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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, 2007

OR



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

For the transition period from
 to

Commission File Number: 000-51472



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COLEY PHARMACEUTICAL GROUP, INC.

(Exact name of registrant as specified in its charter)



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

93 WORCESTER STREET, SUITE 101

WELLESLEY, MA 02481

(Address of principal executive offices, including zip
code)

(781) 431-9000

(Registrants telephone number, including area code)

Not applicable

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



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

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

Large accelerated filer ̈Accelerated
filer  x    Non-accelerated filer ̈

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

As of April 26, 2007, there were 26,504,833 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, 2007



|                               |  |                                                                                                                                                 |  |     
|------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                               |  |                                                                                                                                                 |  | Page
|PART I  FINANCIAL INFORMATION |  |                                                                                                                                                
|                               |  |                                                                                                                                                
|ITEM 1.                        |  | FINANCIAL STATEMENTS                                                                                                                            |  |     
|                               |  |                                                                                                                                                
|                               |  | Condensed Consolidated Balance Sheets (Unaudited) as of March 31, 2007 and December 31, 2006                                                    |  | 3   
|                               |  |                                                                                                                                                
|                               |  | Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited) for the three months ended March 31, 2007 and March 31, 2006 |  | 4   
|                               |  |                                                                                                                                                
|                               |  | Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2007 and March 31, 2006                        |  | 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                                                                                      |  | 17  
|                               |  |                                                                                                                                                
|ITEM 4.                        |  | CONTROLS AND PROCEDURES                                                                                                                         |  | 18  
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                                                                                
|                               |  |                                                                                                                                                
|ITEM 1.                        |  | LEGAL PROCEEDINGS                                                                                                                               |  | 19  
|                               |  |                                                                                                                                                
|ITEM 1A.                       |  | RISK FACTORS                                                                                                                                    |  | 19  
|                               |  |                                                                                                                                                
|ITEM 2.                        |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                                                     |  | 19  
|                               |  |                                                                                                                                                
|ITEM 3.                        |  | DEFAULTS UPON SENIOR SECURITIES                                                                                                                 |  | 19  
|                               |  |                                                                                                                                                
|ITEM 4.                        |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                             |  | 19  
|                               |  |                                                                                                                                                
|ITEM 5.                        |  | OTHER INFORMATION                                                                                                                               |  | 19  
|                               |  |                                                                                                                                                
|ITEM 6.                        |  | EXHIBITS                                                                                                                                        |  | 19  



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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, 2007 |          |   | December 31, 2006 |  
|Assets                                                                                                                |  |                |          |   |                   |   |          |  
|Current assets                                                                                                        |  |                |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                             |  | $              | 53,831   |   |                   | $ | 52,505   |  
|Marketable securities                                                                                                 |  |                | 43,930   |   |                   |   | 54,541   |  
|Accounts receivable                                                                                                   |  |                | 1,101    |   |                   |   | 448      |  
|Prepaid expenses and other current assets                                                                             |  |                | 2,056    |   |                   |   | 1,833    |  
|Deferred royalty fees                                                                                                 |  |                | 2,082    |   |                   |   | 2,022    |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total current assets                                                                                                  |  |                | 103,000  |   |                   |   | 111,349  |  
|Property and equipment, net                                                                                           |  |                | 4,336    |   |                   |   | 4,597    |  
|Deferred royalty fees                                                                                                 |  |                | 3,731    |   |                   |   | 4,236    |  
|Other noncurrent assets                                                                                               |  |                | 1,847    |   |                   |   | 2,093    |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total assets                                                                                                          |  | $              | 112,914  |   |                   | $ | 122,275  |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Liabilities and Shareholders Equity                                                                                  |  |                |          |   |                   |   |          |  
|Current liabilities                                                                                                   |  |                |          |   |                   |   |          |  
|Accounts payable                                                                                                      |  | $              | 1,508    |   |                   | $ | 1,874    |  
|Accrued expenses                                                                                                      |  |                | 4,368    |   |                   |   | 4,332    |  
|Current portion of note payable                                                                                       |  |                | 2,344    |   |                   |   | 2,024    |  
|Deferred revenue                                                                                                      |  |                | 16,425   |   |                   |   | 15,873   |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total current liabilities                                                                                             |  |                | 24,645   |   |                   |   | 24,103   |  
|Deferred revenue                                                                                                      |  |                | 21,761   |   |                   |   | 25,596   |  
|Note payable                                                                                                          |  |                | 835      |   |                   |   | 1,093    |  
|Other noncurrent liabilities                                                                                          |  |                | 805      |   |                   |   | 841      |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total liabilities                                                                                                     |  |                | 48,046   |   |                   |   | 51,633   |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Commitments and contingencies                                                                                         |  |                |          |   |                   |   |          |  
|Shareholders equity                                                                                                  |  |                |          |   |                   |   |          |  
|Preferred stock, $0.01 par value:                                                                                     |  |                |          |   |                   |   |          |  
|Authorized shares5,000,000 shares at March 31, 2007 and December 31, 2006, respectively                              |  |                |          |   |                   |   |          |  
|No shares outstanding at March 31, 2007 and December 31, 2006, respectively                                           |  |                |          |   |                   |   |          |  
|Common stock, $0.01 par value:                                                                                        |  |                |          |   |                   |   |          |  
|Authorized shares50,000,000 shares at March 31, 2007 and December 31, 2006                                           |  |                |          |   |                   |   |          |  
|Issued and outstanding shares 26,480,081 and 26,382,432 shares at March 31, 2007 and December 31, 2006,
respectively |  |                | 264      |   |                   |   | 264      |  
|Additional paid-in capital                                                                                            |  |                | 293,613  |   |                   |   | 293,032  |  
|Accumulated other comprehensive income                                                                                |  |                | 690      |   |                   |   | 619      |  
|Deferred compensation                                                                                                 |  |                | (4,148   | ) |                   |   | (5,438   | )
|Accumulated deficit                                                                                                   |  |                | (225,551 | ) |                   |   | (217,835 | )
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total shareholders equity                                                                                            |  |                | 64,868   |   |                   |   | 70,642   |  
|                                                                                                                      |  |                |          |   |                   |   |          |  
|Total liabilities and shareholders equity                                                                            |  | $              | 112,914  |   |                   | $ | 122,275  |  
|                                                                                                                      |  |                |          |   |                   |   |          |  

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)                                 |  | 2007                         |        |   | 2006 |  
|Revenue                                                                  |  |                              |        |   |      |   |        |  
|Collaborative agreements                                                 |  | $                            | 4,352  |   |      | $ | 4,024  |  
|Government contracts and grants                                          |  |                              | 1,171  |   |      |   | 1,025  |  
|                                                                         |  |                              |        |   |      |   |        |  
|Total revenue                                                            |  |                              | 5,523  |   |      |   | 5,049  |  
|                                                                         |  |                              |        |   |      |   |        |  
|Operating expenses                                                       |  |                              |        |   |      |   |        |  
|Research and development                                                 |  |                              | 10,033 |   |      |   | 10,817 |  
|General and administrative                                               |  |                              | 3,883  |   |      |   | 2,863  |  
|Royalty expense                                                          |  |                              | 474    |   |      |   | 505    |  
|                                                                         |  |                              |        |   |      |   |        |  
|Total operating expenses                                                 |  |                              | 14,390 |   |      |   | 14,185 |  
|                                                                         |  |                              |        |   |      |   |        |  
|Loss from operations                                                     |  |                              | (8,867 | ) |      |   | (9,136 | )
|Other income (expense)                                                   |  |                              |        |   |      |   |        |  
|Interest income                                                          |  |                              | 1,278  |   |      |   | 1,469  |  
|Interest expense                                                         |  |                              | (70    | ) |      |   | (67    | )
|Foreign currency loss                                                    |  |                              | (35    | ) |      |   | (35    | )
|                                                                         |  |                              |        |   |      |   |        |  
|Total other income                                                       |  |                              | 1,173  |   |      |   | 1,367  |  
|                                                                         |  |                              |        |   |      |   |        |  
|Loss before income taxes                                                 |  |                              | (7,694 | ) |      |   | (7,769 | )
|Income tax expense                                                       |  |                              | (21    | ) |      |   | (21    | )
|                                                                         |  |                              |        |   |      |   |        |  
|Net loss                                                                 |  |                              | (7,715 | ) |      |   | (7,790 | )
|                                                                         |  |                              |        |   |      |   |        |  
|Comprehensive loss                                                       |  |                              |        |   |      |   |        |  
|Net loss                                                                 |  | $                            | (7,715 | ) |      | $ | (7,790 | )
|Other comprehensive income (loss):                                       |  |                              |        |   |      |   |        |  
|Foreign currency translation adjustments                                 |  |                              | 64     |   |      |   | 53     |  
|Unrealized gain (loss) on investments                                    |  |                              | 7      |   |      |   | (77    | )
|                                                                         |  |                              |        |   |      |   |        |  
|Comprehensive loss                                                       |  | $                            | (7,644 | ) |      | $ | (7,814 | )
|                                                                         |  |                              |        |   |      |   |        |  
|Basic and diluted net loss per share                                     |  | $                            | (0.29  | ) |      | $ | (0.30  | )
|                                                                         |  |                              |        |   |      |   |        |  
|Weighted average shares used to compute basic and diluted loss per share |  |                              | 26,432 |   |      |   | 26,063 |  

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)                                       |  | 2007                         |         |   | 2006 |  
|Cash flows from operating activities                 |  |                              |         |   |      |   |         |  
|Net cash used in operating activities                |  |                              | (9,395  | ) |      |   | (8,780  | )
|                                                     |  |                              |         |   |      |   |         |  
|Cash flows from investing activities                 |  |                              |         |   |      |   |         |  
|Purchases of marketable securities                   |  |                              | (29,192 | ) |      |   | (21,543 | )
|Maturities of marketable securities                  |  |                              | 39,810  |   |      |   | 8,110   |  
|Purchases of property and equipment                  |  |                              | (56     | ) |      |   | (187    | )
|Other                                                |  |                              | 59      |   |      |   | 46      |  
|                                                     |  |                              |         |   |      |   |         |  
|Net cash provided by (used in) investing activities  |  |                              | 10,621  |   |      |   | (13,574 | )
|                                                     |  |                              |         |   |      |   |         |  
|Cash flows from financing activities                 |  |                              |         |   |      |   |         |  
|Principal payments of capital lease obligations      |  |                              | (41     | ) |      |   | (381    | )
|Proceeds from stock option exercises                 |  |                              | 65      |   |      |   | 372     |  
|Proceeds from repayment of shareholder note          |  |                              |        |   |      |   | 40      |  
|                                                     |  |                              |         |   |      |   |         |  
|Net cash provided by financing activities            |  |                              | 24      |   |      |   | 31      |  
|                                                     |  |                              |         |   |      |   |         |  
|Exchange rate effect on cash and cash equivalents    |  |                              | 76      |   |      |   | 98      |  
|                                                     |  |                              |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents |  |                              | 1,326   |   |      |   | (22,225 | )
|Cash and cash equivalents, beginning of period       |  |                              | 52,505  |   |      |   | 85,911  |  
|                                                     |  |                              |         |   |      |   |         |  
|Cash and cash equivalents, end of period             |  | $                            | 53,831  |   |      | $ | 63,686  |  
|                                                     |  |                              |         |   |      |   |         |  

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

(in thousands, except share data)

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

Nature of the Business

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

Basis of Presentation and Principles of Consolidation

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

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



|                            |  |                |        |                  |   |                   |  |   |                             |   |  |   |       
|--------------------------- |  | -------------- | ------ | ---------------- | - | ----------------- |  | - | --------------------------- | - |  | - | ------
|                            |  | Amortized Cost |        | Unrealized Gains |   | Unrealized Losses |  |   | Estimated Fair Market Value
|Certificates of deposit     |  |                | 2,000  |                  |   | 1                 |  |   |                             |   |  |   | 2,001 
|U.S. government obligations |  |                | 18,382 |                  |   | 1                 |  |   | (1                          | ) |  |   | 18,382
|Corporate bonds             |  |                | 5,076  |                  |   | 1                 |  |   |                             |   |  |   | 5,077 
|Commercial paper            |  |                | 4,470  |                  |   |                   |  |   |                             |   |  |   | 4,470 
|Auction rate securities     |  |                | 14,000 |                  |   |                   |  |   |                             |   |  |   | 14,000
|                            |  |                |        |                  |   |                   |  |   |                             |   |  |   |       
|Total marketable securities |  | $              | 43,928 |                  | $ | 3                 |  | $ | (1                          | ) |  | $ | 43,930
|                            |  |                |        |                  |   |                   |  |   |                             |   |  |   |       

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



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been deferred and will be recognized as expense as the Company recognizes the related revenue under its collaborative research and development agreements.

Deferred royalty fees included in the condensed consolidated balance sheet totaled $5,813 and $6,258 at March 31, 2007 and
December 31, 2006, respectively.

2. Stock-Based Compensation

The Company currently has one equity-based compensation plan from which stock-based compensation awards can be granted to employees and directors. In addition, the Company has one plan that has been terminated as to
future grants, but under which options are currently outstanding. The equity incentive plans are described more fully in Note 2 to the consolidated financial statements included in the Companys Annual Report on Form 10-K for the fiscal year
ended December 31, 2006.

The table below illustrates the fair value per share and Black-Scholes option pricing model with the
following assumptions used for grants issued during the quarters ended March 31, 2007 and 2006:



|                                                                 |  |                              |            |   |      |   |            |  
|---------------------------------------------------------------- |  | ---------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                 |  | Three Months Ended March 31, |           
|                                                                 |  | 2007                         |            |   | 2006 |  
|Weighted average fair value of options granted during the period |  | $                            | 6.43       |   |      | $ | 10.85      |  
|Assumptions:                                                     |  |                              |            |   |      |   |            |  
|Risk-free interest rate                                          |  |                              | 4.56       | % |      |   | 4.83       | %
|Expected dividend yield                                          |  |                              | 0          | % |      |   | 0          | %
|Expected option life                                             |  |                              | 6.25 years |   |      |   | 6.25 years |  
|Expected stock price volatility                                  |  |                              | 67         | % |      |   | 75         | %

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

The following table shows stock-based compensation expense included in the condensed consolidated statements of operations for the three months ended
March 31, 2007 and 2006:



|                                       |  |                              |       |      |   |      
|-------------------------------------- |  | ---------------------------- | ----- | ---- | - | -----
|                                       |  | Three Months Ended March 31,
|                                       |  | 2007                         |       | 2006
|Research and development               |  | $                            | 794   |      | $ | 690  
|General and administrative             |  |                              | 1,011 |      |   | 671  
|                                       |  |                              |       |      |   |      
|Total stock-based compensation expense |  | $                            | 1,805 |      | $ | 1,361
|                                       |  |                              |       |      |   |      

In the three months ended March 31,
2007, $289 of non-cash stock compensation expense was recognized for the re-measurement of stock options related to the modification of options that was undertaken for three employees impacted by the decision to suspend further development of
ACTILONTMin January 2007. For stock options accounted for under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB No. 25), $515 of deferred compensation was reclassified against additional paid-in-capital to account for the terminations.

A summary of stock option activity under the Companys 1997 Employee, Director and Consultant Stock Option Plan and 2005 Stock Option Plan for the
period ended March 31, 2007 is as follows:



|                                         |  |                  |   |  |                                           |      |                                                        |     |                           |   |       
|---------------------------------------- |  | ---------------- | - |  | ----------------------------------------- | ---- | ------------------------------------------------------ | --- | ------------------------- | - | ------
|                                         |  | Number of Shares |   |  | Weighted Average Exercise Price per
Share |      | Weighted Average Remaining Contractual
Life (in Years) |     | Aggregate Intrinsic Value
|Options outstanding at December 31, 2006 |  | 3,154,389        |   |  | $                                         | 5.87 |                                                        | 7.7 |                           | $ | 17,570
|Granted                                  |  | 740,300          |   |  | $                                         | 9.86 |                                                        |     |                           |   |       
|Cancelled                                |  | (53,690          | ) |  | $                                         | 9.09 |                                                        |     |                           |   |       
|Exercised                                |  | (53,235          | ) |  | $                                         | 1.21 |                                                        |     |                           |   |       
|                                         |  |                  |   |  |                                           |      |                                                        |     |                           |   |       
|Options outstanding at March 31, 2007    |  | 3,787,764        |   |  | $                                         | 6.67 |                                                        | 7.9 |                           | $ | 16,783
|Options vested at March 31, 2007         |  | 1,870,202        |   |  | $                                         | 4.45 |                                                        | 7.0 |                           | $ | 12,257



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As of March 31, 2007, there remained approximately $14,595 of compensation costs, net of
forfeitures, related to unvested stock options to be recognized as expense over a weighted average period of approximately 2.82 years.

3. Net Loss Per
Common Share

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

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



|                      |  |                              |  |          
|--------------------- |  | ---------------------------- |  | ---------
|                      |  | Three Months Ended March 31,
|                      |  | 2007                         |  | 2006     
|Options               |  | 2,026,694                    |  | 2,334,011
|Common stock warrants |  | 1,673,759                    |  | 2,038,205
|                      |  |                              |  |          
|                      |  | 3,700,453                    |  | 4,372,216
|                      |  |                              |  |          

4. Significant Research and Development and Licensing Agreements

Pfizer Inc.

In March 2005, the Company entered into a
series of agreements with Pfizer Inc. (Pfizer) under which it has granted Pfizer development and worldwide marketing rights to CPG 7909, now referred to as PF-3512676 by Pfizer. Under the license agreement, the Company received a $50,000
upfront license fee and may receive up to $455,000 in milestone payments, a significant majority of which relates to potential development and regulatory approval milestones, as well as royalties on any future product sales. The Company also entered
into a stock purchase agreement with Pfizer pursuant to which Pfizer purchased $10,000 of the Companys common stock in a private placement concurrent with the Companys initial public offering.

A primary focus of the agreements with Pfizer is the development and commercialization of 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 all future development of 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 PF-3512676 in the first-line treatment of advanced NSCLC patients. Target patient enrollment of approximately 800 patients has been achieved in each trial.

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

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

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



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In connection with the $50,000 upfront license payment from Pfizer, the Company will recognize this
initial fee over 44 months, the expected period of the Companys performance obligations. For the three months ended March 31, 2007 and 2006, the Company recognized license, sponsored research revenue and expense reimbursements of $4,120
and $3,795. To date, the Company has received or invoiced $55,987 for upfront license, sponsored research and expense reimbursement under the Pfizer agreement. As of March 31, 2007, there is $26,718 of deferred revenue that will be recognized
over the remaining 21 months of the performance period.

During 2005, the Company paid UIRF $6,500 and the OHRI $150 for royalties related
to the $50,000 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 upfront payment from Pfizer.

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 grant with the NIAID to perform research and preclinical development in the area of pulmonary innate immune activation for bio-terror defense. This grant terminated in February 2007 and the Company has applied for a
one-year extension for this grant through February 2008. The Company has recognized revenues under this grant of $121 and $441 for the three months ended March 31, 2007 and 2006, respectively.

In 2004, the Company was awarded a $16,902 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 $1,050 and $584 for the three months ended March 31, 2007 and 2006, 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. Suspension of ACTILON Clinical Development

In January 2007, the Company suspended its independent development of ACTILON, the Companys product candidate for the treatment of Hepatitis C virus (HCV) infection. In accordance with this program decision, the
Company is reducing its headcount by approximately 22 percent, or 32 employees, with such reduction to be completed in the second quarter of 2007. As of March 31, 2007, the Company has reduced its workforce (predominately clinical development
staff) by approximately 18 percent, or 27 employees. Five additional positions will be eliminated in the second quarter of 2007.

In
accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the Company has recognized $1,176 of expense related to the severance and outplacement support offered to employees affected by this program
decision. For the three months ended March 31, 2007, $767 was recorded as research and development expense and $409 as general and administrative expense. The Company also has $648 accrued for severance expenses at March 31, 2007, which will be
fully paid by December 2007. In addition, the Company has recognized $289 of non-cash stock compensation expense for the re-measurement of stock options related to the modification of options that was undertaken for three employees impacted by this
program decision in compliance with their severance agreements. For stock options accounted for under APB No. 25, $515 of deferred compensation was reclassified against additional paid-in-capital to account for the terminations.

6. Accounting for the Uncertainty of Income Taxes

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

The Company has an uncertain tax position of approximately $5,000 which did not change significantly during the three months ended March 31, 2007.
The uncertain tax position results in a decrease of the Companys net operating loss deferred tax asset, which is offset by a valuation allowance. Accordingly, there was no impact on the Companys consolidated financial position, results
of operations and cash flows as a result of the adoption of FIN 48.

Interest and penalties related to income taxes will be recorded as a
component of the tax provision. As of March 31, 2007, we have not accrued any amounts for interest or penalties.

The open tax years
by major jurisdiction are:



| | 1) | United States: the years ended December 31, 1997 through 2006;
| | -- | --------------------------------------------------------------



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| | 2) | Canada: the years ended December 31, 2001 through 2006;
| | -- | -------------------------------------------------------



| | 3) | Germany: the years ended December 31, 2001 through 2006.
| | -- | --------------------------------------------------------

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

7. Recent Accounting Pronouncements

In February
2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits entities to choose to measure many financial assets and financial
liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is in the
process of evaluating whether this standard will have a material effect on its financial position or results of operations.

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

8. Subsequent Event

In April 2007, the Company entered into an agreement with Merck & Co., Inc.
(Merck) that grants a worldwide, non-exclusive license for the Companys VaxImmuneTMvaccine
adjuvant for incorporation into vaccines being developed by Merck for certain infectious diseases and Alzheimers disease, as well as the option to add additional fields to the license. Under the terms of the agreement, Merck has agreed to pay
the Company an upfront license fee of $4,000 which is expected to be recognized as revenue in the second quarter of 2007. The Company is also eligible to receive milestone payments of up to $33,000 as well as royalties from the sale of any products
that are commercialized under the agreement.



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

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 expectations and we assume no obligation to update
this information. Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks or uncertainties. Consequently,
no forward-looking statement can be guaranteed. Actual results may vary materially from those set forth in the forward-looking statements. Forward-looking statements, therefore, should be considered in light of all of the information included or
referred to in this Quarterly Report on Form 10-Q, including the cautionary information set forth under Part II, Item 1A., Risk Factors.

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

Overview

We are a biopharmaceutical company focused on discovering and developing TLR TherapeuticsTM, a novel class of drug candidates, for several disease indications including cancers, asthma and allergic disorders, and to enhance the effectiveness of vaccines. We began operations in 1998. We and our collaborators currently have
three clinical drug candidates in clinical trials, all of which agonize, or stimulate, one specific Toll-like receptor (TLR), TLR9. Our most advanced clinical compound is in Phase III clinical testing for cancer with our collaborator,
Pfizer Inc. We have a collaboration with sanofi-aventis in the area of asthma and allergic disorders. We also have license agreements with various vaccine developers to improve the performance and efficacy of their vaccines with our proprietary
vaccine adjuvant technology, which we call VaxImmuneTM. Our most advanced VaxImmune program is currently in Phase II
clinical testing with GlaxoSmithKline. Since our inception, we have generated significant losses while we or our collaborators have advanced our products into clinical trials. As of March 31, 2007, we had accumulated a deficit of $225.6
million.

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

In accordance with this program decision, we are reducing our headcount by approximately 22 percent, or 32 employees, with such reduction to be completed
in the second quarter of 2007. As of March 31, 2007, we have reduced our workforce (predominately clinical development staff) by approximately 18 percent, or 27 employees to 121 full-time employees located in the United States, Canada and
Germany. Five additional positions will be eliminated in the second quarter of 2007. As a result of this reduction in headcount and based upon our current operating plan, we anticipate achieving approximately $3.0 million in cost savings in 2007.

For the three months ended March 31, 2007, we have recognized $1.2 million of expense related to the severance and outplacement
support offered to employees affected by this program decision and have $0.6 million accrued for severance expenses, which will be fully paid by December 2007. In addition, we have recognized $0.3 million of non-cash stock compensation expense for
the re-measurement of stock options related to the modification of options that was undertaken for three employees impacted by this program decision in compliance with their severance agreements.

As a result of our decision to suspend our independent development of ACTILON, we will focus our resources towards discovering and developing new TLR
Therapeutics, including other synthetic agonists and antagonists targeting TLRs 7, 8 and 9, as well as synthetic RNA-based drugs designed to stimulate Toll-like receptors 7 and 8. This change will result in a shift in the components of our research
and development spending in 2007 compared to 2006. Based on our current operating plan, we expect spending in discovery research and preclinical expense to increase by approximately $5.5 million in 2007 from 2006 and spending in clinical trials and
drug development to decrease by approximately $6.5 million in 2007 from 2006. Overall spending in research and development is expected to decrease by approximately $2.0 million in 2007 from 2006 to approximately $39.0 million.



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United States Government Contracts and Grants

As of March 31, 2007, gross proceeds of $10.3 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 financial status of
our United States government contracts and grants, in millions, is as follows:



|                                                          |  |        |     |  |               |      |                                       |   |                                                 |  |                            |      |  |     
|--------------------------------------------------------- |  | ------ | --- |  | ------------- | ---- | ------------------------------------- | - | ----------------------------------------------- |  | -------------------------- | ---- |  | ----
|Program Title                                             |  | Agency |     |  | Program Total |      | Total Received Through March 31, 2007 |   | Remaining Amounts to be Received March 31, 2007 |  | Contract/ Grant Expiration
|Pulmonary Innate Immune Activation for Bio-terror Defense |  | NIAID  | (1) |  | $             | 6.3  |                                       | $ | 6.0                                             |  | $                          | 0.3  |  | 2007
|Innate Immune Receptors and Adjuvant Discovery            |  | NIAID  | (1) |  |               | 16.9 |                                       |   | 6.9                                             |  |                            | 10.0 |  | 2009
|                                                          |  |        |     |  |               |      |                                       |   |                                                 |  |                            |      |  |     
|Total                                                     |  |        |     |  | $             | 23.2 |                                       | $ | 12.9                                            |  | $                          | 10.3 |  |     
|                                                          |  |        |     |  |               |      |                                       |   |                                                 |  |                            |      |  |     

---

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

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

We have an uncertain tax position of approximately $5.0 million which did not change significantly during the three months ended March 31, 2007. The uncertain tax position results in a decrease of our net
operating loss deferred tax asset, which is offset by a valuation allowance. Accordingly, there was no impact on our consolidated financial position, results of operations and cash flows as a result of the adoption of FIN 48.



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Results of Operations

For the Three Months Ended March 31, 2007 and 2006

Revenue: Revenue increased by $0.5 million to $5.5
million in the three months ended March 31, 2007 from $5.0 million in the same period in 2006, an increase of 9.4%.



|                                        |  |                             |       |                     |   |       |  |   |    
|--------------------------------------- |  | --------------------------- | ----- | ------------------- | - | ----- |  | - | ---
|                                        |  | Three months endedMarch 31, |       | Increase/(Decrease)
|Revenue                                 |  | 2007                        |       | 2006                |  
|                                        |  |                             |       | (in thousands)      |   |      
|Collaborator:                           |  |                             |       |                     |   |       |  |   |    
|Fees recognized over performance period |  | $                           | 3,604 |                     | $ | 3,602 |  | $ | 2  
|Cost reimbursement and other            |  |                             | 748   |                     |   | 422   |  |   | 326
|                                        |  |                             |       |                     |   |       |  |   |    
|Total collaborator                      |  |                             | 4,352 |                     |   | 4,024 |  |   | 328
|Government                              |  |                             | 1,171 |                     |   | 1,025 |  |   | 146
|                                        |  |                             |       |                     |   |       |  |   |    
|Total Revenue                           |  | $                           | 5,523 |                     | $ | 5,049 |  | $ | 474
|                                        |  |                             |       |                     |   |       |  |   |    

Collaborator revenue increased by $0.3 million in the three months ended March 31, 2007
compared to the same period in 2006. This increase was primarily due to reimbursement from Pfizer for development services incurred on their behalf under our license agreement with them.

Government revenue increased by $0.1 million in the three months ended March 31, 2007 compared to the same period in 2006. This increase is due
primarily to a $0.4 million increase in our Innate Immune Receptors and Adjuvant Discovery grant with NIAID offset by a $0.3 million decrease in our Pulmonary Innate Immune Activation for Bio-terror Defense grant with NIAID.

In the second quarter of 2007, we expect to record an additional $4.0 million in revenue associated with an upfront license fee from a VaxImmune license
entered into with Merck & Co., Inc.

Research and development expenses:Research and development expenses decreased by $0.8
million to $10.0 million in the three months ended March 31, 2007 from $10.8 million in the same period in 2006, a decrease of 7.3%. In the three months ended March 31, 2007, we recorded $0.8 million of severance costs and $0.1 million of
non-cash stock compensation expense, predominantly for clinical development staff, associated with the decision to suspend development of ACTILON.



|                                             |  |                             |        |                     |   |        |  |   |        |  
|-------------------------------------------- |  | --------------------------- | ------ | ------------------- | - | ------ |  | - | ------ | -
|                                             |  | Three months endedMarch 31, |        | Increase/(Decrease) |  
|Research and Development Expenses            |  | 2007                        |        | 2006                |  
|                                             |  |                             |        | (in thousands)      |   |        | 
|Discovery research and preclinical expense   |  | $                           | 4,820  |                     | $ | 4,062  |  | $ | 758    |  
|Clinical trials and drug development expense |  |                             | 3,070  |                     |   | 4,849  |  |   | (1,779 | )
|Government program expense                   |  |                             | 985    |                     |   | 852    |  |   | 133    |  
|Stock compensation expense                   |  |                             | 794    |                     |   | 690    |  |   | 104    |  
|Depreciation and amortization expense        |  |                             | 364    |                     |   | 364    |  |   |       |  
|                                             |  |                             |        |                     |   |        |  |   |        |  
|Total research and development expenses      |  | $                           | 10,033 |                     | $ | 10,817 |  | $ | (784   | )
|                                             |  |                             |        |                     |   |        |  |   |        |  

Discovery research and preclinical expense increased by $0.8 million in the three months ended
March 31, 2007 as compared to the same period in 2006. The increase was due primarily to higher patent related costs and higher compensation and lab supply expenses. Discovery research and preclinical expense includes basic research, chemical
development, pharmacology, product development and patent related legal costs related to our internal research programs.

Clinical trials
and drug development expense decreased by $1.8 million in the three months ended March 31, 2007 as compared to the same period in 2006. This decrease was comprised of a $0.1 million decrease in internal expenses and a $1.7 million decrease in
external expenses. Our internal resources, employees and infrastructure are not directly tied to any individual project. Only external costs are tracked by product candidate. External expenses by product candidate are as follows:



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|                                                  |  |                             |       |                     |   |       |  |   |        |  
|------------------------------------------------- |  | --------------------------- | ----- | ------------------- | - | ----- |  | - | ------ | -
|                                                  |  | Three months endedMarch 31, |       | Increase/(Decrease) |  
|                                                  |  | 2007                        |       | 2006                |  
|                                                  |  |                             |       | (in thousands)      |   |       | 
|Internal expenses (non-program specific)          |  | $                           | 2,606 |                     | $ | 2,683 |  | $ | (77    | )
|External expenses:                                |  |                             |       |                     |   |       |  |   |        |  
|PF-3512676                                        |  |                             | 53    |                     |   | 64    |  |   | (11    | )
|ACTILON                                           |  |                             | 411   |                     |   | 2,102 |  |   | (1,691 | )
|                                                  |  |                             |       |                     |   |       |  |   |        |  
|Total external expenses                           |  |                             | 464   |                     |   | 2,166 |  |   | (1,702 | )
|                                                  |  |                             |       |                     |   |       |  |   |        |  
|Total clinical trial and drug development expense |  | $                           | 3,070 |                     | $ | 4,849 |  | $ | (1,779 | )
|                                                  |  |                             |       |                     |   |       |  |   |        |  

External expenses for our ACTILON program were $0.4 million in the three months ended
March 31, 2007, a decrease of $1.7 million over the same period in 2006. This decrease was due primarily to lower manufacturing, toxicology, and clinical trial expenses resulting from our decision to suspend further development of ACTILON.

External expenses for our PF-3512676 program were $0.1 million for the three months ended March 31, 2007, and were substantially
unchanged compared to the same period in 2006.

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

Government program expense increased by $0.1 million to $1.0 million in the three months ended March 31, 2007 compared to the same period in 2006,
due primarily to higher expenses on our Innate Immune Receptors and Adjuvant Discovery grant with NIAID. Government program expense includes amounts incurred for our labor, external consulting and manufacturing costs, as well as sub-contractor costs
attributable to our government contracts and grants.

Stock compensation expense increased $0.1 million to $0.8 million for the three
months ended March 31, 2007 from $0.7 million in the same period 2006. The increase in stock compensation expense is due primarily to the re-measurement of stock options related to the modification of options that was undertaken for an employee
impacted by the decision to suspend further development of ACTILON.

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, 2007 was unchanged as compared to the same period in 2006.

General and administrative expenses: General and administrative expenses increased by $1.0 million to $3.9 million in the three months ended March 31, 2007 from $2.9 million in the same period in 2006, an
increase of 35.6%. In the three months ended March 31, 2007, we recorded $0.4 million of severance costs and $0.2 million of non-cash stock compensation expense associated with the decision to suspend further development of ACTILON.



|                                           |  |                             |       |                     |   |       |  |   |       |  
|------------------------------------------ |  | --------------------------- | ----- | ------------------- | - | ----- |  | - | ----- | -
|                                           |  | Three months endedMarch 31, |       | Increase/(Decrease) |  
|General and Administrative Expenses        |  | 2007                        |       | 2006                |  
|                                           |  |                             |       | (in thousands)      |   |       | 
|Compensation and personnel related expense |  | $                           | 1,897 |                     | $ | 1,313 |  | $ | 584   |  
|Professional services                      |  |                             | 656   |                     |   | 597   |  |   | 59    |  
|Insurance                                  |  |                             | 229   |                     |   | 191   |  |   | 38    |  
|Facility costs                             |  |                             | 68    |                     |   | 69    |  |   | (1    | )
|Stock compensation expense                 |  |                             | 1,011 |                     |   | 671   |  |   | 340   |  
|Depreciation and amortization expense      |  |                             | 22    |                     |   | 22    |  |   |      |  
|                                           |  |                             |       |                     |   |       |  |   |       |  
|Total general and administrative expenses  |  | $                           | 3,883 |                     | $ | 2,863 |  | $ | 1,020 |  
|                                           |  |                             |       |                     |   |       |  |   |       |  

The $1.0 million increase in general and administrative expenses in the three months ended
March 31, 2007 compared to the same period in 2006 was primarily attributed to a $0.6 million increase in compensation expense, primarily severance, and a $0.3 million increase in stock compensation expense. The increase in stock compensation
expense is due primarily to the re-measurement of stock options related to the modification of options that was undertaken for two employees impacted by the decision to suspend further development of ACTILON.



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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 was $0.5 million for the three months ended March 31, 2007 and was substantially unchanged as compared to the same period in
2006.

Other income and expense: Interest income decreased by $0.2 million to $1.3 million in the three months ended March 31,
2007 compared to the same period in 2006 reflecting lower average cash and investment balances. Interest expense was $0.1 million in the three months ended March 31, 2007 and was substantially unchanged compared to the same period in 2006.

Net loss: For the reasons stated above, net loss decreased by $0.1 million to $7.7 million in the three months ended March 31,
2007 from a net loss of $7.8 million in the same period in 2006.

Liquidity and Capital Resources

Sources of Liquidity

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



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



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



| |  |  | cash receipts of $92.4 million from our commercial collaborations;
| | - |  | ------------------------------------------------------------------



| |  |  | cash receipts of $24.6 million from United States government contracts and grants;
| | - |  | ----------------------------------------------------------------------------------



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



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

Included in the amounts above is $66.0 million from Pfizer that we have received in upfront license fees, sales of common stock, sponsored research fees
and expense reimbursements.

At March 31, 2007, we had unrestricted cash, cash equivalents and marketable securities of $97.8 million
compared to $107.0 million as of December 31, 2006.

We invest in cash equivalents, U.S. government obligations, high-grade municipal
and corporate notes, commercial paper and auction rate securities. 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                                |  | 2007                         |        |   | 2006           |   |         | 2007 vs. 2006 | 
|                                                             |  |                              |        |   | (in thousands) |   |         |               | 
|Net cash provided by (used in):                              |  |                              |        |   |                |   |         |               |  |   |         |  
|Operating activities                                         |  | $                            | (9,395 | ) |                | $ | (8,780  | )             |  | $ | (615    | )
|Investing activities                                         |  |                              | 10,621 |   |                |   | (13,574 | )             |  |   | 24,195  |  
|Financing activities                                         |  |                              | 24     |   |                |   | 31      |               |  |   | (7      | )
|Exchange rate effect on cash and cash equivalents            |  |                              | 76     |   |                |   | 98      |               |  |   | (22     | )
|                                                             |  |                              |        |   |                |   |         |               |  |   |         |  
|Net increase (decrease) in cash and cash equivalents         |  | $                            | 1,326  |   |                | $ | (22,225 | )             |  |   | 23,551  |  
|                                                             |  |                              |        |   |                |   |         |               |  |   |         |  
|Cash and cash equivalents at March 31                        |  | $                            | 53,831 |   |                | $ | 63,686  |               |  | $ | (9,855  | )
|Marketable securities at March 31                            |  |                              | 43,930 |   |                |   | 70,431  |               |  |   | (26,501 | )
|                                                             |  |                              |        |   |                |   |         |               |  |   |         |  
|Cash, cash equivalents and marketable securities at March 31 |  | $                            | 97,761 |   |                | $ | 134,117 |               |  | $ | (36,356 | )
|                                                             |  |                              |        |   |                |   |         |               |  |   |         |  

Three months ended March 31, 2007 and 2006

Net cash used in operating activities increased by $0.6 million to $9.4 million in the three months ended March 31, 2007 as compared to the same
period in 2006 due primarily to a $0.9 million change in net working capital resulting primarily from timing in the collection of accounts receivables from collaborators.

Net cash provided by investing activities increased by $24.2 million to $10.6 million in the three months ended March 31, 2007 primarily due to an increase in maturities of marketable securities.



15



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Net cash provided by financing activities in the three months ended March 31, 2007 was substantially
unchanged compared to the same period in 2006.

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, 2007, the U.S. Dollar depreciated approximately 1.0% 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, 2007:



|                       |  |                             |        |                 |   |                |  |           |       |              |   |       |  |   |    
|---------------------- |  | --------------------------- | ------ | --------------- | - | -------------- |  | --------- | ----- | ------------ | - | ----- |  | - | ---
|                       |  | Cash Payments Due by Period
|                       |  | Total                       |        | Less than1 year |   | 1-3 years      |  | 4-5 years |       | After5 years
|                       |  |                             |        |                 |   | (in thousands) |  |           |       |             
|Operating leases       |  | $                           | 6,142  |                 |   | 1,728          |  |           | 2,872 |              |   | 1,272 |  |   | 270
|Capital leases         |  |                             | 458    |                 |   | 191            |  |           | 267   |              |   |      |  |   |   
|Note payable           |  |                             | 3,179  |                 |   | 2,344          |  |           | 835   |              |   |      |  |   |   
|In-licensed technology |  |                             | 750    |                 |   | 150            |  |           | 300   |              |   | 300   |  |   | *  
|Other liabilities      |  |                             | 549    |                 |   |               |  |           |      |              |   |      |  |   | 549
|                       |  |                             |        |                 |   |                |  |           |       |              |   |       |  |   |    
|                       |  | $                           | 11,078 |                 | $ | 4,413          |  | $         | 4,274 |              | $ | 1,572 |  | $ | 819
|                       |  |                             |        |                 |   |                |  |           |       |              |   |       |  |   |    

---

|* | 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, expiring in 2008, our lease in Ottawa, Canada, expiring in 2012, our two leases in
Langenfeld, Germany, expiring in 2007 and 2010, and our lease in Düsseldorf, Germany, expiring in 2010.

Capital Leases

In August 2006, we entered into a 0.3 million ($0.4 million at March 31, 2007) capital lease agreement for the purchase of a piece of
laboratory equipment. The lease extends for a period of 36 months with an annual interest rate of 7.33%. As of March 31, 2007, we have principal and interest obligations of 0.3 million ($0.4 million at March 31, 2007) remaining.

Note Payable

In 1998, our foreign
subsidiary, Coley Pharmaceutical GmbH (Coley GmbH), obtained a research and development loan from Technologie-Beteiligungs-Gesellschaft (Tbg). The loan of 1.5 million ($2.0 million at March 31, 2007) was to fund the early research
and development of our product candidates. The loan bears interest at 6% annually, with principal payable by December 31, 2007 and interest payable semi-annually on March 31 and September 30. An additional fee of 6% annually of the
loan principal is payable when the loan is due. We and Tbg revised the payment terms of this additional fee during 2006, delaying the payments of $1.2 million due in 2007 until March and June of 2008.

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.

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



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##### Table of Contents

| |  |  | 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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------

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, 2007 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. In addition, we may incur expenses from time to time in connection with any acquisitions or other in-licenses of
technology or other assets.

Although we have no specific plans to raise additional capital in the next two years, we will continue to
review our financing options, and if opportunities arise to raise capital on favorable terms, we may avail ourselves of these opportunities. If we need to raise funds in the future, we may be required to raise those funds through public or private
financings, strategic relationships or other arrangements. We cannot assure you that the funding, if needed, will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders and
debt financing, if available, may involve restrictive covenants. Our failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to pursue our business strategy.

Recent Accounting Pronouncements

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

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

Off-Balance Sheet Arrangements

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



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

Market Risks

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

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



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|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, 2007, our
disclosure controls and procedures were effective.



| | (b) | Changes in Internal Controls
| | --- | ----------------------------

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



18



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##### Table of Contents

PART II  OTHER INFORMATION



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

None.



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

Our risk factors are described in Part I, Item 1A of
our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2006.



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

On
January 29, 2007, AP Private Equity Investments IBV exercised a warrant for 102,000 shares of common stock at an exercise price of $5.64 per share. As a result of this cashless exercise, we issued 44,414 shares of common stock. No underwriters
were involved in the transaction, and there were no underwriting discounts or commissions. We relied upon Section 4(2) of the Securities Act of 1933, as amended, because the transaction did not involve any public offering by us.

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.

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



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

None.



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

None.



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

None.



|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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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 9, 2007 |  | /s/ ROBERT L. BRATZLER, PH.D.                                                                
|            |  | Robert L. Bratzler, Ph.D. President and Chief Executive Officer (Principal Executive Officer)
|            | 
|May 9, 2007 |  | /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.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------