applied the
intrinsic value method set forth in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), in accounting for employee stock options. Under APB No. 25, when the exercise
price of options granted to employees under these plans is less than the market price of the common stock on the date of grant, compensation expense is recognized over the vesting period.

Upon the adoption of SFAS No. 123(R), $0.8 million of our deferred stock-based compensation balance of $9.6 million as of December 31, 2005,
which was accounted for under APB No. 25, was reclassified against additional paid-in-capital. The remaining portion of the deferred stock-based compensation balance at March 31, 2006 is comprised of the intrinsic value of stock options
granted prior to April 20, 2005 (the date the Company filed its Registration Statement on Form S-1 with the United States Securities and Exchange Commission) at an exercise price below fair market value that were accounted for under the minimum
value method since our stock was not publicly traded.

In order to determine the amount of stock-based compensation to be recorded under
SFAS No. 123(R), we are required to develop estimates to be used in calculating the grant date fair value of stock options. We calculated the grant date fair value of the awards using the Black-Scholes option pricing model. Given our limited
history as a public company, we calculated our expected stock price volatility assumption based upon the expected volatility of companies, who are of a similar size and development stage as our Company and whose stock prices are publicly available.
For stock options granted during the three months ended March 31, 2006 we used an average stock price volatility of 75%. Given the nature of our awards, we used the simplified method prescribed under Staff Accounting Bulletin No. 107
(SAB 107) to estimate the expected term. For the three months ended March 31, 2006, the expected term was calculated to be 6.25 years. The dividend yield of zero is based upon on the fact that we have never paid cash dividends and
have no present intention to pay cash dividends. The risk-free interest rate used for each grant is equal to the U.S. Treasury yield curve in effect at the time of the grant for instruments with a similar expected life.

As of March 31, 2006, the estimated cost of unvested employee awards was $13.9 million net of estimated forfeitures. The weighted average remaining
vesting period for these awards is 2.97 years.

The following table shows stock-based compensation expense included in the condensed
consolidated statements of operations for the three months ended March 31, 2006 and 2005:



|                                       |  |                              |       |      |   |      
|-------------------------------------- |  | ---------------------------- | ----- | ---- | - | -----
|                                       |  | Three Months Ended March 31,
|                                       |  | 2006                         |       | 2005
|                                       |  | (in thousands)              
|Research and development               |  | $                            | 690   |      | $ | 2,670
|General and administrative             |  |                              | 671   |      |   | 2,241
|                                       |  |                              |       |      |   |      
|Total stock-based compensation expense |  | $                            | 1,361 |      | $ | 4,911
|                                       |  |                              |       |      |   |      

The amount of stock-based compensation expense to be recognized in future periods cannot be
predicted at this time because it will depend on the number of options granted in the future as well as the portion of awards that will actually vest. Under SFAS No. 123(R), we are required to estimate forfeitures at the time of grant and
revise this estimate in subsequent periods, if necessary, if actual forfeiture rates differ from those estimates. This estimate will be re-evaluated quarterly and the forfeiture rate adjusted accordingly.



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##### Table of Contents

Results of Operations

For the Three Months Ended March 31, 2006 and 2005

Revenue: Revenue increased by $3.3 million to $5.1
million in the three months ended March 31, 2006 from $1.8 million in the same period in 2005, an increase of 182%.



|                                        |  |                             |       |                     |   |       |  |   |       |  
|--------------------------------------- |  | --------------------------- | ----- | ------------------- | - | ----- |  | - | ----- | -
|                                        |  | Three months endedMarch 31, |       | Increase/(Decrease) |  
|Revenue                                 |  | 2006                        |       | 2005                |  
|                                        |  | (in thousands)              |      
|Collaborator:                           |  |                             |       |                     |   |       |  |   |       |  
|Fees recognized over performance period |  | $                           | 3,602 |                     | $ | 263   |  | $ | 3,339 |  
|Cost reimbursement and other            |  |                             | 422   |                     |   | 32    |  |   | 390   |  
|                                        |  |                             |       |                     |   |       |  |   |       |  
|Total collaborator                      |  |                             | 4,024 |                     |   | 295   |  |   | 3,729 |  
|Government                              |  |                             | 1,025 |                     |   | 1,495 |  |   | (470  | )
|                                        |  |                             |       |                     |   |       |  |   |       |  
|Total Revenue                           |  | $                           | 5,049 |                     | $ | 1,790 |  | $ | 3,259 |  
|                                        |  |                             |       |                     |   |       |  |   |       |  

Collaborator revenue increased by $3.7 million in the three months ended March 31, 2006
compared to the same period in 2005. This increase was primarily due to our licensing agreement with Pfizer.

Government revenue decreased
by $0.5 million in the three months ended March 31, 2006 compared to the same period in 2005. This decrease is primarily due to the completion of our DARPA contract in 2005.

Research and development expenses:Research and development expenses of $10.8 million in the three months ended March 31, 2006 were basically
flat as compared to the same period in 2005.



|                                             |  |                             |        |                      |   |        |  |   |        |  
|-------------------------------------------- |  | --------------------------- | ------ | -------------------- | - | ------ |  | - | ------ | -
|                                             |  | Three months endedMarch 31, |        | Increase/ (Decrease) |  
|Research and Development Expenses            |  | 2006                        |        | 2005                 |  
|                                             |  | (in thousands)              |       
|Basic research and preclinical expense       |  | $                           | 3,081  |                      | $ | 3,094  |  | $ | (13    | )
|Clinical trials and drug development expense |  |                             | 5,830  |                      |   | 3,672  |  |   | 2,158  |  
|Government program expense                   |  |                             | 852    |                      |   | 918    |  |   | (66    | )
|Stock-based compensation expense             |  |                             | 690    |                      |   | 2,670  |  |   | (1,980 | )
|Depreciation and amortization expense        |  |                             | 364    |                      |   | 410    |  |   | (46    | )
|                                             |  |                             |        |                      |   |        |  |   |        |  
|Total research and development expenses      |  | $                           | 10,817 |                      | $ | 10,764 |  | $ | 53     |  
|                                             |  |                             |        |                      |   |        |  |   |        |  

Basic research and preclinical expense of $3.1 million in the three months ended March 31,
2006 was flat as compared to the same period in 2005. Basic research and preclinical expense includes discovery research, chemical development, pharmacology, product development and patent related legal costs related to our internal research
programs.

Clinical trials and drug development expense increased by $2.2 million in the three months ended March 31, 2006 as compared
to the same period in 2005. This increase was comprised of a $0.8 million increase in internal expenses due to higher compensation expense and a $1.4 million increase in external expenses. Prior to the Companys initial public offering in the
third quarter of 2005, the Companys Board of Directors had not approved an annual cash bonus for employees. 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:



14



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##### Table of Contents

|                                                  |  |                             |       |                     |   |       |  |   |       |  
|------------------------------------------------- |  | --------------------------- | ----- | ------------------- | - | ----- |  | - | ----- | -
|                                                  |  | Three months endedMarch 31, |       | Increase/(Decrease) |  
|                                                  |  | 2006                        |       | 2005                |  
|                                                  |  | (in thousands)              |      
|Internal expenses (non-program specific)          |  | $                           | 2,788 |                     | $ | 2,001 |  | $ | 787   |  
|External expenses:                                |  |                             |       |                     |   |       |  |   |       |  
|ProMune                                           |  |                             | 63    |                     |   | 1,050 |  |   | (987  | )
|ACTILON                                           |  |                             | 2,081 |                     |   | 596   |  |   | 1,485 |  
|Other TLR Therapeutics                            |  |                             | 898   |                     |   | 25    |  |   | 873   |  
|                                                  |  |                             |       |                     |   |       |  |   |       |  
|Total external expenses                           |  |                             | 3,042 |                     |   | 1,671 |  |   | 1,371 |  
|                                                  |  |                             |       |                     |   |       |  |   |       |  
|Total clinical trial and drug development expense |  | $                           | 5,830 |                     | $ | 3,672 |  | $ | 2,158 |  
|                                                  |  |                             |       |                     |   |       |  |   |       |  

External expenses for our ProMune program were $0.1 million in the three months ended
March 31, 2006, a decrease of $1.0 million over the same period in 2005. This decrease was due primarily to lower clinical trial expenses, as our Phase II clinical trials in NSCLC and advanced melanoma were completed during 2005.

External expenses for our ACTILON program were $2.1 million for the three months ended March 31, 2006, an increase of $1.5 million over the same
period in 2005. This increase was due primarily to higher drug supply, clinical trial and toxicology study expenses as additional ACTILON clinical trials were initiated.

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 decreased by
$0.1 million to $0.9 million in the three months ended March 31, 2006 compared to the same period in 2005, due to the completion of our DARPA contract in 2005. 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.

We adopted SFAS
No. 123(R), Share-Based Payment, at the beginning of the first quarter of 2006. Stock-based compensation expense for research and development employees and consultants, which is a non-cash expense, is allocated on an employee
and consultant specific basis. Stock-based compensation expense decreased $2.0 million to $0.7 million for the three months ended March 31, 2006 from $2.7 million in the same period 2005. This decrease is primarily due to expense that was
immediately recognized for fully vested stock options granted to employees in 2005.

Depreciation and amortization expense for laboratory
equipment and leasehold improvements at our research facilities of $0.4 million in the three months ended March 31, 2006 was basically flat as compared to the same period in 2005.

General and administrative expenses: General and administrative expenses decreased by $0.7 million to $2.9 million in the three months ended
March 31, 2006 from $3.6 million in the same period in 2005, a decrease of 19.4%.



|                                           |  |                             |       |                      |   |       |  |   |        |  
|------------------------------------------ |  | --------------------------- | ----- | -------------------- | - | ----- |  | - | ------ | -
|                                           |  | Three months endedMarch 31, |       | Increase/ (Decrease) |  
|General and Administrative Expenses        |  | 2006                        |       | 2005                 |  
|                                           |  | (in thousands)              |      
|Compensation and personnel related expense |  | $                           | 1,588 |                      | $ | 951   |  | $ | 637    |  
|Professional services                      |  |                             | 513   |                      |   | 273   |  |   | 240    |  
|Facility costs                             |  |                             | 69    |                      |   | 52    |  |   | 17     |  
|Stock-based compensation expense           |  |                             | 671   |                      |   | 2,242 |  |   | (1,571 | )
|Depreciation and amortization expense      |  |                             | 22    |                      |   | 32    |  |   | (10    | )
|                                           |  |                             |       |                      |   |       |  |   |        |  
|Total general and administrative expenses  |  | $                           | 2,863 |                      | $ | 3,550 |  | $ | (687   | )
|                                           |  |                             |       |                      |   |       |  |   |        |  

The $0.7 million decrease in general and administrative expenses in the three months ended
March 31, 2006 was primarily attributed to a $1.6 million decrease in stock-based compensation expense offset by a $0.9 million increase in compensation (salaries and accrued bonus) and public company expenses. Prior to the Companys
initial public offering in the third quarter of 2005, the Companys Board of Directors had not approved an annual cash bonus for employees. The decrease in stock-based compensation expense in the three months ended March 31, 2006 was
primarily due to expense that was immediately recognized for fully vested stock options granted in 2005.

Royalty expense: Royalty
expense results from royalties paid to the University of Iowa Research Foundation and the Ottawa Health Research Institute related to revenues from collaboration agreements. Royalty expense increased by $0.4 million to $0.5 million



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in the three months ended March 31, 2006 from $0.1 million in the same period in 2005. This increase results
primarily from royalties paid to the University of Iowa Research Foundation that were related to the $50.0 million upfront payment received from Pfizer in 2005.

Other income and expense: Interest income increased by $1.4 million in the three months ended March 31, 2006 reflecting higher average cash and investment balances due to proceeds from our 2005 initial
public offering, the Pfizer private placement and receipt of an upfront license fee from Pfizer. Interest expense decreased by $0.1 million in the three months ended March 31, 2006 as a result of lower interest payments on our declining debt
balance under our capital lease facility.

Net loss: Net loss decreased, for the reasons stated above, by $4.9 million to $7.8
million in the three months ended March 31, 2006 from a net loss of $12.7 million in the same period in 2005.

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 $88.0 million from our commercial collaborations;
| | - |  | ------------------------------------------------------------------



| |  |  | cash receipts of $21.3 million from United States government contracts and grants;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | $6.8 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 $63.2 million from Pfizer that we have received in upfront license fees, sales of common stock, sponsored research fees and expense reimbursements.

At March 31, 2006, we had unrestricted cash, cash equivalents and marketable securities of $134.1 million, compared to $142.9 million as of
December 31, 2005.

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



|                                                             |  |                              |         |   |        |   |        |               |  |   |         |  
|------------------------------------------------------------ |  | ---------------------------- | ------- | - | ------ | - | ------ | ------------- |  | - | ------- | -
|                                                             |  | Three Months Ended March 31, |         |   | Change |  
|Summary Cash Flow Information                                |  | 2006                         |         |   | 2005   |   |        | 2006 vs. 2005 | 
|                                                             |  | (in thousands)               |        
|Net cash provided by (used in):                              |  |                              |         |   |        |   |        |               |  |   |         |  
|Operating activities                                         |  | $                            | (8,780  | ) |        | $ | (7,972 | )             |  | $ | (808    | )
|Investing activities                                         |  |                              | (13,574 | ) |        |   | 8,048  |               |  |   | (21,622 | )
|Financing activities                                         |  |                              | 31      |   |        |   | (446   | )             |  |   | 477     |  
|Exchange rate effect on cash and cash equivalents            |  |                              | 98      |   |        |   | (283   | )             |  |   | 381     |  
|                                                             |  |                              |         |   |        |   |        |               |  |   |         |  
|Net decrease in cash and cash equivalents                    |  | $                            | (22,225 | ) |        | $ | (653   | )             |  | $ | (21,572 | )
|                                                             |  |                              |         |   |        |   |        |               |  |   |         |  
|Cash and cash equivalents at March 31                        |  | $                            | 63,686  |   |        | $ | 12,537 |               |  | $ | 51,149  |  
|Marketable securities at March 31                            |  |                              | 70,431  |   |        |   | 2,000  |               |  |   | 68,431  |  
|                                                             |  |                              |         |   |        |   |        |               |  |   |         |  
|Cash, cash equivalents and marketable securities at March 31 |  | $                            | 134,117 |   |        | $ | 14,537 |               |  | $ | 119,580 |  
|                                                             |  |                              |         |   |        |   |        |               |  |   |         |  

Three months ended March 31, 2006 and 2005

Net cash used in operating activities increased by $0.8 million in the three months ended March 31, 2006 as compared to the same period in 2005 due
primarily to a $2.1 million increase in clinical trials and drug development expenses offset by a $1.4 million increase in collections of accounts receivable.

Net cash used in investing activities increased by $21.6 million in the three months ended March 31, 2006 primarily due to an increase in purchases of marketable securities.



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Net cash provided by financing activities increased by $0.5 million primarily due to the increase in
stock option activity in the three months ended March 31, 2006 as compared to the same period in 2005.

Our foreign currency cash
balances at our subsidiary in Germany expose us to fluctuations in currency exchange rates. During the three months ended March 31, 2006, the U.S. Dollar depreciated approximately 1.9% against the Euro, which resulted in a $0.1 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 March 31, 2006:



|                       |  |                             |        |                 |   |           |  |           |       |              |   |       |  |   |    
|---------------------- |  | --------------------------- | ------ | --------------- | - | --------- |  | --------- | ----- | ------------ | - | ----- |  | - | ---
|                       |  | Cash Payments Due by Period
|                       |  | Total                       |        | Less than1 year |   | 1-3 years |  | 4-5 years |       | After5 years
|                       |  | (in thousands)             
|Operating leases       |  | $                           | 6,930  |                 | $ | 1,603     |  | $         | 2,909 |              | $ | 1,512 |  | $ | 906
|Capital leases         |  |                             | 352    |                 |   | 352       |  |           |      |              |   |      |  |   |   
|Long-term debt         |  |                             | 2,769  |                 |   |          |  |           | 2,769 |              |   |      |  |   |   
|In-licensed technology |  |                             | 750    |                 |   | 150       |  |           | 300   |              |   | 300   |  |   | *  
|                       |  |                             |        |                 |   |           |  |           |       |              |   |       |  |   |    
|                       |  | $                           | 10,801 |                 | $ | 2,105     |  | $         | 5,978 |              | $ | 1,812 |  | $ | 906
|                       |  |                             |        |                 |   |           |  |           |       |              |   |       |  |   |    

---

|* | Minimum annual license fees of $0.2 million are required through the date of the last patent expiration. As a result of pending patents, 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, U.S.A. expiring in 2008, our lease in Ottawa, Canada, expiring in 2012, and our two
leases in Langenfeld, Germany, expiring in 2007 and 2010.

Capital Leases

We have entered into a capital lease facility agreement with General Electric Capital Corporation, primarily for new laboratory and computer equipment.
Based on the terms of the agreement and the type of underlying equipment, each lease extends for a period of 36 or 48 equal monthly payments at a weighed average interest rate of 8.25%. As of March 31, 2006, we have principal and interest
obligations of $0.4 million remaining.

Long-term Debt

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 ($1.9 million at
March 31, 2006) was to fund the early research and development of our product candidates. The loan bears interest at 6% annually, with principal payable December 31, 2007 and interest payable semi-annually on March 31 and
September 30. An additional contingent fee of 6% annually of the loan principal is payable when the loan is due or earlier if the loan is terminated before its due date by either Coley GmbH or Tbg. We have accrued this contingent fee under the
loan as Tbg may, at its sole discretion, request payment of the fee. The minimum contingent fee is 30% of the loan principal. As of March 31, 2006, we have accrued $0.9 million for this potential contingent fee.

In-Licensed Technology

We have also entered into
technology in-license agreements with the University of Iowa Research Foundation and the Ottawa Health Research Institute 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. In 2005, we paid the University of Iowa Research Foundation $6.5 million and the Ottawa Health Research Institute $0.2 million related to the $50.0 million
received from Pfizer as an upfront license fee payment.



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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 success of our collaborative arrangement with Pfizer for the development and commercialization of PF-3512676;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | the scope of our HCV program and results of our clinical trials of ACTILON;
| | - |  | ---------------------------------------------------------------------------



| |  |  | 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, other than Pfizer.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------

As a public company, we anticipate incurring increases in general and administrative expenses for directors and officers insurance, investor relations
and professional fees associated with operating a publicly-traded company. These increases will also likely include the hiring of additional personnel.

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 March 31,
2006 will be sufficient to finance our working capital and capital requirements for approximately 3 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 PF-3512676, sanofi-aventis drug candidates and VaxImmune, proceeds from our government programs and other collaborative license agreements we
may enter into.

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

The Company does
not believe there exists any recent accounting pronouncements that will have a material impact on its results of operations or financial position.

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.

Related Party Transactions

In 2001, we loaned our scientific co-founder and Chief Scientific Officer, Dr. Arthur Krieg, $0.5 million evidenced by a promissory note bearing
interest of 7% and payable in full on May 8, 2006. The loan was in connection with Dr. Kriegs purchase of a home in Massachusetts. The loan is collateralized by our common stock held by Dr. Krieg equal to at least 150% of the
outstanding balance of the loan, but in no case greater than 184,061 shares and a second mortgage on Dr. Kriegs home.

In 2005,
Dr. Krieg remitted $0.3 million to the Company as a partial pre-payment of his loan. On May 8, 2006, Dr. Krieg settled the remaining balance, including interest, of approximately $0.3 million by tendering Coley common stock to the
Company.



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Forward-Looking Statements

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 expectation 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 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.

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
10%, the impact on our annual net loss and cash burn would be $1.5 million.

From time to time, we may enter into forward foreign exchange
contracts, principally to hedge the impact of currency fluctuations on certain inter-company balances. The periods of these forward contracts typically range from one to three months and have varying notional amounts which are intended to be
consistent with changes in inter-company balances. Gains and losses on these forward foreign exchange contracts are recorded in the consolidated statement of operations. We did not have any open forward foreign exchange contracts at March 31,
2006 and December 31, 2005.

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 March 31, 2006, 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.



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##### Table of Contents

PART II  OTHER INFORMATION

Item 1A. Risk Factors

Risks Related to Our Business and Strategy

We have a history of net losses, which we expect to continue for at least several years and, as a result, we are unable to predict the extent of any future losses or
when, if ever, we will become profitable.

We have incurred $195.9 million in cumulative net losses from our inception in 1997, and we
expect losses to continue for the next several years. Our net loss for the three months ended March 31, 2006 was $7.8 million and for the fiscal year ended December 31, 2005 was $38.1 million. To date, we have only recognized revenues
through payments for funded research and development and license or collaboration fees and we do not anticipate generating significant revenues from sales of our products, if approved, for at least several years, if at all. All of our product
candidates are in development and none has been approved for commercial sale. We expect to increase our operating expenses over the next several years as we expand clinical trials for our product candidates currently in clinical development,
including ACTILON, advance our other TLR Therapeutic product candidates into clinical trials, expand our research and development activities, and seek regulatory approvals and engage in commercialization activities in anticipation of potential
United States Food and Drug Administration, or FDA, approval of our product candidates. Because of the numerous risks and uncertainties associated with developing our product candidates and their potential for commercialization, we are unable to
predict the extent of any future losses or when we will become profitable, if at all. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. If we are unable to achieve and
sustain profitability, the market value of our common stock will likely decline.

We have limited sources of revenue and if we are unable to secure
additional funding, we will have to reduce or discontinue operations.

We will require substantial funds to conduct development,
including preclinical testing and clinical trials of our product candidates. We currently believe that our available cash, cash equivalents and marketable securities, expected milestone payments and reimbursements from Pfizer and other collaborators
under our collaboration agreements, and interest income will be sufficient to fund our anticipated levels of operations for approximately the next three years. However, our future capital requirements will depend on many factors, including:



| |  |  | the scope, progress, expansion, costs and results of our research and development programs and clinical trials;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | the timing of, and the costs involved in, obtaining regulatory approvals;
| | - |  | -------------------------------------------------------------------------



| |  |  | our ability to establish and maintain collaborative arrangements and obtain milestone, royalty and other payments from collaborators;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the emergence of competing technologies and other adverse market developments;
| | - |  | ------------------------------------------------------------------------------



| |  |  | the costs of maintaining, expanding and protecting our intellectual property portfolio, including potential litigation or interference costs and liabilities; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the resources we devote to manufacturing, marketing and commercializing our products.
| | - |  | -------------------------------------------------------------------------------------

Since our inception in 1997, we have financed our operations primarily through the sale of equity, interest income earned on cash and cash equivalent balances, lines of credit and payments under agreements with our
collaborators. In order to fund our future needs, we may seek additional funding through public or private equity or debt financings, collaborative arrangements, lines of credit or other sources. Additional funding may not be available to us on
acceptable terms or at all. If we are unable to raise additional funds when needed, we may be required to delay, reduce or terminate some or all of our development programs and clinical trials. We may also be required to license technologies to
others that we would prefer to develop and commercialize ourselves. If we raise additional capital through the sale of equity, or securities convertible into equity, further dilution to our then existing stockholders will result and new investors
could have rights superior to the rights of holders of the shares of common stock. If we raise additional funds through the issuance of debt securities, these securities could have rights that are senior to holders of our common stock and could
contain covenants that restrict our operations. In addition, the terms of future financings may restrict our ability to raise additional capital, which would delay or prevent the further development or commercialization of our product candidates.



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We depend heavily on the success of our lead product candidate, PF-3512676, which is still under development.

We have invested a significant portion of our time and financial resources since our inception in the development of TLR Therapeutics,
including PF-3512676 for the potential treatment of cancer. We anticipate that in the near term our ability to generate revenues will depend primarily on the successful development and commercialization of PF-3512676 for cancers by Pfizer pursuant
to our collaboration. The commercial success of PF-3512676 will depend on several factors, including the following:



| |  |  | our ability to work effectively with Pfizer under our collaboration during their development of ProMune for cancer;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | commencement and successful completion of Phase III clinical trials in NSCLC and Phase II clinical trials in other cancer indications;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | receipt of marketing approvals from the FDA and similar foreign regulatory authorities;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | if approved, the successful commercial launch of PF-3512676 by Pfizer;
| | - |  | ----------------------------------------------------------------------



| |  |  | producing batches of the active pharmaceutical ingredient used in PF-3512676 in commercial quantities through a validated process; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | acceptance of PF-3512676 or competitive products in the medical community and with third-party payors.
| | - |  | ------------------------------------------------------------------------------------------------------

If Pfizer is not successful in developing or commercializing PF-3512676, or is significantly delayed in doing so, our business will be materially harmed
and we may need to curtail or cease operations.

We also depend on the success of ACTILON, which is at an early stage of clinical development.

Most of our work to date with ACTILON has been limited to preclinical studies and early stage clinical trials in a small number of
healthy volunteers and patients infected with the Hepatitis C virus or HCV. We have only recently begun clinical trials of ACTILON in patients infected with Hepatitis C virus. We will be required to spend considerable additional time, money and
effort on development activities before seeking regulatory approval to market ACTILON. There can be no assurance that we will receive regulatory approval or that, if we do, such regulatory approval will be timely enough to assure the commercial
viability of ACTILON. Our business prospects depend on our ability to successfully complete clinical trials, obtain required regulatory approvals and successfully commercialize ACTILON. If we do not achieve clinical success with ACTILON or if we
ultimately fail to commercialize ACTILON, we may be unable to generate sufficient revenues to maintain our business, and our reputation in the industry and in the investment community would likely be significantly damaged, each of which could cause
our stock price to decline.

Positive results from preclinical studies or early clinical trials do not assure that later or larger-scale
clinical trials will succeed. The initial trials of ACTILON have been conducted only in small numbers of patients who may not fully represent the diversity of larger populations infected with HCV and may not predict the ability of ACTILON to achieve
a sustained virological response or its ability to provide a long-term therapeutic benefit. We will be required to demonstrate through larger-scale clinical trials that ACTILON is safe and effective for use in a diverse patient population before we
can seek regulatory approval for its commercial sale. If ACTILON fails to demonstrate sufficient safety and efficacy in any clinical trial, we would likely experience significant delays or be required to abandon development of ACTILON.

If our competitors develop treatments for HCV that are approved faster, marketed more successfully or demonstrated to be more effective than ACTILON, our
commercial opportunity will be reduced or eliminated.

If approved by the necessary regulatory authorities, ACTILON will be subject to
competition in the treatment of HCV from a significant number of additional drugs that are currently under development and may become available in the future for the treatment of HCV. These treatments may be more effective or less costly than
ACTILON. A partial list of potential new products for the treatment of HCV includes Viramidine, which is being developed by Valeant Pharmaceuticals; Zadaxin®, which is being developed by SciClone Pharmaceuticals; ANA 975, which is being developed by Anadys Pharmaceuticals; VX 950, which is being developed by
Vertex Pharmaceuticals; NM283, which is being developed by Idenix Pharmaceuticals and Novartis; and Albuferon, which is being developed by Human Genome Sciences. Additionally, less expensive generic forms of currently marketed drugs could lead to additional competition upon the expiration or
invalidation of patents underlying such currently marketed drugs.



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A key part of our business strategy is to establish collaborative relationships to commercialize and fund development
of our TLR Therapeutic product candidates. If any collaborator terminates or fails to perform its obligations under agreements with us, the development and commercialization of our drug candidates could be delayed or terminated.

A key aspect of our business strategy is to develop and commercialize products for the treatment of diseases through collaborative arrangements with
pharmaceutical companies, research institutions, the United States government and universities. Currently, we have established collaborative relationships with several pharmaceutical companies and government agencies. We also intend to establish
collaborative relationships to obtain domestic and international sales, marketing and distribution capabilities for our TLR Therapeutic product candidates.

The process of establishing collaborative relationships is difficult, time-consuming and involves significant uncertainty. Moreover, even if we do establish collaborative relationships, our collaborators may seek to
renegotiate or terminate their relationships with us due to unsatisfactory clinical results, a change in business strategy, a change of control or other reasons. If any collaborator fails to fulfill its responsibilities in a timely manner, or at
all, our research, clinical development or commercialization efforts related to that collaboration could be delayed or terminated, or it may be necessary for us to assume responsibility for activities that would otherwise have been the
responsibility of our collaborator. If we are unable to establish and maintain collaborative relationships on acceptable terms, we may have to delay or discontinue further development of one or more of our product candidates, undertake development
and commercialization activities at our own expense or find alternative sources of funding.

Risks Related to our Intellectual Property

If the combination of patents, trade secrets and contractual provisions that we rely on to protect our intellectual property is inadequate, our
ability to successfully commercialize our product candidates will be harmed and we may not be able to operate our business profitably.

Our success depends on our ability to obtain, maintain and enforce our intellectual property rights domestically and abroad. The patent position of biotechnology companies is generally highly uncertain, involves complex legal and factual
questions and has recently been the subject of much litigation. Neither the United States Patent and Trademark Office, or PTO, nor the courts have a consistent policy regarding the breadth of claims allowed or the degree of protection afforded under
many biotechnology patents. The validity, enforceability and commercial value of these rights, therefore, is highly uncertain.

Our patent
estate includes, on a worldwide basis, 16 patents issued in the U.S., 63 patents issued in the rest of the world and more than 422 pending patent applications. However, our patents may not protect us against our competitors. The issuance of a patent
is not conclusive as to its scope, validity or enforceability. The scope, validity or enforceability of our patents can be challenged in litigation. Such litigation can involve substantial costs and distraction. If the outcome of such litigation is
adverse to us, third parties may be able to use our patented inventions and compete directly with us, without payment to us. Third parties may also be able to circumvent our patents by design innovations. We may not receive any additional patents
based on the applications currently pending.

Because patent applications in the United States and many foreign jurisdictions are typically
not published until 18 months after filing or, in some cases, not at all, and because publications of discoveries in the scientific literature often lag behind actual discoveries, neither we nor our licensors or collaborators can be certain that we
or they were the first to make the inventions claimed in patents or pending patent applications, or that we or they were the first to file for protection of the inventions set forth in these patent applications.



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Risks Related to Our Common Stock

If there are substantial sales of our common stock, our stock price could decline.

Our current
stockholders hold a substantial number of shares, which they are able to sell in the public market. If we or our stockholders sell significant amounts of our common stock in the public market, including shares issued upon the exercise of outstanding
options and warrants, the market price of our common stock could decline significantly. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem reasonable or
appropriate.

We have also registered all common stock that we have or may issue under our stock compensation plans. These shares can be
freely sold in the public market upon issuance, subject to applicable restrictions under the securities laws. If any of these stockholders cause a large number of securities to be sold in the public market, the sale could reduce the trading price of
our common stock. These sales also could impede our ability to raise future capital.

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.

Item 6. Exhibits



|     |  |                                                                                                                                                                                   
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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   |  | 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.

---

|* | 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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##### Table of Contents

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.                                                             
|             | 
|May 12, 2006 |  | /s/    ROBERT L. BRATZLER,
PH.D.                                                             
|             |  | Robert L. Bratzler, Ph.D. President and Chief Executive Officer (Principal Executive Officer)
|             | 
|May 12, 2006 |  | /s/    CHARLES H. ABDALIAN,
JR.                                                              
|             |  | Charles H. Abdalian, Jr. Chief Financial Officer (Principal Financial and Accounting Officer)



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##### Table of Contents

COLEY PHARMACEUTICAL GROUP, INC.

EXHIBIT INDEX



|            |  |                                                                                                                                                                                   
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                       
|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          |  | 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.

---

|* | 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.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25