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**UNITED            STATES            SECURITIES AND EXCHANGE COMMISSION            WASHINGTON, D.C. 20549**

**FORM            10-Q**

(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                                                                                                                                         |
|   |                                                                                                                                       |
| **o**  | **TRANSITION REPORT                        PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES                        EXCHANGE ACT OF 1934** |
|   |                                                                                                                                       |
|   | *Commission File                        Number 0-26483*                                                                                    |

**VaxGen,            Inc.**(Exact name of Registrant as Specified in its Charter)
|                                                                                                         |   |                                                        |
|--------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------|
| **Delaware**                                                                                                 |   | **94-3236309**                                              |
| (State or other                        jurisdiction of                        incorporation or organization) |   | (I.R.S. Employer                        Identification No.) |
|                                                                                                         |   |                                                        |
| **349 Oyster Point                        Boulevard,**                                                       |   | **94080**                                                   |
| **South San Francisco,                        California**                                                   |   | (Zip                        Code)                           |
| (Address of Principal                        Executive Offices)                                              |   |                                                        |

**(650)            624-1000**(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether            the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of            the Securities 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 o  | No x   |   |

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 o | Accelerated filer                        x | Non-accelerated                        filer o |

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

The issuer has one class of            common stock with 33,106,523 shares outstanding as of August 31, 2007.

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**VaxGen,            Inc.**

**Form            10-Q**

**For the            Quarter Ended March 31, 2007**

**Table of            Contents**

|                           |   |                                                                                                                                      |     |
|--------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                           |   |                                                                                                                                      | **Page** |
|                           |   |                                                                                                                                      |          |
|                           |   |                                                                                                                                      |     |
| Part                        I  |   | Financial                        Information                                                                                              |     |
| Item                        1  |   | Financial                        Statements (unaudited):                                                                                  |     |
|                           |   | Condensed                        Consolidated Balance Sheets                                                                              | 3        |
|                           |   | Condensed                        Consolidated Statements of Operations                                                                    | 4        |
|                           |   | Condensed                        Consolidated Statements of Cash Flows                                                                    | 5        |
|                           |   | Notes to                        Condensed Consolidated Financial Statements                                                               | 6        |
| Item                        2  |   | Management’s                        Discussion and Analysis of Financial Condition and Results of                        Operations |     |
|                           |   | Overview                                                                                                                                  | 12       |
|                           |   | Critical                        Accounting Policies and Estimates                                                                         | 13       |
|                           |   | Results                        of Operations                                                                                              | 14       |
|                           |   | Liquidity                        and Capital Resources                                                                                    | 16       |
| Item                        3  |   | Quantitative                        and Qualitative Disclosures About Market Risk                                                         | 18       |
| Item                        4  |   | Controls                        and Procedures                                                                                            | 19       |
|                           |   |                                                                                                                                      |     |
| Part                        II |   | Other                        Information                                                                                                  |     |
| Item                        1  |   | Legal                        Proceedings                                                                                                  | 21       |
| Item                        1A |   | Risk                        Factors                                                                                                       | 21       |
| Item                        2  |   | Unregistered                        Sales of Equity Securities and Use of Proceeds                                                        | 30       |
| Item                        3  |   | Defaults                        Upon Senior Securities                                                                                    | 30       |
| Item                        4  |   | Submission                        of Matters to a Vote of Security Holders                                                                | 30       |
| Item                        5  |   | Other                        Information                                                                                                  | 30       |
| Item                        6  |   | Exhibits                                                                                                                                  | 31       |
|                           |   |                                                                                                                                      |     |
|                           |   | Signatures                                                                                                                                | 31       |
|                           |   |                                                                                                                                      |     |
|                           |   | Certifications                                                                                                                            |     |

2

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**PART I —            FINANCIAL INFORMATION**

**Item 1.            Financial Statements**

**VaxGen,            Inc.CONDENSED CONSOLIDATED BALANCE SHEETS            (Unaudited)            (in thousands)**

|                                                                    |   |                                      |   |                                         |   |   |   |   |     |   |   |
|-------------------------------------------------------------------------|--------|-------------------------------------------|--------|----------------------------------------------|--------|--------|--------|--------|----------|--------|--------|
|                                                                    |   | **March 31,                        2007** |   | **December 31,                        2006** |   |
|                                                                    |   |                                           |   |                                              |   |
|                                                                    |   |                                      |   |                                         |   |   |   |   |     |   |   |
| **ASSETS**                                                              |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Current                        assets:                                  |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Cash and cash                        equivalents:                       |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Cash and commercial                        paper                        |   |                                      | $      | 35,353                                       |   |   |   | $      | 18,697   |   |   |
| Reverse repurchase                        agreements                    |   |                                      |   | 32,923                                       |   |   |   |   | 54,378   |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
| Total cash and cash                        equivalents                  |   |                                      |   | 68,276                                       |   |   |   |   | 73,075   |   |   |
| Investment                        securities                            |   |                                      |   | 15,312                                       |   |   |   |   | 24,668   |   |   |
| Accounts                        receivable                              |   |                                      |   | 6,481                                        |   |   |   |   | 516      |   |   |
| Unbilled accounts                        receivable                     |   |                                      |   | 4,540                                        |   |   |   |   | 7,164    |   |   |
| Prepaid expenses and                        other current assets        |   |                                      |   | 2,061                                        |   |   |   |   | 2,828    |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
| Total current                        assets                             |   |                                      |   | 96,670                                       |   |   |   |   | 108,251  |   |   |
| Property and                        equipment                           |   |                                      |   | 26,722                                       |   |   |   |   | 28,417   |   |   |
| Restricted                        cash                                  |   |                                      |   | 2,939                                        |   |   |   |   | 2,895    |   |   |
| Other                        assets                                     |   |                                      |   | 2,383                                        |   |   |   |   | 2,497    |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
| Total assets                                                            |   |                                      | $      | 128,714                                      |   |   |   | $      | 142,060  |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
|                                                                    |   |                                      |   |                                         |   |   |   |   |     |   |   |
| **LIABILITIES AND                        STOCKHOLDERS’ EQUITY**   |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Current                        liabilities:                             |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Accounts                        payable                                 |   |                                      | $      | 2,834                                        |   |   |   | $      | 4,660    |   |   |
| Accrued and other                        current liabilities            |   |                                      |   | 5,236                                        |   |   |   |   | 5,610    |   |   |
| Derivative                        liability                             |   |                                      |   | 5,388                                        |   |   |   |   | 8,220    |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
| Total current                        liabilities                        |   |                                      |   | 13,458                                       |   |   |   |   | 18,490   |   |   |
| Convertible senior                        subordinated notes            |   |                                      |   | 30,410                                       |   |   |   |   | 30,321   |   |   |
| Deferred rent and                        other liabilities              |   |                                      |   | 4,358                                        |   |   |   |   | 4,188    |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
| Total                        liabilities                                |   |                                      |   | 48,226                                       |   |   |   |   | 52,999   |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
|                                                                    |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Contingencies (Note                        12)                          |   |                                      |   |                                         |   |   |   |   |     |   |   |
|                                                                    |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Stockholders’                        equity:                      |   |                                      |   |                                         |   |   |   |   |     |   |   |
| Common stock                                                            |   |                                      |   | 331                                          |   |   |   |   | 331      |   |   |
| Additional paid-in                        capital                       |   |                                      |   | 300,391                                      |   |   |   |   | 299,226  |   |   |
| Accumulated                        deficit                              |   |                                      |   | (220,237                                     | )      |   |   |   | (210,498 | )      |   |
| Accumulated other                        comprehensive income           |   |                                      |   | 3                                            |   |   |   |   | 2        |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
| Total                        stockholders’ equity                 |   |                                      |   | 80,488                                       |   |   |   |   | 89,061   |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |
| Total liabilities and                        stockholders’ equity |   |                                      | $      | 128,714                                      |   |   |   | $      | 142,060  |   |   |
|                                                                    |   |                                      |        |                                              |   |   |   |        |          |   |   |

See accompanying            notes to condensed consolidated financial statements.

3

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**VaxGen,            Inc.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS            (Unaudited)            (in thousands, except per share data)**

|                                                                                                  |   |                                                                           |    |     |   |    |   |
|-------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|---------|----------|--------|---------|--------|
|                                                                                                  |   | **Three Months                        Ended                        March 31,** |    |
|                                                                                                  |   |                                                                                |    |
|                                                                                                  |   | **2007**                                                                       |    | **2006** |   |
|                                                                                                  |   |                                                                                |    |          |   |
| Revenues                                                                                              |   | $                                                                              | 4,184   |     | $      | 6,304   |   |
|                                                                                                  |   |                                                                                |    |          |   |
| Operating                        expenses:                                                            |   |                                                                           |    |     |   |    |   |
| Research and                        development                                                       |   |                                                                           | 7,088   |     |   | 14,176  |   |
| General and                        administrative                                                     |   |                                                                           | 6,578   |     |   | 6,646   |   |
| Restructuring                                                                                         |   |                                                                           | 3,717   |     |   | — |   |
|                                                                                                  |   |                                                                                |         |     |        |         |   |
| Total operating                        expenses                                                       |   |                                                                           | 17,383  |     |   | 20,822  |   |
|                                                                                                  |   |                                                                                |         |     |        |         |   |
| Loss from                        operations                                                           |   |                                                                           | (13,199 | )        |   | (14,518 | )      |
|                                                                                                  |   |                                                                                |         |     |        |         |   |
| Other income                        (expense):                                                        |   |                                                                           |    |     |   |    |   |
| Interest                        expense                                                               |   |                                                                           | (611    | )        |   | (630    | )      |
| Interest income and                        other                                                      |   |                                                                           | 1,239   |     |   | 267     |   |
| Valuation                        adjustments                                                          |   |                                                                           | 2,832   |     |   | 395     |   |
| Equity in loss of                        affiliate                                                    |   |                                                                           | — |     |   | (2,506  | )      |
| Gain on foreign                        currency transactions                                          |   |                                                                           | — |     |   | 158     |   |
|                                                                                                  |   |                                                                                |         |     |        |         |   |
| Total other income                        (expense), net                                              |   |                                                                           | 3,460   |     |   | (2,316  | )      |
|                                                                                                  |   |                                                                                |         |     |        |         |   |
| Net loss                                                                                              |   | $                                                                              | (9,739  | )        | $      | (16,834 | )      |
|                                                                                                  |   |                                                                                |         |     |        |         |   |
| Basic and diluted                        net loss per share                                           |   | $                                                                              | (0.29   | )        | $      | (0.53   | )      |
|                                                                                                  |   |                                                                                |         |     |        |         |   |
| Weighted average                        shares used in computing basic and diluted net loss per share |   |                                                                           | 33,107  |     |   | 31,551  |   |
|                                                                                                  |   |                                                                                |         |     |        |         |   |

See accompanying            notes to condensed consolidated financial statements.

4

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**VaxGen,            Inc.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS            (Unaudited)            (in thousands)**

|                                                                                               |   |                                                                           |    |     |   |    |   |
|----------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|---------|----------|--------|---------|--------|
|                                                                                               |   | **Three Months                        Ended                        March 31,** |    |
|                                                                                               |   |                                                                                |    |
|                                                                                               |   | **2007**                                                                       |    | **2006** |   |
|                                                                                               |   |                                                                                |    |          |   |
| Cash flows from                        operating activities:                                       |   |                                                                           |    |     |   |    |   |
| Net loss                                                                                           |   | $                                                                              | (9,739  | )        | $      | (16,834 | )      |
| Adjustments to                        reconcile net loss to net cash used in operating activities: |   |                                                                           |    |     |   |    |   |
| Gain on foreign                        currency transactions                                       |   |                                                                           | — |     |   | (158    | )      |
| Equity in loss of                        affiliate                                                 |   |                                                                           | — |     |   | 2,506   |   |
| Valuation                        adjustments                                                       |   |                                                                           | (2,832  | )        |   | (395    | )      |
| Depreciation and                        amortization                                               |   |                                                                           | 1,562   |     |   | 1,578   |   |
| Stock-based                        compensation                                                    |   |                                                                           | 1,165   |     |   | 816     |   |
| Amortization of                        premiums and discounts on investment securities             |   |                                                                           | (284    | )        |   | (4      | )      |
| Non-cash interest                        expense                                                   |   |                                                                           | 178     |     |   | 177     |   |
| Changes in assets and                        liabilities:                                          |   |                                                                           |    |     |   |    |   |
| Receivables                                                                                        |   |                                                                           | (3,114  | )        |   | (5,574  | )      |
| Prepaid expenses and                        other current assets                                   |   |                                                                           | 483     |     |   | 26      |   |
| Accounts                        payable                                                            |   |                                                                           | (1,826  | )        |   | (3,271  | )      |
| Accrued and other                        current liabilities                                       |   |                                                                           | 2,124   |     |   | (2,226  | )      |
| Other                                                                                              |   |                                                                           | 322     |     |   | 790     |   |
|                                                                                               |   |                                                                                |         |     |        |         |   |
| Net cash used in                        operating activities                                       |   |                                                                           | (11,961 | )        |   | (22,569 | )      |
|                                                                                               |   |                                                                                |         |     |        |         |   |
| Cash flows from                        investing activities:                                       |   |                                                                           |    |     |   |    |   |
| Purchase of property                        and equipment                                          |   |                                                                           | (19     | )        |   | (1,540  | )      |
| Proceeds (fees) from                        sale of investment in affiliate                        |   |                                                                           | (2,441  | )        |   | 2,399   |   |
| Proceeds from sale and                        maturities of investment securities                  |   |                                                                           | 22,852  |     |   | 3,219   |   |
| Purchase of investment                        securities                                           |   |                                                                           | (13,211 | )        |   | — |   |
| Other                                                                                              |   |                                                                           | (19     | )        |   | (22     | )      |
|                                                                                               |   |                                                                                |         |     |        |         |   |
| Net cash provided by                        investing activities                                   |   |                                                                           | 7,162   |     |   | 4,056   |   |
|                                                                                               |   |                                                                                |         |     |        |         |   |
| Cash flows from                        financing activities:                                       |   |                                                                           |    |     |   |    |   |
| Proceeds from private                        placement, net                                        |   |                                                                           | — |     |   | 25,226  |   |
| Other                                                                                              |   |                                                                           | — |     |   | (1,064  | )      |
|                                                                                               |   |                                                                                |         |     |        |         |   |
| Net cash provided by                        financing activities                                   |   |                                                                           | — |     |   | 24,162  |   |
|                                                                                               |   |                                                                                |         |     |        |         |   |
| (Decrease) increase                        in cash and cash equivalents                            |   |                                                                           | (4,799  | )        |   | 5,649   |   |
| Cash and cash                        equivalents at beginning of period                            |   |                                                                           | 73,075  |     |   | 4,560   |   |
|                                                                                               |   |                                                                                |         |     |        |         |   |
| Cash and cash                        equivalents at end of period                                  |   | $                                                                              | 68,276  |     | $      | 10,209  |   |
|                                                                                               |   |                                                                                |         |     |        |         |   |

See accompanying            notes to condensed consolidated financial statements.

5

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**VaxGen,            Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

|   |             |
|--------|------------------|
| **1.** | **Organization** |

*          Nature            of Business Activities*

VaxGen, Inc., or VaxGen, is a            biopharmaceutical company focused on the development, manufacture and commercialization            of biologic products for the prevention and treatment of human infectious            disease.

VaxGen was incorporated on            November 27, 1995. Since 2002, VaxGen has been developing vaccines against inhalation            anthrax and smallpox for the purpose of biodefense. In December 2006, the Department of            Health and Human Services, or HHS, terminated for default its contract with VaxGen            related to the development and delivery of a next-generation anthrax vaccine. Following            the HHS decision, VaxGen scaled back development of its anthrax vaccine and began            actively pursuing strategic and other alternatives.

Through March 31, 2007,            VaxGen’s principal source of revenue has been the U.S. government, principally            the National Institutes of Health, or NIH, and related entities.

VaxGen’s activities            involve inherent risks. These risks include, but are not limited to, the possibility            that internal controls are not or will not be adequate to ensure timely and reliable            financial information, the risk that VaxGen may not be able to raise additional            capital, the risk that VaxGen may fail to perform under any future contracts, the risk            that VaxGen may not be able to complete a strategic transaction and the risk that            VaxGen may be unable to commercialize its vaccine product candidates.

*          Delisting            from the Nasdaq National Market*

As a result of VaxGen’s            inability to timely file financial statements, it was delisted effective August 9, 2004            from the Nasdaq National Market, now the Nasdaq Global Market, or Nasdaq. Since that            time, VaxGen’s common stock has traded over the counter, or OTC, and has been            quoted on the Pink Sheets LLC under the symbol, VXGN.PK.

*          Basis            of Presentation*

The unaudited condensed            consolidated financial statements of VaxGen and its subsidiaries, collectively referred            to as the Company, included herein have been prepared pursuant to the rules and            regulations of the Securities and Exchange Commission, or SEC. All intercompany            accounts and transactions have been eliminated in consolidation.

Certain information or footnote            disclosure normally included in financial statements prepared in accordance with            generally accepted accounting principles in the United States of America, or GAAP, have            been condensed or omitted pursuant to such rules and regulations. In the opinion of the            Company’s management, the accompanying unaudited condensed consolidated financial            statements contain all adjustments, consisting only of normal recurring adjustments,            considered necessary for a fair statement of the unaudited condensed consolidated            financial information included herein. While VaxGen believes that the disclosures are            adequate to make the information not misleading, these unaudited condensed consolidated            financial statements should be read in conjunction with VaxGen’s audited            financial statements contained in its Annual Report on Form 10-K for the year ended            December 31, 2006.

The results of operations for            the three-month period ended March 31, 2007 are not necessarily indicative of the            operating results for the full year. The preparation of financial statements in            conformity with GAAP requires management to make estimates, judgments and assumptions            that affect the reported amounts of assets, liabilities, revenues, expenses and related            disclosures. While management believes its estimates, judgments and assumptions are            reasonable, the inherent nature of estimates is that actual results will likely be            different from the estimates made.

For the three months ended March            31, 2006, VaxGen’s investment in Celltrion, Inc., or Celltrion, a company            developing and operating a mammalian cell-culture biomanufacturing facility in the            Republic of Korea, was accounted for under the equity method. At March 31, 2006,            VaxGen’s ownership interest in Celltrion was 22%. During 2006, VaxGen sold            substantially all of its Celltrion common stock, and as of July 1, 2006, VaxGen            accounted for its investment in Celltrion under the cost method. At December 31, 2006            and March 31, 2007, VaxGen held a nominal ownership interest in Celltrion.

|   |                                                                  |
|--------|-----------------------------------------------------------------------|
| **2.** | **Summary of                        Significant Accounting Policies** |

The Company’s significant            accounting policies are disclosed in the Company’s annual report of Form 10-K for            the year ended December 31, 2006 and have not changed significantly as of March 31,            2007, with the exception of the following:

*          Accounting            Principles Recently Adopted*

In July 2006, the Financial            Accounting Standards Board, or FASB, issued FIN 48, *Accounting for Uncertainty in            Income Taxes—an interpretation of FASB Statement No. 109*, or FIN 48, which            clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the            Company recognize in its financial statements the impact of a tax position if that            position is more likely than not of being sustained upon audit, based on the technical            merits of the position. FIN 48 is effective for fiscal years beginning after December            15,

6

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2006 which is the beginning of            the Company’s fiscal 2007. The Company’s unaudited consolidated financial            statements have not been materially affected by the adoption of FIN 48 as of January 1,            2007. In May 2007, the FASB issued FSP No. FIN 48-1*, Definition of            ‘Settlement’ in FASB Interpretation No. 48,* or FIN 48-1. FIN 48-1            provides guidance on how an enterprise should determine whether a tax position is            effectively settled for the purpose of recognizing previously unrecognized tax            benefits. The adoption of FIN 48-1 is not expected to have a material impact on the            Company’s consolidated financial position, results of operations or cash flows.            See *Note 9, Income Taxes,* for further details of the impact of            adoption*.*

In December 2006, the FASB            issued FASB Staff Position EITF 00-19-2, *Accounting for Registration Payment            Arrangements*, or FSP 00-19-2, which provides guidance on accounting for            registration payment arrangements. FSP 00-19-2 specifies that the contingent obligation            to make future payments or otherwise transfer consideration under a registration            payment arrangement, whether issued as a separate agreement or included as a provision            of a financial instrument or other agreement, should be separately recognized and            measured in accordance with FASB Statement No. 5, *Accounting for Contingencies*.            FSP 00-19-2 is required to be applied to reporting periods beginning after December 15,            2006. The Company adopted FSP 00-19-2 as of January 1, 2007. The Company’s            previous accounting for registration payment arrangements in connection with its 5 1/2%            Convertible Senior Subordinated Notes, due April 1, 2010, or Notes, as well as shares            issued or issuable in private placements of its common stock, or collectively Issuable            Shares, was already in compliance with FSP 00-19-2.

                      *Accounting Principles Not Yet Adopted*

In September 2006, the FASB            issued FAS No. 157, *Fair Value Measurement,* or FAS 157. FAS 157 defines fair            value, establishes a framework for measuring fair value and expands disclosures about            fair value measurements. FAS 157 is effective for financial statements issued for            fiscal years beginning after November 15, 2007 and interim periods within those fiscal            years. The Company is evaluating the impact of adopting FAS 157 on the Company’s            consolidated financial position, results of operations and cash flows.

In February 2007, the FASB            issued FAS No. 159, *The Fair Value Option for Financial Assets and Financial            Liabilities - Including an Amendment of FASB Statement No. 115*, or FAS 159, which            permits all entities to choose to measure eligible items, including many financial            instruments, at fair value at specified election dates. A business entity will report            unrealized gains and losses on items for which the fair value option has been elected            in earnings at each subsequent reporting date. The fair value option: (a) may be            applied instrument by instrument, with a few exceptions, such as investments otherwise            accounted for by the equity method; (b) is irrevocable (unless a new election date            occurs); and (c) is applied only to entire instruments and not to portions of            instruments. Most of the provisions in FAS 159 are elective; however, the amendment to            FAS No. 115, *Accounting for Certain Investments in Debt and Equity Securities,*            applies to all entities with available-for-sale and trading securities. FAS 159 is            effective for fiscal years beginning after November 15, 2007. The Company is evaluating            the impact of adopting FAS 159 on its consolidated financial position, results of            operations and cash flows.

In June 2007, the Emerging            Issues Task Force, or EITF, published Issue No. 07-3, *Accounting for Nonrefundable            Advance Payments for Goods or Services to Be Used in Future Research and Development            Activities*, or EITF 07-3. The EITF reached a consensus that these payments made by            an entity to third parties should be deferred and capitalized. Such amounts should be            recognized as an expense as the related goods are delivered or the related services are            performed. Entities should report the effects of applying this Issue as a change in            accounting principle through a cumulative-effect adjustment to retained earnings as of            the beginning of the year of adoption. EITF 07-3 is effective beginning on            January 1, 2008. Earlier application is not permitted. The Company does not expect            that adoption of this new Standard will have a material effect on its financial            position or results of operations.

|   |                                          |
|--------|-----------------------------------------------|
| **3.** | **Net Loss per                        Share** |

Basic net loss per share is            computed as net loss divided by the weighted average number of common shares            outstanding for the period. For the three months ended March 31, 2007 and 2006, the            following potential common shares were excluded from the computation of diluted net            loss per share, as their effect was antidilutive (in thousands):

|                                                         |   |     |   |     |   |   |   |
|--------------------------------------------------------------|--------|----------|--------|----------|--------|--------|--------|
|                                                         |   | **2007** |   | **2006** |   |
|                                                         |   |          |   |          |   |
| Options to purchase                        common stock      |   |     | 5,668  |     |   | 4,572  |   |
| Warrants to purchase                        common stock     |   |     | 2,359  |     |   | 1,659  |   |
| Convertible senior                        subordinated notes |   |     | 2,134  |     |   | 2,134  |   |
|                                                         |   |          |        |     |        |        |   |
| Total                                                        |   |     | 10,161 |     |   | 8,365  |   |
|                                                         |   |          |        |     |        |        |   |

7

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|   |                                          |
|--------|-----------------------------------------------|
| **4.** | **Comprehensive                        Loss** |

Comprehensive loss combines net            loss and other comprehensive income (loss). Other comprehensive income (loss)            represents certain amounts that are reported as components of stockholders’            equity in the consolidated balance sheet, including foreign currency translation            adjustments and unrealized gains or losses on investment securities.

The Company’s            comprehensive loss the three months ended March 31, 2007 and 2006 consists of the            following (in thousands):

|                                                                       |   |     |    |     |   |    |   |
|----------------------------------------------------------------------------|--------|----------|---------|----------|--------|---------|--------|
|                                                                       |   | **2007** |    | **2006** |   |
|                                                                       |   |          |    |          |   |
| Net loss                                                                   |   | $        | (9,739  | )        | $      | (16,834 | )      |
| Foreign currency                        translation adjustments            |   |     | — |     |   | 686     |   |
| Change in unrealized                        gains on investment securities |   |     | 1       |     |   | 38      |   |
|                                                                       |   |          |         |     |        |         |   |
| Comprehensive                        loss                                  |   | $        | (9,738  | )        | $      | (16,110 | )      |
|                                                                       |   |          |         |     |        |         |   |

|   |                                                             |
|--------|------------------------------------------------------------------|
| **5.** | **Accrued and Other                        Current Liabilities** |

The Company’s accrued and            other current liabilities consist of the following (in thousands):

|                                           |   |                                      |   |                                         |   |   |   |
|------------------------------------------------|--------|-------------------------------------------|--------|----------------------------------------------|--------|--------|--------|
|                                           |   | **March 31,                        2007** |   | **December 31,                        2006** |   |
|                                           |   |                                           |   |                                              |   |
| Employment                        benefits     |   |                                      | $      | 1,006                                        |   |   |   | $ | 2,049 |   |   |
| Income taxes                                   |   |                                      |   | 1,210                                        |   |   |   |   | 1,210 |   |   |
| Restructuring                                  |   |                                      |   | 832                                          |   |   |   |   | — |   |   |
| Clinical trial                        expenses |   |                                      |   | 818                                          |   |   |   |   | 931 |   |   |
| Other                                          |   |                                      |   | 1,370                                        |   |   |   |   | 1,420 |   |   |
|                                           |   |                                      |        |                                              |   |   |   |  |  |   |   |
|                                           |   |                                      | $      | 5,236                                        |   |   |   | $ | 5,610 |   |   |
|                                           |   |                                      |        |                                              |   |   |   |  |  |   |   |

|   |              |
|--------|-------------------|
| **6.** | **Restructuring** |

In January 2007, the Company            restructured operations to significantly reduce operating costs and announced it was            actively pursuing avenues to enhance stockholder value through a strategic transaction.            The Company incurred restructuring costs associated with this plan of $2.6 million for            employee termination benefits, $0.1 million related to the acceleration of stock            options and $1.0 million of costs associated with the consolidation of its facilities            in California. All of these costs are expected to be paid by March 31, 2008. At March            31, 2007, $0.8 million of these costs were unpaid and included in accrued and other            current liabilities and include the following:

|                                                                |   |                                      |   |                                    |   |                                                                                                  |   |   |   |   |
|---------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|-------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
|                                                                |   | **Costs                        Incurred** |   | **Amounts                        Paid** |   | **Balance                        as of                        March 31,                        2007** |   |
|                                                                |   |                                           |   |                                         |   |                                                                                                       |   |
| Workforce                        reduction                          |   |                                      | $      | 2,642                                   |   |                                                                                                  |   | $      | (2,070 | )      |   |   | $ | 572 |   |   |
| Consolidation of excess                        facilities and other |   |                                      |   | 1,006                                   |   |                                                                                                  |   |   | (746   | )      |   |   |   | 260 |   |   |
|                                                                |   |                                      |        |                                         |   |                                                                                                  |   |        |        |   |   |   |  |  |   |   |
| Total                                                               |   |                                      | $      | 3,648                                   |   |                                                                                                  |   | $      | (2,816 | )      |   |   | $ | 832 |   |   |
|                                                                |   |                                      |        |                                         |   |                                                                                                  |   |        |        |   |   |   |  |  |   |   |

|   |                                          |
|--------|-----------------------------------------------|
| **7.** | **Private                        Placements** |

In February 2006, VaxGen raised            net proceeds of $25.2 million through a private equity placement to a group of            accredited institutional investors. In connection with this financing, VaxGen issued to            the investors five-year warrants initially exercisable to purchase 699,996 shares of            common stock at an exercise price of $9.24 per share. Because VaxGen did not file all            of its delinquent periodic reports with the SEC by September 30, 2006, the warrants            became exercisable for an additional 350,000 shares of common stock, at a price of            $9.24 per share. Because VaxGen again did not file all of its delinquent periodic            reports with the SEC by January 31, 2007, the warrants became exercisable for an            additional 350,000 shares of common stock, at a price of $9.24 per share.

|   |                                                      |
|--------|-----------------------------------------------------------|
| **8.** | **Executive Officer                        Compensation** |

In February 2007, the Board of            Directors granted to executive officers options for 1,590,000 shares and implemented an            option exchange program allowing executive officers to exchange old options for 714,700            shares for new options for 178,675 shares. All of the options were granted effective            February 12, 2007 with an exercise price of $2.23 per share, the closing market price            of one share of the Company’s common stock on that date. Each option will vest            monthly on a pro-rata basis over one to four years. The Board also approved two            potential retention bonus payments. The aggregate first retention bonus payment of $0.3            million will be made to the executives who remain regular full-time employees in good            standing through June 30, 2007. Additionally, a second cash bonus payment of the same            amount will be made, conditioned upon the executive remaining a regular full-time            employee in good standing through the completion of a strategic transaction and other            terms.

8

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|   |                                    |
|--------|-----------------------------------------|
| **9.** | **Income                        Taxes** |

The Company accounts for income            taxes using an asset and liability approach, which requires the recognition of deferred            income tax assets and liabilities for the expected future tax consequences of events            that have been recognized in the Company’s consolidated financial statements or            tax returns. Deferred income tax assets and liabilities are determined based upon the            temporary differences between the financial statement and tax bases of assets and            liabilities using enacted tax rates. A valuation allowance is provided on deferred tax            assets if it is determined that it is more likely than not that the asset will not be            realized.

The Company adopted FIN 48 on            January 1, 2007 and in so doing, has analyzed filing positions in all of the federal            and state jurisdictions where it is required to file income tax returns, as well as all            open tax years in these jurisdictions. The implementation of FIN 48 did not have a            material impact on the condensed consolidated financial statements and did not require            an adjustment to accumulated deficit. The Company has an unrecognized tax benefit of            approximately $1.2 million, which did not change significantly during the three months            ended March 31, 2007. If recognized, there would be no impact to the 2007 effective            income tax rate due to the existence of the valuation allowance. In addition, future            changes to the unrecognized tax benefits will have no impact on the effective tax rate            due to the existence of the valuation allowance.

Under special IRS rules, or            Section 382 Limitation, cumulative stock purchases by material shareholders exceeding            50% during a 3-year period can potentially limit a company’s future use of net            operating losses, or NOL’s. Under current tax rules, any Section 382 Limitation            is not expected to significantly impact the recorded value or timing of utilization of            the Company’s NOL’s.

The Company’s policy is to            classify and accrue interest expense and penalties on income tax underpayments            (overpayments) as other expense in its condensed consolidated statement of operations.            The amount of unrecognized tax related interest expense and penalties at January 1,            2007 was zero. The Company did not incur any income tax related interest income,            interest expense or penalties for the three months ended March 31, 2007. At January 1,            2007, the Company had recorded a liability of $1.2 million representing alternative            minimum taxes payable to the Internal Revenue Service and state jurisdictions related            to its net income in 2006. As a result of significant changes to its financial            statements, the Company plans to amend its U.S. federal and state returns for the tax            years ended December 31, 2002 through 2005. These amendments will have no impact on the            effective tax rate due to the existence of the valuation allowance. The Company’s            U.S. tax returns for 2002 and subsequent years remain subject to examination by tax            authorities. The Company is also subject to examination in various state jurisdictions            for 2002 and subsequent years.

|    |                                                |
|---------|-----------------------------------------------------|
| **10.** | **Stock-Based                        Compensation** |

In February 2007, the Board of            Directors granted to executive officers options for 1,590,000 shares and implemented an            option exchange program allowing executive officers to exchange old options for 714,700            shares for new options for 178,675 shares. Options for 235,000 shares were also granted            to members of the board of directors. The options were granted with an exercise price            of $2.23 per share, the closing market price of one share of the Company’s common            stock. Option shares will vest monthly on a pro-rata basis over one to four            years.

The impact on consolidated            results of operations of recording stock-based compensation for the three months ended            March 31, 2007 and 2006 was as follows (in thousands):

|                                                  |   |     |   |     |   |   |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|--------|--------|
|                                                  |   | **2007** |   | **2006** |   |
|                                                  |   |          |   |          |   |
| Research and                        development       |   | $        | 548    |     | $      | 572    |   |
| General and                        administrative     |   |     | 617    |     |   | 244    |   |
|                                                  |   |          |        |     |        |        |   |
| Total stock-based                        compensation |   | $        | 1,165  |     | $      | 816    |   |
|                                                  |   |          |        |     |        |        |        |

|    |          |
|---------|---------------|
| **11.** | **Celltrion** |

VaxGen provides services to            assist Celltrion with their operations under a Technical Support and Services            Sub-Agreement. VaxGen is paid for out-of-pocket expenses and services rendered. These            services were considered to be related party in 2006, while VaxGen maintained an            investment in Celltrion. VaxGen recognized $0.3 million and $0.4 million of services            revenue from Celltrion during the three months ended March 31, 2007 and 2006,            respectively.

In February 2006, Celltrion and            VaxGen entered into an agreement, or Agreement to Provide U.S. GAAP Financial            Information, whereby Celltrion agreed to use its best efforts to timely prepare annual            and quarterly financial statements in accordance with U.S. GAAP. Under the agreement,            VaxGen agreed to reimburse Celltrion for all invoiced costs of their independent            accountants relating to the preparation of U.S. GAAP financial statements as well as            all invoiced costs of audits and reviews performed by another independent registered            public accounting firm. In addition, VaxGen will compensate Celltrion for the cost of            internal resources utilized in support of these activities at a rate of 190% of the            employee’s hourly wage; such costs shall not exceed the U.S. dollar equivalent of            300 million Korean Won (equivalent to $0.3 million at the exchange rate on March 31,            2007) per year and shall be subject to VaxGen’s approval. In March 2007,            Celltrion and VaxGen amended the Technical Support and Services Sub-Agreement as well            as the Agreement to Provide U.S. GAAP Financial Information to reflect a reduction in            overhead rate on services performed from 90% to 40%. During the three months ended            March 31, 2007 and 2006, the Company incurred $1.1 million and $0.6 million,            respectively, of expenses under these agreements.

9

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VaxGen’s 2002 investment            in Celltrion consisted of providing mammalian cell culture technology and biologics            production expertise. VaxGen’s proportionate share of the investee’s            undistributed losses was recorded as equity in loss of affiliate through July 1, 2006.            Summarized selected financial information, while the Company’s investment in            Celltrion was accounted for under the equity method, for the three months ended March            31, 2006 is as follows (in thousands):

|                                        |   | **2006** |    |
|---------------------------------------------|--------|----------|---------|
|                                        |   |          |    |
| Operating                        expenses   |   | $        | 10,918  |   |
|                                        |   |          |         |   |
| Loss from                        operations |   |     | (10,918 | ) |
| Other                        expense        |   |     | (1,275  | ) |
|                                        |   |          |         |   |
| Net loss                                    |   | $        | (12,193 | ) |
|                                        |   |          |         |   |

During the three months ended            March 31, 2007, the Company paid the final $2.4 million in fees due from the 2006 sale            of substantially all of its remaining Celltrion common stock.

|    |              |
|---------|-------------------|
| **12.** | **Contingencies** |

The Company has agreed to file            with the SEC a registration statement, or Registration Statement, under the Securities            Exchange Act of 1933, as amended, or Securities Act, with respect to the Issuable            Shares no later than thirty days following the first date the Company becomes current            in its reporting requirements under the Securities and Exchange Act of 1934, or Filing            Date, and to use its best efforts to cause the Registration Statement to become            effective on or before the date that is the earlier of (1) in the event of no            review by the SEC no later than 90 days after the Filing Date, (2) in the event of            a review by the SEC, no later than 120 days after the Filing Date, the earlier of            (1) and (2) is referred to as the Required Effective Date.

In the event of a default, the            Company is required to pay as liquidated damages, for each 30-day period of a default,            an amount in cash equal to 1% of the principal amount of the Notes and the purchase            price of the private placements until the applicable failure has been cured. The            Company considers the likelihood of becoming obligated for such liquidated damages to            be remote and accordingly no provision for their payment has been recorded. Should the            Company become obligated to make payment of these liquidated damages, it could have a            material adverse effect on its financial position and results of operations,            particularly if the Company becomes obligated to make a payment in full for all            liquidated damages potentially due and payable under these agreements.

The Company’s obligation            to maintain the effectiveness of the registration statement ends upon the earlier to            occur of (i) two years from the date of effectiveness of the Registration Statement,            (ii) the date when all holders of Issuable Shares are eligible to sell such securities            under Rule 144(k) promulgated under the Securities Act, (iii) the date when all            securities registered under the Registration Statement have been sold and (iv) the date            when all securities registered under the Registration Statement cease to be            outstanding. The Company estimates that the maximum monthly amount of consideration            that the Company could be required to pay as liquidated damages under these            registration payment obligations is approximately $1.0 million.

If an executive officer’s            employment with VaxGen is terminated without cause, or the executive resigns due to            good reasons, as defined in their employment agreements, the executive would be            entitled to receive as severance 12 months of their base salary and all of their            outstanding unvested stock options would be accelerated and become immediately            exercisable. If this occurs within 13 months of a change of control, as defined in            their agreements, the executive will also be eligible to receive a bonus payment equal            to up to 30 percent of his salary on a prorated basis. As of March 31, 2007, the            aggregate salary and bonus obligations under these circumstances would be $1.6            million.

|    |                                           |
|---------|------------------------------------------------|
| **13.** | **Segment                        Information** |

Since July 1, 2005, the Company            has operated in one business segment, the development of vaccines that immunize against            infectious disease. All of VaxGen’s operating assets are located in the United            States of America. Substantially all of VaxGen’s revenue is derived from federal            government contracts and grants, primarily from HHS, NIH and related            entities.

10

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|    |                                         |
|---------|----------------------------------------------|
| **14.** | **Subsequent                        Events** |

*          Strategic            National Stockpile Contract*

In September 2002, the Company            was awarded a $20.9 million cost-plus contract, or 2002 Anthrax Contract, from the            National Institute of Allergy and Infectious Diseases, or NIAID, to develop a new            anthrax vaccine candidate and to create a feasibility plan for how the Company would            manufacture an emergency stockpile of 25 million doses of the vaccine. On September 30,            2003, NIAID awarded the Company a second cost-plus contract valued at $80.3 million for            the advanced development of the Company’s anthrax vaccine candidate, or 2003            Anthrax Contract.

In November 2004, the Company            was awarded a contract for $877.5 million to provide 75 million doses of its            recombinant anthrax vaccine to the U.S. government Strategic National Stockpile, or            SNS, for civilian defense, or SNS Contract. In November 2006, VaxGen received a            clinical hold notification from the Food and Drug Administration that postponed the            initiation of the second Phase 2 trial for its investigational anthrax vaccine, rPA102.            On December 19, 2006, HHS terminated for default the SNS Contract. HHS based the            decision on its determination that VaxGen “failed to successfully cure the            condition endangering performance and failed to” meet a milestone imposed by HHS            that required VaxGen to initiate the Phase 2 trial of the vaccine candidate by December            18, 2006.

On April 3, 2007, the Company            entered into a settlement agreement with HHS. In accordance with the agreement, the            parties terminated the remaining cost-plus contract related to the development of a            next-generation anthrax vaccine through a separate contract modification. As part of            the settlement agreement, NIAID paid the Company $11.0 million. The settlement            agreement also released both parties of all liabilities associated with the            Company’s three anthrax government contracts: the 2002 Anthrax Contract, the 2003            Anthrax Contract and the SNS Contract. As part of the settlement agreement, the parties            converted the termination of the SNS Contract, which HHS terminated for default on            December 19, 2006, to a termination for convenience and also terminated the 2003            Anthrax Contract under a bilateral contract modification for the convenience of the            government on a no-cost basis. During the three months ended March 31, 2007, the            Company recorded the $11.0 million settlement as a collection of $7.1 million of 2006            receivables and $3.9 million of 2007 receivables. The $3.9 million was recorded as            revenue during the three months ended March 31, 2007 primarily for the reimbursement of            restructuring costs incurred as a result of the termination of the            contracts.

*          Restructurings*

The majority of the January 2007            restructuring costs were recovered from the U.S. government as part of the April 2007            settlement agreement noted above. In May 2007, the Company further reduced its            workforce to decrease operating costs. Restructuring costs included employee            termination and benefit costs. Estimated costs of the restructuring are $0.6 million.            In September 2007, the Company again reduced its workforce to decrease operating costs.            Restructuring costs included employee termination and benefit costs. Estimated costs of            the restructuring are $1.1 million.

*          Smallpox*

In June 2007, the Company and            the Chemo-Sero-Therapeutic Research Institute of Japan, or Kaketsuken, terminated by            mutual consent their agreement to co-develop a next-generation, attenuated smallpox            vaccine, LC16m8, for use in the United States and elsewhere. Under the terms of the            termination agreement, VaxGen transferred to Kaketsuken or its designee all reports,            data and materials and all intellectual property rights that relate to conducting            non-clinical and clinical development of LC16m8 in the U.S. In return, Kaketsuken has            released VaxGen from ongoing development obligations.

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

***Special            Note Regarding Forward-Looking Statements***

This discussion and analysis            should be read in conjunction with our Annual Report on Form 10-K for the year ended            December 31, 2006, and our unaudited condensed consolidated financial statements and            related notes thereto appearing in Item 1 of this Quarterly Report on Form 10-Q. In            addition to the other information contained or incorporated by reference in this            Quarterly Report on Form 10-Q, you should carefully consider the risk factors described            in Part II – Item 1A herein when evaluating an investment in our common stock.            This Quarterly Report includes “forward-looking statements” within the            meaning of Section 27A of the Securities Act of 1933, or Securities Act, and Section            21E of the Securities Exchange Act of 1934, or Exchange Act. All statements other than            statements of historical fact are “forward-looking statements” for purposes            of these provisions, including any statements of the plans and objectives of management            for future operations, any statements regarding future operations, any statements            concerning proposed new products or services, any statements regarding pending or            future mergers or acquisitions, any statements regarding future economic conditions or            performance, and any statement of assumptions underlying any of the foregoing. In some            cases, forward-looking statements can be identified by the use of terminology such as            “may,” “will,” “expects,” “plans,”            “anticipates,” “estimates,” “potential” or            “continue” or the negative thereof or other comparable            terminology.

11

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There can be no assurance that            such expectations or any of the forward-looking statements will prove to be correct,            and actual results could differ materially from those projected or assumed in the            forward-looking statements. Our forward-looking statements are subject to inherent            risks and uncertainties including, but not limited to, the risk factors set forth in            this Quarterly Report. Factors that could cause or contribute to such differences            include, but are not limited to, our limited cash resources, our ability to finance our            research, our significant corporate and Securities and Exchange Commission, or SEC,            related expenses and limited revenue to offset these expenses, availability of            appropriate prospective acquisitions or investment opportunities, litigation and the            risks discussed in our other SEC filings. All forward-looking statements and reasons            why results may differ included in this Quarterly Report are made as of the date            hereof, and we assume no obligation to update any such forward-looking statement or            reason why actual results might differ. When used in the report, unless otherwise            indicated, “we,” “our” and “us” refers to            VaxGen.

**OVERVIEW**

We are a biopharmaceutical            company focused on the development, manufacture and commercialization of biologic            products for the prevention and treatment of human infectious disease. We were            incorporated in 1995 and formed to complete the development of an investigational            recombinant protein vaccine intended to prevent infection by human immunodeficiency            virus. In 2002, we broadened our product development portfolio to also include            biodefense vaccines.

On August 6, 2004, we announced            that we had received notification from Nasdaq that our stock would discontinue trading            on Nasdaq effective August 9, 2004. This action followed our appeal to Nasdaq for a            listing extension after not meeting the stated time requirements to file Quarterly            Reports on Form 10-Q for the quarters ended March 31 and June 30, 2004, respectively.            We intend to apply for relisting on Nasdaq or listing on another exchange upon filing            our remaining, outstanding and delinquent reports. Our common stock is currently quoted            on the OTC Pink Sheets under the symbol VXGN.PK.

In September 2002, we were            awarded a $20.9 million cost-plus contract, or 2002 Anthrax Contract, from the National            Institute of Allergy and Infectious Diseases, or NIAID, to develop a new anthrax            vaccine candidate and to create a feasibility plan for how we would manufacture an            emergency stockpile of 25 million doses of the vaccine. On September 30, 2003, NIAID            awarded us a second cost-plus contract, or 2003 Anthrax Contract, valued at $80.3            million for the advanced development of our anthrax vaccine candidate. These two            contracts are collectively referred to as the Anthrax Contracts.

In November 2004, we were            awarded a contract for $877.5 million to provide 75 million doses of our recombinant            anthrax vaccine to the U.S. government Strategic National Stockpile, or SNS, for            civilian defense, or SNS Contract. In November 2006, we received a clinical hold            notification from the Food and Drug Administration, or FDA, that postponed the            initiation of the second Phase 2 trial for our investigational anthrax vaccine, rPA102.            On December 19, 2006, the U.S. Department of Health and Human Services, or HHS,            terminated for default the SNS Contract. HHS based the decision on its determination            that we “failed to successfully cure the condition endangering performance and            failed to” meet a milestone imposed by HHS that required us to initiate a Phase 2            trial of the vaccine candidate by December 18, 2006. Following the HHS decision, we            scaled back development of rPA 102 and began pursuing strategic and other            alternatives.

As a result of the termination            of our SNS Contract, we implemented a reduction in force, or RIF, in January 2007. The            cash outflow of the January RIF was $2.8 million and $0.5 million during the three            months ended March 31, 2007 and June 30, 2007, respectively, and $0.3 million            thereafter. Beginning in April 2007, expected wage savings per month were $0.7 million            and $0.2 million, respectively, for Research and Development, or R&D, and General            and Administrative, or G&A. In addition, we did not renew an office space lease            that expired at the end of May 2007. This lease, coupled with utilities and            maintenance, reduced future expenses by $0.2 million per month.

**Celltrion**

For the three months ended March            31, 2006, our investment in Celltrion, Inc., or Celltrion, a company developing and            operating a mammalian cell culture biomanufacturing facility in the Republic of Korea,            was accounted for under the equity method. At March 31, 2006, our ownership interest in            Celltrion was 22%. During June and December 2006, we received gross proceeds of $130.3            million from the sale of substantially all of our Celltrion common stock. At December            31, 2006 and March 31, 2007, we held a nominal ownership interest in            Celltrion.

**Subsequent            Events**

In December 2006, HHS terminated            for default the SNS Contract. In April 2007, we entered into a settlement agreement            with HHS, in which HHS modified the SNS Contract from a termination for default to a            termination for convenience. As part of the settlement agreement, NIAID paid us $11.0            million. The settlement agreement also released both parties of all liabilities            associated with our three government anthrax contracts. We also mutually terminated the            2003 Anthrax Contract for the convenience of the government. The majority of the            January 2007 restructuring costs were recovered from the U.S. government as part of the            April 2007 settlement agreement.

In May 2007, we reduced our            workforce to further lower operating costs. The cash outflow of this RIF was $0.4            million during the three months ended June 30, 2007 and $0.2 million thereafter. This            RIF mostly impacted R&D. Beginning in July 2007, additional

12

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expected wage savings are $0.1            million per month. The RIFs in January 2007 and May 2007 have reduced our cash            disbursements by approximately $1.2 million to $1.4 million per month since June 30,            2007. We do not expect these savings to be materially offset by any anticipated            increases in other expenses.

In June 2007, we terminated by            mutual consent our agreement with the Chemo-Sero-Therapeutic Research Institute of            Japan, or Kaketsuken, to co-develop a next-generation, attenuated smallpox vaccine,            LC16m8, for use in the United States and elsewhere. Under the terms of the termination            agreement, we transferred to Kaketsuken or its designee all reports, data and materials            and all intellectual property rights that relate to conducting non-clinical and            clinical development of LC16m8 in the U.S. In return, Kaketsuken has released us from            ongoing development obligations.

In September 2007, we further            reduced our workforce to decrease operating costs. Restructuring costs included            employee termination and benefit costs. Estimated costs of the restructuring are $1.1            million. The cash outflow of this RIF is expected to be $0.7 million during the three            months ended September 30, 2007 and $0.2 million and $0.2 million during the three            months ended December 31, 2007 and thereafter, respectively. This RIF mostly impacted            R&D. Beginning in October 2007, additional expected wage savings are $0.3 million            per month. We do not expect these savings to be materially offset by any anticipated            increases in other expenses.

See Note 14, Subsequent Events,            for more information regarding events occurring after March 31, 2007.

**CRITICAL            ACCOUNTING POLICIES AND ESTIMATES**

Reference should be made to Item            7, Management’s Discussion and Analysis of Financial Condition and Results of            Operations, in our Annual Report on Form 10-K for the fiscal year ended December 31,            2006, filed with the SEC in August 2007, for a description of our critical accounting            policies. There have been no significant changes to our policies since we filed that            report other than our adoption of FIN 48, *Accounting for Uncertainty in Income            Taxes—an interpretation of FASB Statement No. 109*, or FIN 48.

Effective January 1, 2007, we            adopted FIN 48; see Note 9. We have filed tax returns with positions that may be            challenged by the tax authorities. These positions relate to, among others,            deductibility of certain expenses, expenses included in our research and development            tax credit computations, as well as other matters. Although the outcome of tax audits            is uncertain, in management’s opinion, adequate provisions for income taxes have            been made for potential liabilities resulting from such matters. We regularly assess            the tax positions for such matters and include reserves for those differences in            position. The reserves are utilized or reversed once the statute of limitations has            expired and/or at the conclusion of the tax examination. We believe that the ultimate            outcome of these matters will not have a material impact on our financial position,            financial operations or liquidity.

In December 2006, the FASB            issued FASB Staff Position EITF 00-19-2, *Accounting for Registration Payment            Arrangements*, or FSP 00-19-2, which provides guidance on accounting for            registration payment arrangements. FSP 00-19-2 specifies that the contingent obligation            to make future payments or otherwise transfer consideration under a registration            payment arrangement, whether issued as a separate agreement or included as a provision            of a financial instrument or other agreement, should be separately recognized and            measured in accordance with FASB Statement No. 5, *Accounting for Contingencies*.            FSP 00-19-2 is required to be applied to reporting periods beginning after December 15,            2006. We adopted FSP 00-19-2 as of January 1, 2007. Our previous accounting for            registration payment arrangements in connection with our 5 1/2% Convertible Senior            Subordinated Notes, due April 1, 2010, or Notes, as well as shares issued or issuable            in private placements of our common stock, or collectively Issuable Shares, was already            in compliance with FSP 00-19-2.

We have agreed to file with the            SEC a registration statement, or Registration Statement, under the Securities Exchange            Act of 1933, as amended, or Securities Act, with respect to the Issuable Shares no            later than thirty days following the first date we become current in our reporting            requirements under the Securities and Exchange Act of 1934, or Filing Date, and to use            our best efforts to cause the Registration Statement to become effective on or before            the date that is the earlier of (1) in the event of no review by the SEC no later            than 90 days after the Filing Date, (2) in the event of a review by the SEC, no            later than 120 days after the Filing Date, the earlier of (1) and (2) is referred            to as the Required Effective Date.

In the event of a default, we            are required to pay as liquidated damages, for each 30-day period of a default, an            amount in cash equal to 1% of the principal amount of the Notes and the purchase price            of the private placements until the applicable failure has been cured. We consider the            likelihood of becoming obligated for such liquidated damages to be remote and            accordingly no provision for their payment has been recorded.

Our obligation to maintain the            effectiveness of the registration statement ends upon the earlier to occur of (i) two            years from the date of effectiveness of the Registration Statement, (ii) the date when            all holders of Issuable Shares are eligible to sell such securities under Rule 144(k)            promulgated under the Securities Act, (iii) the date when all securities registered            under the Registration Statement have been sold and (iv) the date when all securities            registered under the Registration Statement cease to be outstanding. We estimate that            the maximum monthly amount of consideration that we could be required to pay as            liquidated damages under these registration payment obligations is approximately $1.0            million.

13

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**RESULTS OF            OPERATIONS**

**Comparison of Fiscal Quarters            Ended March 31, 2007 and 2006**

*         Revenues*

|     |   |                                                                           |   |                                                                       |   |   |   |   |   |   |
|----------|--------|--------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|
|     |   | **Three Months                        Ended                        March 31,** |   | **Percent                        change                        2007/2006** |   |
|     |   |                                                                                |   |                                                                       |
|     |   | **2007**                                                                       |   | **2006**                                                                   |   |   |
|     |   |                                                                                |   |                                                                            |   |        |   |
|     |   | **(in                        thousands)**                                      |   |                                                                       |   |   |
| Revenues |   | $                                                                              | 4,184  |                                                                       | $      | 6,304  |   | (34    | %)     |   |

Revenues for the three months            ended March 31, 2007 and 2006 were primarily from our Anthrax Contracts principally            reflecting work performed in 2006 for NIAID and the 2007 reimbursement of restructuring            costs incurred during the three months ended March 31, 2007 as a result of the            termination of the Anthrax Contracts in December 2006. In 2007, NIAID-related            activities decreased from the comparable period in the prior year as our work on the            Anthrax contract ended in December 2006 and revenue in 2007 was primarily related to            the restructuring. Services revenues were also earned as part of a consulting services            agreement with Celltrion to provide technical assistance related to the design,            engineering and start-up of Celltrion’s manufacturing facility. VaxGen recognized            $0.3 million and $0.4 million of revenue from Celltrion during the three months ended            March 31, 2007 and 2006, respectively. The amounts earned vary with the level of            services required.

Revenues earned in one period            are not indicative of revenues to be earned in future periods. Following the HHS            decision, we ceased actively developing our anthrax vaccine, scaled back our biodefense            activities and are actively pursuing strategic and other alternatives; therefore, we            expect future 2007 quarters’ revenues to primarily include revenues from            Celltrion, which are not expected to be significant.

*          Research            and development expenses*

|                                                     |   |                                                                           |   |                                                                       |   |   |   |   |   |   |
|----------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|
|                                                     |   | **Three Months                        Ended                        March 31,** |   | **Percent                        change                        2007/2006** |   |
|                                                     |   |                                                                                |   |                                                                       |
|                                                     |   | **2007**                                                                       |   | **2006**                                                                   |   |   |
|                                                     |   |                                                                                |   |                                                                            |   |        |   |
|                                                     |   | **(in                        thousands)**                                      |   |                                                                       |   |   |
| Research and                        development expenses |   | $                                                                              | 7,088  |                                                                       | $      | 14,176 |   | (50    | %)     |   |

Research expenses include costs            associated with research and testing of our product candidates and include the costs of            internal personnel, outside contractors, allocated overhead and laboratory supplies.            Product development expenses include costs of preclinical development and conducting            clinical trials, costs of internal personnel, drug supply costs, research fees charged            by outside contractors, allocated overhead and co-development costs.

The decrease in research and            development expenses in the three months ended March 31, 2007 over the comparable            period in 2006 was primarily due to:

|   |   |                                                                                                                                                                                                                                                                             |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | Outside consultant                        expenses, which decreased by $3.8 million primarily due to reduced                        activities related to our Anthrax Contracts since March 31, 2006;                        and                                                 |
|   |   |                                                                                                                                                                                                                                                                             |
|   | • | Labor and benefits,                        which decreased by $3.3 million primarily associated with the reductions in                        force in January 2007 and as a result of overall reductions in activities                        related to our Anthrax Contracts. |

The process of conducting            preclinical studies and clinical trials necessary to obtain FDA approval is costly and            time consuming. The probability of success for each product candidate and clinical            trial may be affected by a variety of factors, including, among others, the quality of            product candidate early clinical data, investment in the program, competition,            manufacturing capabilities and commercial viability. As a result of the uncertainties            discussed above, the uncertainty associated with clinical trial enrollments and the            risks inherent in the development process, we are unable to determine the duration and            completion costs of future clinical stages of product candidates. Development            timelines, probability of success and development costs vary widely. We anticipate that            we will make determinations as to which new programs to pursue and how much funding to            direct to each program on an ongoing basis in response to the scientific and clinical            success of future product candidates.

We expect quarterly research and            development expenses to decrease during the remainder of 2007 because following the HHS            decision we scaled back development of our anthrax vaccine and eliminated our other            biodefense activities.

14

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*          General            and administrative expenses*

|                                                       |   |                                                                           |   |                                                                       |   |   |   |   |   |   |
|------------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|
|                                                       |   | **Three Months                        Ended                        March 31,** |   | **Percent                        change                        2007/2006** |   |
|                                                       |   |                                                                                |   |                                                                       |
|                                                       |   | **2007**                                                                       |   | **2006**                                                                   |   |   |
|                                                       |   |                                                                                |   |                                                                            |   |        |   |
|                                                       |   | **(in                        thousands)**                                      |   |                                                                       |   |   |
| General and                        administrative expenses |   | $                                                                              | 6,578  |                                                                       | $      | 6,646  |   | (1     | )%     |   |

The minor decrease in general            and administrative expenses in the three months ended March 31, 2007 over the            comparable period of 2006 was primarily due to:

|   |   |                                                                                                                                                                                                                                                                                                                             |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | Facility expenses,                        which decreased by $0.9 million primarily associated with the reductions in                        force in January 2007 and as a result of overall reductions in activities                        related to our Anthrax Contracts;                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                             |
|   | • | Labor and benefits,                        which decreased by $0.7 million primarily associated with the reductions in                        force in January 2007 and as a result of overall reductions in activities                        related to our Anthrax Contracts;                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                             |
|   | • | Stock-based                        compensation expenses, which increased by $0.5 million primarily due to                        stock option awards in February 2007; and                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                             |
|   | • | Professional                        services, which increased by $1.1 million principally reflecting services                        consisting of accounting, consulting and legal fees associated with our                        efforts to comply with various reporting and regulatory                        requirements. |

We expect quarterly general and            administrative expenses to decrease during the remainder of 2007 because following the            HHS decision we scaled back activities and are actively pursuing strategic and other            alternatives.

*          Restructuring            expenses*

|                                          |   |                                                                              |   |     |   |    |   |   |   |   |
|-----------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|----------|--------|---------|--------|--------|--------|--------|
|                                          |   | **Three Months                        Ended****March                        31,** |   |
|                                          |   |                                                                                   |   |
|                                          |   | **2007**                                                                          |   | **2006** |   |
|                                          |   |                                                                                   |   |          |   |
|                                          |   | **(in                        thousands)**                                         |   |
| Restructuring                        expenses |   | $                                                                                 | 3,717  |     | $      | — |   |

Restructuring expenses for the            three months ended March 31, 2007 reflect a RIF, in January 2007. The restructuring            costs include $2.7 million for employee termination benefits and $1.0 million for costs            associated with the consolidation of our facilities in California. Refer to Note 6 for            further details.

*          Other            income (expense)*

|                                                         |   |                                                                           |    |     |   |   |   |   |   |   |
|--------------------------------------------------------------|--------|--------------------------------------------------------------------------------|---------|----------|--------|--------|--------|--------|--------|--------|
|                                                         |   | **Three Months                        Ended                        March 31,** |    |     |
|                                                         |   |                                                                                |    |     |
|                                                         |   | **2007**                                                                       |    | **2006** |   |   |
|                                                         |   |                                                                                |    |          |   |   |
|                                                         |   | **(in                        thousands)**                                      |    |     |
| Interest                        expense                      |   | $                                                                              | (611    | )        | $      | (630   | )      |   |
| Interest income and                        other             |   |                                                                           | 1,239   |     |   | 267    |   |   |
| Valuation                        adjustments                 |   |                                                                           | 2,832   |     |   | 395    |   |   |
| Equity in loss of                        affiliate           |   |                                                                           | — |     |   | (2,506 | )      |   |
| Gain on foreign                        currency transactions |   |                                                                           | — |     |   | 158    |   |   |
|                                                         |   |                                                                                |         |     |        |        |   |   |
| Other income (expense),                        net           |   | $                                                                              | 3,460   |     | $      | (2,316 | )      |   |
|                                                         |   |                                                                                |         |     |        |        |   |   |

The changes in other income            (expense) were primarily due to:

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | Interest income and                        other increased primarily due to the increased cash, cash equivalent and                        investment balances from financing activities, primarily from the sale of                        substantially all of our investment in Celltrion during June and December                        2006;                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | • | Expenses for                        mark-to-market adjustments related to the valuation of our outstanding                        derivatives on our 5 1/2% Convertible Senior Subordinated Notes, due April                        1, 2010, or Notes, changed primarily due to changes in the likelihood of a                        change in control potentially triggering the redemption option related to                        the Notes; |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | • | For the three months                        ended March 31, 2006, we recognized our share of Celltrion’s losses                        under the equity method. We sold substantially all of our ownership                        interest in Celltrion during 2006 and accordingly effective July 1, 2006 no                        longer account for it under the equity method; and                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | • | Realized foreign                        currency gains in 2006 were primarily due to the 2006 collection of the                        remaining proceeds from the 2005 sale of some of our Celltrion common                        stock.                                                                                                                                                                                                        |

15

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We anticipate future investment            income will fluctuate and will be primarily driven by our future cash, cash equivalent            and investment balances. Valuation adjustments will continue to be affected by changes            in our common stock price, our volatility and our expectations relative to a change in            control. No changes in our debt levels are anticipated and therefore quarterly interest            expense is expected to remain at the three months ended March 31, 2007 level throughout            2007.

As noted in Note 13, Segment            Information, included in the notes to the unaudited condensed consolidated financial            statements in Part I – Item 1 of this report, we have only one            segment.

**LIQUIDITY            AND CAPITAL RESOURCES**

|                                                                    |   |                                      |    |     |   |    |   |
|-------------------------------------------------------------------------|--------|-------------------------------------------|---------|----------|--------|---------|--------|
|                                                                    |   | **2007**                                  |    | **2006** |   |
|                                                                    |   |                                           |    |          |   |
|                                                                    |   | **(in                        thousands)** |    |
| **As of March                        31:**                              |   |                                      |    |     |   |    |   |
| Cash, cash                        equivalents and investment securities |   | $                                         | 83,588  |     | $      | 19,498  |   |
| Working                        capital                                  |   |                                      | 83,212  |     |   | 13,724  |   |
|                                                                    |   |                                      |    |     |   |    |   |
| **Three months                        ended March 31:**                 |   |                                      |    |     |   |    |   |
| Cash provided by                        (used in):                      |   |                                      |    |     |   |    |   |
| Operating                        activities                             |   | $                                         | (11,961 | )        | $      | (22,569 | )      |
| Investing                        activities                             |   |                                      | 7,162   |     |   | 4,056   |   |
| Financing                        activities                             |   |                                      | — |     |   | 24,162  |   |

Our primary financing            requirements as of March 31, 2007 were the funding of our remaining operations during            the next twelve months because following the HHS decision we scaled back development of            rPA102 and eliminated our other biodefense activities. Through March 31, 2007, we            financed our operations primarily through sales of our common stock, the issuance of            Series A Preferred Stock, the issuance of the Notes, sales of our Celltrion common            stock and revenues from research contracts and grants. From time-to-time, as part of            our investment strategy, we enter into reverse repurchase agreements to increase our            return on investments and improve our liquidity. Reverse repurchase agreements involve            a purchase of securities and an agreement to resell the same securities at a later date            at an agreed-upon price. The primary risk associated with short-term collateralized            borrowings is that the counterparty might be unable to perform under the terms of the            contract. Our exposure is limited, however, because we generally invest in overnight            agreements.

In April 2005, we raised            aggregate net proceeds of $29.7 million through a private placement of $31.5 million of            Notes due April 1, 2010. The Notes require us to make semi-annual payments of interest            in cash at a rate of 5 1/2%, due April 1 and October 1. If a change in control occurs,            as defined in the indenture, on or prior to the stated maturity of the Notes, the            holders of the Notes may require under certain circumstances us to repurchase the Notes            and pay a make-whole premium to the holders of the Notes. If the stock price on the            effective date of redemption is less than $12.30 per share, no make-whole premium will            be paid. If the holders request such a repurchase, we or our successor entity, may            choose to pay in cash, common stock or a combination of cash and common stock. In            addition, in the event of a default, we are required to pay as liquidated damages, for            each 30-day period of a default, an amount in cash equal to 1% of the principal amount            of the Notes and the purchase price of our private placements until the applicable            failure has been cured.

During the year ended December            31, 2006, we received gross proceeds of $130.3 million from the sale of substantially            all of our Celltrion common stock. The Company’s basis in the shares sold in 2006            was $19.0 million. The Company incurred $7.3 million in fees and related expenses            associated with the sale of this stock, resulting in a gain of $104.0 million. At            December 31, 2006 and March 31, 2007, we held a nominal ownership interest in            Celltrion.

As a result of the termination            of our SNS Contract, we implemented a RIF in January 2007. The cash outflow of the            January RIF was $2.8 million and $0.5 million during the three months ended March 31,            2007 and June 30, 2007, respectively, and $0.3 million thereafter. Beginning in April            2007, expected wage savings per month were $0.7 million and $0.2 million, respectively,            for R&D and G&A. In addition, we did not renew an office space lease that            expired at the end of May 2007. This lease, coupled with utilities and maintenance,            reduced future expenses by $0.2 million per month.

In May 2007, we reduced our            workforce to further lower operating costs. The cash outflow of this RIF was $0.4            million during the three months ended June 30, 2007 and $0.2 million thereafter. This            RIF mostly impacted R&D. Beginning in July 2007, additional expected wage savings            are $0.1 million per month. The RIFs in January 2007 and May 2007 have reduced our cash            disbursements by approximately $1.2 million to $1.4 million per month since June 30,            2007. We do not expect these savings to be materially offset by any anticipated            increases in other expenses.

In September 2007, we further            reduced our workforce to decrease operating costs. Restructuring costs included            employee termination and benefit costs. Estimated costs of the restructuring are $1.1            million. The cash outflow of this RIF is expected to be $0.7 million during the three            months ended September 30, 2007 and $0.2 million and $0.2 million during the three            months ended December 31, 2007 and thereafter, respectively. This RIF mostly impacted            R&D. Beginning in October 2007, additional expected wage savings are $0.3 million            per month. We do not expect these savings to be materially offset by any anticipated            increases in other expenses.

16

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Net cash used in operating            activities of $12.0 million and $22.6 million for the three months ended March 31, 2007            and 2006, respectively, was primarily attributable to our operating losses although the            effect of non-cash charges upon net cash used in operating activities was significant            in both periods and included:

|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | Stock-based                        compensation expense of $1.2 million in 2007 and $0.8 million in 2006. The                        increase from 2006 is primarily the result of stock option awards during                        the three months ended March 31, 2007;                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
|   | • | Valuation                        adjustments of $2.8 million and $0.4 million in 2007 and 2006,                        respectively, reflecting changes in the fair value of outstanding                        derivatives. At March 31, 2007 and 2006, we had a derivative liability                        associated with the Notes; and                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
|   | • | For the three months                        ended March 31, 2006, we recognized our share of Celltrion’s losses                        under the equity method. We sold substantially all of our ownership                        interest in Celltrion during 2006 and accordingly effective July 1, 2006 no                        longer account for it under the equity method. |

Cash used in operating            activities was also affected by the following:

|   |   |                                                                                                                                                                                                                                                  |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | Accrued and other                        current liabilities, which increased by $2.1 million in 2007, decreased by                        $2.2 million in 2006 primarily due to the timing of payments;                                              |
|   |   |                                                                                                                                                                                                                                                  |
|   | • | Accounts payable,                        which decreased by $1.8 million in 2007 and by $3.3 million in 2006                        primarily due to the timing of payments and the reduced level of operating                        activities; and |
|   |   |                                                                                                                                                                                                                                                  |
|   | • | Receivables, which                        increased by $3.1 million in 2007 and by $5.6 million in 2006 primarily due                        to the timing of payments received from the U.S. government.                                             |

In January and May 2007, we            restructured operations to significantly reduce operating cash flows.

Net cash used in investing            activities consisted primarily of activities relating to the purchase and sale of            investment securities and in 2006 capital expenditures. We expect minimal capital            expenditures during the remainder of 2007 because we scaled back development of rPA102            and eliminated our other biodefense activities. Capital expenditures of $0.5 million in            the three months ended March 31, 2006 were made in connection with the expansion of the            research and development laboratories and leasehold improvements associated with the            California manufacturing and office facilities. In addition, during the three months            ended March 31, 2006 we purchased $1.0 million of software related to the            implementation of a new enterprise resource planning system. During the three months            ended March 31, 2007, we paid the final $2.4 million in fees due from the 2006 sale of            substantially all of our remaining Celltrion common stock. During the three months            ended March 31, 2006, we collected the final $2.4 million in cash due from the 2005            sale of some of our Celltrion common stock.

Net cash provided by our            financing activities in the three months ended March 31, 2006 was from net proceeds of            $25.2 million through a private placement of 3,500,000 shares of our common stock at            $7.70 per share at a discount to the $9.20 per share closing price.

At March 31, 2007, $83.6            million, or 65%, of our assets consisted of cash, cash equivalents and investment            securities. Working capital was $83.2 million at March 31, 2007, compared to $13.7            million at March 31, 2006. This increase in working capital is due primarily to the            June and December 2006 sale of our Celltrion common stock, partially offset by our            operating losses for the twelve months ended March 31, 2007.

We believe that our existing            cash, cash equivalents and investment securities will be sufficient to cover our            working capital needs, capital expenditures, debt obligations and commitments through            at least December 31, 2008. Our future capital requirements will depend upon our            ability to identify and exploit business development opportunities including actively            pursuing avenues to enhance stockholder value through a strategic            transaction.

**Off-Balance Sheet            Arrangements**

As of March 31, 2007, we did not            have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC            Regulation S-K.

**Recent Accounting            Pronouncements**

In September 2006, the Financial            Accounting Standards Board, or FASB, issued FAS No. 157*, Fair Value Measurement*,            or FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair            value and expands disclosures about fair value measurements. FAS 157 is effective for            financial statements issued for fiscal years beginning after November 15, 2007 and            interim periods within those fiscal years. We are evaluating the impact of adopting FAS            157 on our consolidated financial position, results of operations and cash            flows.

17

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In February 2007, the FASB            issued FAS No. 159, *The Fair Value Option for Financial Assets and Financial            Liabilities - Including an Amendment of FASB Statement No. 115*, or FAS 159, which            permits all entities to choose to measure eligible items, including many financial            instruments, at fair value at specified election dates. A business entity will report            unrealized gains and losses on items for which the fair value option has been elected            in earnings at each subsequent reporting date. The fair value option: (a) may be            applied instrument by instrument, with a few exceptions, such as investments otherwise            accounted for by the equity method; (b) is irrevocable (unless a new election date            occurs); and (c) is applied only to entire instruments and not to portions of            instruments. Most of the provisions in FAS 159 are elective; however, the amendment to            FAS No. 115, *Accounting for Certain Investments in Debt and Equity Securities,*            applies to all entities with available-for-sale and trading securities. FAS 159 is            effective for fiscal years beginning after November 15, 2007. We are evaluating the            impact of adopting FAS 159 on our consolidated financial position, results of            operations and cash flows.

In May 2007, the FASB issued FSP            No. FIN 48-1*, Definition of ‘Settlement’ in FASB Interpretation No.            48,* or FIN 48-1.FIN 48-1 provides guidance on how an enterprise should determine            whether a tax position is effectively settled for the purpose of recognizing previously            unrecognized tax benefits. FIN 48-1 will be applied retrospectively to our initial            adoption of FIN 48 on January 1, 2007. The adoption of FIN 48-1 is not expected to have            a material impact on our consolidated financial position, results of operations or cash            flows.

In June 2007, the Emerging            Issues Task Force, or EITF, published Issue No. 07-3, *Accounting for Nonrefundable            Advance Payments for Goods or Services to Be Used in Future Research and Development            Activities*, or EITF 07-3. The EITF reached a consensus that these payments made by            an entity to third parties should be deferred and capitalized. Such amounts should be            recognized as an expense as the related goods are delivered or the related services are            performed. Entities should report the effects of applying this Issue as a change in            accounting principle through a cumulative-effect adjustment to retained earnings as of            the beginning of the year of adoption. EITF 07-3 is effective beginning on            January 1, 2008. Earlier application is not permitted. We do not expect that            adoption of this new Standard will have a material effect on our financial position or            results of operations.

**ITEM 3.            QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

*          Interest            Rate Risk*

We are exposed to market rate            changes by debt securities included in our investment portfolio. By policy, we invest            in debt instruments of the U.S. government, federal agencies and high-quality corporate            issuers, limit the amount of credit exposure to any one issuer, and limit duration by            restricting the term. Investments in both fixed rate and floating rate instruments            carry a degree of interest rate risk. Fixed rate securities may have their fair market            value adversely affected due to a rise in interest rates, while floating rate            securities may produce less income than expected if interest rates fall. Due in part to            these factors, our future investment income may decrease due to changes in interest            rates or due to losses we may suffer when securities decline in market value. At March            31, 2007, we held available-for-sale securities in the principal amount of $15.3            million. If market interest rates were to increase immediately and uniformly by 10%            from levels at March 31, 2007, the fair value of our portfolio would decline by an            immaterial amount, and would not have a significant effect on our operations or cash            flows. Our exposure to losses as a result of interest rate changes is managed through            investing in a portfolio of securities with a weighted-average maturity of one year or            less.

*          Indebtedness*

At March 31, 2007, our            outstanding non-current liabilities include $31.5 million of our Notes due April            1, 2010 which we sold in a private placement in April 2005. As the Notes bear interest            at a fixed rate, our interest expense under the Notes would not be affected by interest            rate changes. As of March 31, 2007, we did not invest in derivative financial            instruments, interest rate swaps or other investments that alter interest rate            exposure.

*          Derivative            Valuation Risk*

The terms of our Notes include            put features not under our control. These features are considered to be an embedded            derivative liability and we determined the fair value of this derivative to be $1.8            million on the date of issuance. Due to the quarterly revaluation of the embedded            derivative liability, we recorded in our statements of operations other income of $2.8            million and $0.4 million for the three months ended March 31, 2007 and 2006,            respectively. At March 31, 2007, the embedded derivative liability was valued at $5.4            million. We determine the fair value of the derivative liabilities using the Monte            Carlo Simulation methodology. This methodology allows flexibility in incorporating            various assumptions such as probabilities of certain triggering events. The valuations            are based on the information available as of the various valuation dates**.**            Factors affecting the amount of these liabilities include expectations regarding            triggering events, the market value of our common stock, the estimated volatility of            our common stock, our market capitalization, the risk free interest rate and other            assumptions. The inputs for the valuation analysis of the derivatives include the            probabilities of certain triggering events, which we believed to be unlikely as of            March 31, 2007. A change in this probability and or a change in the market value of our            common stock could have a significant impact on the results of our operations; however,            there would not be any impact on our cash flows.

18

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**ITEM 4.            CONTROLS AND PROCEDURES**

*          Disclosure            Controls and Procedures*

As required by Rule 13a-15(b)            under the Securities Exchange Act of 1934, as amended, or Exchange Act, we carried out            an evaluation, under the supervision and with the participation of our management,            including our Chief Executive Officer and Chief Financial Officer, of the effectiveness            of the design and operation of our disclosure controls and procedures as of the end of            the period covered by this report. Disclosure controls and procedures are designed to            ensure that the information required to be disclosed in our reports which we file or            submit under the Exchange Act is (i) accumulated and communicated to our management            (including the Chief Executive Officer and Chief Financial Officer) as appropriate to            allow timely decisions regarding required disclosures, and (ii) recorded, processed,            summarized and reported within the time periods specified in the Securities and            Exchange Commission, or SEC, rules and forms. Based upon the material weaknesses in our            internal control over financial reporting as described below, our Chief Executive            Officer and Chief Financial Officer have concluded that our disclosure controls and            procedures were not effective as of the end of the period covered by this            report.

A material weakness is a control            deficiency, or combination of control deficiencies, that results in more than a remote            likelihood that a material misstatement of the annual or interim financial statements            will not be prevented or detected.

We previously identified the            following material weaknesses:

|   |                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1)     | We did not maintain                        an effective control environment, specifically, the following material                        weaknesses were identified within the control environment: |
|   |                                                                                                                                                                                                |
|   | a)                                                                                                                                                                                                  | We did not maintain                        an effective control environment based on criteria established in                        *Internal Control-Integrated Framework* issued by the Committee of                        Sponsoring Organizations of the Treadway Commission, or COSO. Specifically,                        the financial reporting organization structure was not adequate to support                        the size, complexity or activities of the Company. In addition, certain                        finance positions were staffed with individuals who did not possess the                        level of accounting knowledge, experience and training in the application                        of generally accepted accounting principles in the United States of                        America, or GAAP, commensurate with our financial reporting                        requirements. |
|   |                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   | b)                                                                                                                                                                                                  | We did not maintain                        effective financial reporting processes, including sufficient formalized                        and consistent finance and accounting polices and procedures; nor did we                        prevent or detect instances of non-compliance with certain such policies                        and procedures that do exist. Specifically, we lacked formalized reporting                        policies and procedures.                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   | c)                                                                                                                                                                                                  | We did not maintain                        effective monitoring controls and related segregation of duties over                        automated and manual transactions processes. Specifically, we failed to                        implement processes to ensure periodic monitoring of our existing internal                        control activities over financial reporting to identify and assess                        significant risk that may impact financial statements and related                        disclosures. Additionally, inadequate segregation of duties led to untimely                        identification and resolution of accounting and discourse matters and                        failure to perform timely and effective supervision and reviews.                                                                                                                                   |

The above control deficiencies            resulted in audit adjustments to our fiscal 2006 interim and annual consolidated            financial statements. These control deficiencies affect substantially all financial            statement accounts, which could result in a material misstatement to our interim or            annual consolidated financial statements that would not be prevented or            detected.

|   |                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2)     | The material                        weaknesses in our control environment contributed to the existence of the                        following control deficiencies, each of which is considered to be a                        material weakness: |
|   |                                                                                                                                                                                                                                               |
|   | a)                                                                                                                                                                                                                                                 | We did not maintain                        effective controls over our process to ensure the complete, accurate and                        timely preparation and review of our consolidated financial statements in                        accordance with GAAP. Specifically, we did not have effective controls over                        the process for identifying, accumulating and reviewing all required                        supporting information to ensure the completeness, accuracy and timely                        preparation and review of our consolidated financial statements and                        disclosures. This control deficiency resulted in audit adjustments to our                        fiscal 2006 interim and annual consolidated financial statements.                        Additionally, this control deficiency could result in a misstatement of                        substantially all financial statement accounts that would result in a                        material misstatement to our interim or annual consolidated financial                        statements that would not be prevented or detected. |
|   |                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   | b)                                                                                                                                                                                                                                                 | We did not maintain                        effective controls to ensure that journal entries, both recurring and                        non-recurring, were consistently reviewed and approved in a timely manner                        to ensure the validity, completeness and accuracy of recorded entries. This                        control deficiency resulted in audit adjustments to our fiscal 2006 interim                        and annual consolidated financial statements. Additionally, this control                        deficiency could result in a misstatement of substantially all financial                        statement accounts that would result in a material misstatement to our                        interim or annual consolidated financial statements that would not be                        prevented or detected.                                                                                                                                                                                                                                                                                                           |

19

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|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | c)     | We did not maintain                        effective controls over the procurement process. Specifically, effective                        controls were not in place to ensure the appropriate controls over the                        approval of new vendors, authorization of purchase orders, including                        categorization of appropriate expense line items, the receipt of goods and                        the approval and authorization of vendor payments. This control deficiency                        could result in a misstatement of current liabilities and operating                        expenses that would result in a material misstatement to our interim or                        annual consolidated financial statements that would not be prevented or                        detected.                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | d)     | We did not maintain                        effective controls over the completeness and accuracy of certain revenue                        and expense accruals. Specifically, we failed to identify, analyze and                        review certain accruals at period end relating to certain accounts                        receivable, accounts payable, accrued liabilities, revenue and other direct                        expenses to ensure that they were accurately, completely and properly                        recorded. This control deficiency resulted in audit adjustments to our                        fiscal 2006 interim and annual consolidated financial statements.                        Additionally, this control deficiency could result in a misstatement of the                        aforementioned accounts that would result in a material misstatement to our                        interim or annual consolidated financial statements that would not be                        prevented or detected.                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | e)     | We did not maintain                        effective controls over the existence, completeness and valuation of fixed                        assets and related depreciation expense. Specifically, effective controls                        were not designed and in place to ensure that fixed asset additions and                        disposals were recorded, as well as, the periodic physical verification of                        fixed assets. This control deficiency resulted in audit adjustments to our                        fiscal 2006 interim and annual consolidated financial statements.                        Additionally, this control deficiency could result in a misstatement of                        fixed assets and depreciation expense that would result in a material                        misstatement to our interim or annual consolidated financial statements                        that would not be prevented or detected.                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | f)     | We did not maintain                        effective controls over spreadsheets. Specifically, we did not maintain                        effective controls over the completeness, accuracy and validity of                        spreadsheets used in our financial reporting process to maintain effective                        version control and ensure that access was restricted to appropriate                        personnel, and that unauthorized modification of the data or formulas                        within spreadsheets was prevented. This control deficiency resulted in                        audit adjustments to our fiscal 2006 interim and annual consolidated                        financial statements. Additionally, this control deficiency could result in                        a misstatement of substantially all financial statement accounts that would                        result in a material misstatement to our interim or annual consolidated                        financial statements that would not be prevented or detected. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | g)     | We did not design                        and maintain effective controls over the completeness, accuracy and                        valuation of our payroll and payroll expense. Specifically, we did not                        design and maintain effective controls over the administration of employee                        data or controls to provide reasonable assurance regarding the proper                        authorization of non-recurring payroll changes. This control deficiency                        could result in a misstatement of the aforementioned accounts that would                        result in a material misstatement to our interim or annual consolidated                        financial statements that would not be prevented or detected.                                                                                                                                                                                                                                                                                                |

As described in Item 9A of our            Annual Report on Form 10-K for the year ended December 31, 2006, which we refer to as            our 2006 10-K, our management has established a plan for remediation of the material            weaknesses in our internal control over financial reporting.

The certifications of our            principal executive officer and principal financial officer required in accordance with            Section 302 of the Sarbanes-Oxley Act of 2002 are attached as exhibits to this            Quarterly Report on Form 10-Q. The disclosures set forth in this Item 4 contain            information concerning the evaluation of our disclosure controls and procedures and            changes in internal control over financial reporting, referred to in the            certifications. Those certifications should be read in conjunction with this Item 4 for            a complete understanding of the matters covered by the certifications.

Our management undertook and            completed reconciliations, analyses, reviews and control procedures in addition to            those historically completed to confirm that this Quarterly Report fairly presents in            all material aspects our financial position, results of operations and cash flows as            of, and for the period presented in accordance with U.S. generally accepted accounting            principles.

*          Changes            in Internal Control over Financial Reporting*

There has been no change in            internal control over financial reporting during the three months ended March 31, 2007,            that has materially affected, or is reasonably likely to materially affect, our            internal control over financial reporting. We are in the process of implementing the            remediation plans to address the material weaknesses in our internal control over            financial reporting. Our remediation plan is described Item 9A of our 2006 10-K. We            expect that the implementation of this plan will extend throughout 2007.

20

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*          Elimination            of Fiscal 2006 Material Weakness*

The following material weakness            identified during fiscal 2006 was not applicable during the three months ended March            31, 2007. The cancellation of all our research, grant and revenue contracts has            eliminated the material weakness noted below:

We did not design and maintain            effective controls over the completeness, accuracy, existence and valuation of our            research grant and contract revenue accounts. Specifically, we did not design and            maintain effective controls to provide reasonable assurance that indirect and            provisional rates used to calculate manufacturing overhead and technical overhead were            complete and accurate. This control deficiency resulted in audit adjustments to our            fiscal 2006 interim and annual consolidated financial statements. Additionally, this            control deficiency could result in a misstatement of the aforementioned accounts that            would result in a material misstatement to our interim or annual consolidated financial            statements that would not be prevented or detected.

*          Inherent            Limitations on Effectiveness of Controls*

Our management, including the            Chief Executive Officer and Chief Financial Officer, does not expect that our            disclosure controls and procedures or our internal control over financial reporting            will prevent all error and all fraud. A control system, no matter how well designed and            operated, can provide only reasonable, not absolute, assurance that the objectives of            the control system are met. Because of the inherent limitations in all control systems,            no evaluation of controls can provide absolute assurance that all control issues and            instances of fraud, if any, within the Company have been detected.

**PART            II****OTHER INFORMATION**

**ITEM 1.            LEGAL PROCEEDINGS**

None.

**ITEM 1A.            RISK FACTORS**

You should carefully consider            the following risk factors as well as other information in our filings under the            Exchange Act before making any investment decisions regarding our common stock. The            risks and uncertainties described herein are not the only ones we face. Additional            risks and uncertainties that we do not know or that we currently deem immaterial may            also impair our business, financial condition, operating results and prospects. If            events corresponding to any of these risks actually occur, they could materially            adversely affect our business, financial condition, operating results or prospects. In            that case, the trading price of our common stock could decline. When used in this            report, unless otherwise indicated, “we,” “our” and            “us” refers to VaxGen. Risk factors which have materially changed since our            2006 10-K are marked with an “*”.

**If we fail to cause a            registration statement to be declared effective in accordance with the timetable set            forth in the Notes, or in accordance with agreements we have made in connection with            private placements of our common stock, we will be subject to liquidated damages or            liability for breach of contract.**

In April 2005, we raised gross            proceeds of $31.5 million through a private placement of 5 1/2% Convertible Senior            Subordinated Notes, or Notes, due April 1, 2010. We agreed to register under the            Securities Act shares of our common stock issuable upon conversion of the Notes, as            well as shares issued or issuable in private placements of our common stock. We have            agreed to file registration statements for these shares within 30 days following the            first date we become current in our reporting requirements under the Exchange Act, and            to use our best efforts to cause the registration statements to become effective in no            event later than 120 days after the filing of such registration statements. We have            also made other customary agreements regarding such registrations, including matters            relating to indemnification, maintenance of the registration statements, payment of            expenses and compliance with state “blue sky” laws. We may be liable for            liquidated damages to each Note holder and purchaser in the private placements (a) if            the registration statements are not filed on or prior to 30 days of becoming current in            our reporting requirements; (b) if the registration statements are not declared            effective by the SEC on or prior to 120 days from filing; or (c) if the registration            statements (after being declared effective) cease to be effective in a manner that            violates such agreements, or a Registration Default. In the event of a Registration            Default, we may be required to pay liquidated damages. Should we become obligated to            make payment of these liquidated damages, it could have a material adverse effect on            our financial position and our results of operations, particularly if we become            obligated to make a payment in full for all liquidated damages potentially due and            payable under these agreements.

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**We are not currently listed            on a national exchange and cannot assure you we will ever be listed.**

As a result of our failure to            make timely filings of financial statements, we were delisted from Nasdaq, and our            common stock is not currently listed on another national stock exchange. Until we            complete all necessary filings with the SEC pursuant to Sections 13 and 15(d) of the            Exchange Act, we will not be able to apply for our common stock to be listed on a            national exchange. We do not know when, if ever, this will be completed, and thus,            whether our common stock will ever be listed. In addition, we cannot be certain that            Nasdaq will approve our stock for relisting or that any other exchange will approve our            stock for listing. In order to be eligible for relisting or listing, we must meet            Nasdaq’s or another exchange’s initial listing criteria, and we believe we            will need to be in compliance with Sections 13 and 15(d) of the Exchange Act. Our            common stock is currently quoted on the Pink Sheets, LLC.

**Our business to date has been            largely dependent on the success of rPA 102, which was the subject the SNS Contract            that was terminated in December 2006. Although we scaled back development of rPA102 and            have reduced our workforce, we may be unable to successfully manage our remaining            resources, including available cash, while we seek to identify and complete a strategic            transaction.**

We scaled back clinical            development of rPA102 after HHS terminated our SNS Contract. In addition, in June 2007            we terminated our contract with Kaketsuken to develop a smallpox vaccine. We had            previously devoted substantially all of our research, development and clinical efforts            and financial resources toward the development of rPA, and we have no other product            candidates in clinical or preclinical development. In connection with the suspension of            our clinical development of rPA102, we announced restructuring activities, including            significant workforce reductions. In 2007, we incurred non-recurring charges associated            with our restructuring activities of approximately $5.4 million, which includes            employee severance costs of $4.4 million and facilities-related and other expenses            of $1.0 million. As a result of the termination of our SNS Contract, we are evaluating            strategic alternatives and have retained Lazard Ltd. to act as our advisor in this            process. We cannot predict whether we will be able to identify an appropriate strategic            alternative which will either provide us with a pipeline and/or return value to our            shareholders on a timely basis or at all. We also cannot predict whether any such            transaction would be consummated on favorable terms, and anticipate that such            transaction may require us to incur significant additional costs.

**If we fail to manage            successfully any company or product acquisitions, joint ventures or in-licensed product            candidates, we may be limited in our ability to develop our product candidates and to            rebuild our product candidate pipeline.**

Our current product development            programs were initiated through in-licensing or collaborative arrangements. These            collaborations include licensing proprietary technology from, and other relationships            with, biotechnology companies and government research institutes and organizations. As            part of our business strategy, we may expand our product pipeline and capabilities            through company or product acquisitions, mergers or in-licensing.

Any such activities will be            accompanied by certain risks including:

|   |   |                                                                                                                                    |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------|
|   | • | exposure to unknown                        liabilities of acquired companies;                                                           |
|   |   |                                                                                                                                    |
|   | • | higher than                        anticipated acquisition costs and expenses;                                                          |
|   |   |                                                                                                                                    |
|   | • | the difficulty and                        expense of integrating operations and personnel of acquired                        companies; |
|   |   |                                                                                                                                    |
|   | • | disruption of our                        ongoing business;                                                                              |
|   |   |                                                                                                                                    |
|   | • | diversion of                        management’s time and attention; and                                                          |
|   |   |                                                                                                                                    |
|   | • | possible dilution to                        stockholders.                                                                               |

If our competitors successfully            enter into partnering or license agreements or we are unable to reach agreement on            license or partnering agreements on terms acceptable to us, we may then be precluded            from pursuing those specific opportunities. Since each of these opportunities is            unique, we may not be able to find a substitute. In addition, if we are unable to            manage successfully any acquisitions, joint ventures and other collaboration            opportunities, we may be limited in our ability to develop new products and therefore            to continue to expand our product pipeline.

**We are currently ineligible            to register securities with the SEC, and we may never regain compliance.**

Until we have filed current            financial statements and made all the necessary filings with the SEC pursuant to            Sections 13 and 15(d) of the Exchange Act, we will not be able to register any            securities for resale. Until we are able to register securities with the SEC for            resale, any purchasers of our common stock or other securities directly from us will            have to rely on an exemption from the federal and state securities laws in order to            resell their securities. We cannot estimate when, if ever, we will have filed            outstanding periodic reports and regained compliance with Sections 13 and 15(d) of the            Exchange Act.

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**Our internal controls may be            insufficient to ensure timely and reliable financial information.**

We believe we need to correct            deficiencies in our internal controls and procedures for financial reporting. Because            of the material weaknesses described in Item 4 of this report, management has concluded            that we did not maintain effective internal control over financial reporting as of            March 31, 2007, based on the *Internal Control—Integrated Framework*            issued by the Committee of Sponsoring Organizations of the Treadway            Commission.

Failure to address the            identified deficiencies in a timely manner might increase the risk of future financial            reporting misstatements and may prevent us from being able to meet our filing deadlines            with the SEC. Under the supervision of our Audit Committee, we are continuing the            process of identifying and implementing corrective actions where required to improve            the design and effectiveness of our internal control over financial reporting,            including the enhancement of systems and procedures. Significant additional resources            will be required to establish and maintain appropriate controls and procedures and to            prepare the required financial and other information during this process.

Even after corrective actions            are implemented, the effectiveness of our controls and procedures may be limited by a            variety of risks including:

|   |   |                                                                                                                                                                        |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | faulty human                        judgment and simple errors, omissions or mistakes;                                                                                      |
|   |   |                                                                                                                                                                        |
|   | • | collusion of two or                        more people;                                                                                                                     |
|   |   |                                                                                                                                                                        |
|   | • | inappropriate                        management override of procedures; and                                                                                                 |
|   |   |                                                                                                                                                                        |
|   | • | the risk that                        enhanced controls and procedures may still not be adequate to assure timely                        and reliable financial information. |

If we fail to have effective            internal controls and procedures in place for financial reporting, we could be unable            to provide timely and reliable financial information. Additionally, if we fail to have            effective internal controls and procedures for financial reporting in place, it could            adversely affect our financial reporting requirements under future government            contracts.

**We may need to raise            additional capital to support our operations in order to continue as a going concern if            we successfully complete a strategic transaction.**

Absent a strategic transaction,            we believe that our existing cash, cash equivalents and securities available-for-sale            as of March 31, 2007 along with the proceeds of our April 2007 settlement with the U.S.            government over the termination of the SNS Contract will be sufficient to meet our            projected operating requirements through at least December 31, 2008. In addition to our            workforce reductions and the scaling back of our rPA102 development activities and the            termination of our smallpox development activities, we have announced that we are            exploring strategic alternatives. We may not successfully identify or implement any of            these alternatives, and even if we determine to pursue one or more of these            alternatives, we may be unable to do so on acceptable financial terms. Our            restructuring measures implemented to date and any proposed strategic alternatives may            disappoint investors and further depress the price of our common stock and the value of            an investment in our common stock thereby limiting our ability to raise additional            funds.

We will require substantial            funds to conduct development activities if we acquire additional products or companies            or consummate certain strategic transactions. Our ability to conduct the required            development activities related to any new product candidates will be significantly            limited if we are unable to obtain the necessary capital. We may seek to raise            additional funds through the sale of equity or debt to meet our working capital and            capital expenditure needs. We do not know, however, whether additional financing will            be available when needed, or whether it will be available on favorable terms or at all.            Failure to obtain adequate financing also may adversely affect our ability to operate            as a going concern.

**As a result of the reduction            in our workforce that we announced in January, May and September 2007, we may not be            successful in retaining key employees and in attracting qualified new employees as            required in the future. If we are unable to retain our management, scientific staff and            scientific advisors or to attract additional qualified personnel, our ability to            rebuild our business will be seriously jeopardized.**

In January 2007, we implemented            a restructuring resulting in the reduction of our workforce by approximately 51%. In            May 2007, we scaled back any further development activities with respect to rPA102 and            announced a corporate restructuring plan that included a reduction in our workforce to            fewer than 70 employees. In September 2007, we announced a corporate restructuring plan            that included a reduction in our workforce to fewer than 30 employees. Competition            among biotechnology companies for qualified employees is intense, and the ability to            retain and attract qualified individuals is critical to our success. We may experience            further reductions in force due to voluntary employee resignations and a diminished            ability to recruit new employees. We may be unable to attract or retain key personnel            on acceptable terms, if at all.

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**If we fail to meet our            obligations under the Notes, our payment obligations may be accelerated.**

The Notes have the following            features:

|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | require semi-annual                        payment of interest in cash at a rate of 5 1/2%;                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | • | convert, at the                        option of the holder, into shares of our common stock at an initial                        conversion price of approximately $14.76 per share, subject to                        adjustment;                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | • | will be                        provisionally redeemable at our option in cash upon the occurrence of                        certain circumstances, including among others, that the closing price of                        VaxGen common stock exceeds $22.14 per share, subject to adjustment, for at                        least 20 trading days within a period of 30 consecutive trading                        days;                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | • | if a change in                        control, as defined in the indenture, occurs on or prior to the stated                        maturity of the Notes, the holders of the Notes may require us to                        repurchase the Notes and pay a make-whole premium to the holders of the                        Notes. If the holders request such a repurchase, we or the successor entity                        may choose to pay in cash, common stock or a combination of cash and common                        stock; and |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   | • | constitute senior                        subordinated obligations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

Under the terms of the Notes, if            certain events occur, including, without limitation, our failure to pay any installment            of principal or interest due under the Notes, then the holders may, among other things,            elect to accelerate our obligations under the Notes and declare the outstanding            principal balance of the Notes and accrued but unpaid interest thereon immediately due            and payable. In the event that the holders declare the Notes immediately due and            payable or seek to foreclose on any of our assets, it would have a material adverse            effect on our financial position and we may not have sufficient cash to satisfy our            obligations.

**Our indebtedness could            adversely affect our financial health, limit our cash flow available to invest in the            ongoing requirements of our business and adversely affect the price of our common            stock.**

Our existing indebtedness            consists of $31.5 million in Notes. This indebtedness, and any future indebtedness we            may incur, could have important consequences, including:

|   |   |                                                                                                                                                                                                                                                        |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | making it more                        difficult for us to satisfy our financial and payment obligations, or to                        refinance maturing indebtedness;                                                                                      |
|   |   |                                                                                                                                                                                                                                                        |
|   | • | making us more                        vulnerable to a downturn in the economy or our business;                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                        |
|   | • | limiting our ability                        to obtain additional financing in the future for working capital, capital                        expenditures, acquisitions and other general corporate purposes;                                               |
|   |   |                                                                                                                                                                                                                                                        |
|   | • | requiring                        application of a significant portion of our cash flow from operations to                        the payment of debt service costs, which would reduce the funds available                        to us for our operations; |
|   |   |                                                                                                                                                                                                                                                        |
|   | • | limiting our                        flexibility in planning for, or reacting to, changes in our industry,                        business and markets; and                                                                                                  |
|   |   |                                                                                                                                                                                                                                                        |
|   | • | placing us at a                        competitive disadvantage to the extent we are more highly leveraged than                        some of our competitors.                                                                                             |

We may incur significant            additional indebtedness in the future to fund our continued operations or future            acquisitions. To the extent new debt is added to our current debt levels, the            substantial leverage risks described above would increase. We may be required to            repurchase the Notes if certain change in control events occur.

**We have only a limited            operating history and we expect to continue to generate operating            losses.**

To date, we have engaged            primarily in research, development and clinical testing. Since our inception in 1995,            our operations have not been profitable, and we cannot be certain that we will ever            achieve or sustain operating profitability. At March 31, 2007, we had an accumulated            deficit of $220 million. Developing any future product candidates will require            significant additional research and development, including non-clinical testing and            clinical trials, as well as regulatory approval. We expect these activities, together            with our general and administrative expenses, to result in operating losses for the            foreseeable future.

**Biopharmaceutical product            development is a long, expensive and uncertain process and the approval requirements            for many products, including vaccines used to fight bioterrorism, are still evolving.            If we are unable to successfully develop and test product candidates in accordance with            such requirements, our business will suffer.**

We are subject to rigorous and            extensive regulation by the FDA and comparable foreign regulatory authorities. In the            United States, our product candidates are regulated by the FDA as biological drug            products, known as Biologics. In order to obtain approval from the FDA to market our            product candidates, we will be required to submit to the FDA a Biologics License            Application, or BLA, which must include both preclinical and clinical trial data as            prescribed by the FDA’s current regulatory criteria, as well as extensive data            regarding the manufacturing procedures and processes for the product candidates.            Ordinarily, the FDA requires a sponsor to support a

24

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BLA application with substantial            evidence of the product’s safety and effectiveness in treating the targeted            indication based on data derived from adequate and well-controlled clinical trials,            including Phase 3 efficacy trials conducted in patients with the disease or condition            being targeted.

We cannot predict whether we            will obtain regulatory approval for any of our product candidates pursuant to these            provisions, or at all. We may fail to obtain approval from the FDA or foreign            regulatory authorities, or experience delays in obtaining such approvals, due to            varying interpretations of data or failure to satisfy current safety, efficacy, and            quality control requirements. Further, our business is subject to substantial risk            because the FDA’s current policies may change suddenly and unpredictably and in            ways that could impair our ability to obtain regulatory approval of our product            candidates. We cannot guarantee that the FDA will approve our product candidates on a            timely basis or at all.

**Delays in successfully            completing our clinical trials could jeopardize our ability to obtain regulatory            approval or market our product candidates on a timely basis.**

Our business prospects may            depend on our ability to complete patient enrollment in clinical trials, to obtain            satisfactory results, to obtain required regulatory approvals and to successfully            commercialize our product candidates. Product development is a long, expensive and            uncertain process, and delay or failure can occur at any stage of our non-clinical            studies or clinical trials. Any delay or significant adverse clinical events arising            during any of our clinical trials could force us to abandon a product candidate            altogether or to conduct additional clinical trials in order to obtain approval from            the FDA or other regulatory body. These development efforts and clinical trials are            lengthy and expensive, and the outcome is uncertain. Completion of our clinical trials,            announcement of results of the trials and our ability to obtain regulatory approvals            could be delayed for a variety of reasons, including:

|   |   |                                                                                                                                                                 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | slower-than-anticipated                        enrollment of volunteers in the trials;                                                                               |
|   |   |                                                                                                                                                                 |
|   | • | lower-than-anticipated                        recruitment or retention rate of volunteers in the trials;                                                             |
|   |   |                                                                                                                                                                 |
|   | • | serious adverse                        events related to the product candidates;                                                                                     |
|   |   |                                                                                                                                                                 |
|   | • | unsatisfactory                        results of any clinical trial;                                                                                                 |
|   |   |                                                                                                                                                                 |
|   | • | the failure of our                        principal third-party investigators to perform our clinical trials on our                        anticipated schedules; or |
|   |   |                                                                                                                                                                 |
|   | • | different                        interpretations of our preclinical and clinical data, which could initially                        lead to inconclusive results.    |

Our development costs will            increase if we have material delays in any clinical trial or if we need to perform more            or larger clinical trials than planned. If the delays are significant, or if any of our            product candidates do not prove to be safe or effective or do not receive required            regulatory approvals, our financial results and the commercial prospects for our            product candidates will be harmed. Furthermore, our inability to complete our clinical            trials in a timely manner could jeopardize our ability to obtain regulatory            approval.

**If we resume clinical trials,            the independent clinical investigators that we rely upon to conduct these studies may            not be diligent, careful or timely, and may make mistakes in the conduct of our            clinical trials.**

We depend on independent            clinical investigators to conduct our clinical trials. The investigators are not our            employees, and we cannot control the amount or timing of resources that they devote to            our product development programs. If independent investigators fail to devote            sufficient time and resources to our product development programs, or if their            performance is substandard or fails to comply with the protocol and applicable laws and            regulatory standards, FDA approval of our product candidates may be delayed or            prevented. These independent investigators may also have relationships with other            commercial entities, some of which may compete with us. If these independent            investigators assist our competitors at our expense, it could harm our competitive            position.

**If we fail to comply with            extensive regulations enforced by domestic and foreign regulatory authorities both            before and after we obtain approval of our product candidates, the commercialization of            our product candidates could be prevented, delayed or suspended.**

Product candidates are subject            to extensive government regulations related to development, testing, manufacturing and            commercialization in the United States and other countries. Our product candidates have            not received required regulatory approval from the FDA to be commercially marketed and            sold in the United States. Our product candidates have not received required regulatory            approval from foreign regulatory agencies to be commercially marketed and sold. The            process of obtaining and complying with FDA, other governmental and foreign regulatory            approvals and regulations is costly, time consuming, uncertain and subject to            unanticipated delays. Despite the time and expense exerted, regulatory approval is            never guaranteed.

We also are subject to the            following regulatory risks and obligations, among others;

|   |   |                                                                                                                                                                                    |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | the FDA or foreign                        regulators may refuse to approve an application if they believe that                        applicable regulatory criteria are not satisfied; |
|   |   |                                                                                                                                                                                    |
|   | • | the FDA or foreign                        regulators may require additional testing for safety and                        effectiveness;                                                |

25

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|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|   | • | the FDA or foreign                        regulators may interpret data from non-clinical testing and clinical trials                        in different ways than we interpret them;                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|   | • | if regulatory                        approval of a product is granted, the approval may be limited to specific                        indications or limited with respect to its distribution. In addition, many                        foreign countries control pricing and coverage under their respective                        national social security systems; |
|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|   | • | the FDA or foreign                        regulators may not approve our manufacturing processes or manufacturing                        facilities;                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|   | • | the FDA or foreign                        regulators may change their approval policies or adopt new                        regulations;                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|   | • | even if regulatory                        approval for any product is obtained, the marketing license will be subject                        to continual review, and newly discovered or developed safety or                        effectiveness data may result in suspension or revocation of the marketing                        license;                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|   | • | if regulatory                        approval of the vaccine candidate is granted, the marketing of that vaccine                        would be subject to adverse event reporting requirements and a general                        prohibition against promoting products for unapproved or                        “off-label” uses; and                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                   |
|   | • | in some foreign                        countries, we may be subject to official release requirements that require                        each batch of the vaccine we produce to be officially released by                        regulatory authorities prior to its distribution by us.                                                                              |

Failure to comply with the            regulatory requirements of the FDA and other applicable foreign regulatory bodies may            subject us to administrative or judicially imposed sanctions, including:

|   |   |                                                                                             |
|--------|--------|--------------------------------------------------------------------------------------------------|
|   | • | warning                        letters;                                                          |
|   |   |                                                                                             |
|   | • | civil                        penalties;                                                          |
|   |   |                                                                                             |
|   | • | criminal                        penalties;                                                       |
|   |   |                                                                                             |
|   | • | injunctions;                                                                                     |
|   |   |                                                                                             |
|   | • | product seizure or                        detention, including any products that we manufacture; |
|   |   |                                                                                             |
|   | • | product                        recalls;                                                          |
|   |   |                                                                                             |
|   | • | total or partial                        suspension of production; and                            |
|   |   |                                                                                             |
|   | • | suspension or                        revocation of the marketing license.                        |

**We may be subject to ongoing            regulatory review and periodic inspection and approval of manufacturing procedures and            operations, including compliance with cGMP regulations.**

The manufacturing methods,            equipment and processes used by us and any future subcontractors must comply with the            FDA’s current Good Manufacturing Practices, or cGMP, regulations. The cGMP            requirements govern, among other things, recordkeeping, production processes and            controls, personnel and quality control. The FDA must approve the facilities used to            manufacture our products before they can be used to commercially manufacture our            vaccine products and these facilities are subject to ongoing and periodic inspections.            If we or our subcontractors fail to comply with cGMP requirements, or fail to pass a            pre-approval inspection of our manufacturing facility, we may not receive regulatory            approval. In addition, preparing a manufacturing facility for commercial manufacturing            may involve unanticipated delays and the costs of complying with the cGMP regulations            may be significant. Any material changes we make to our manufacturing processes after            we obtain approval of a product may require approval by the FDA, state or foreign            regulatory authorities.

**Our product development            efforts may not yield marketable products due to results of studies or trials, failure            to achieve regulatory approvals or market acceptance, proprietary rights of others or            manufacturing issues.**

Our success depends on our            ability to successfully acquire, develop and obtain regulatory approval to market new            biopharmaceutical products. Development of a product requires substantial technical,            financial and human resources. Our potential products may appear to be promising at            various stages of development yet fail to reach the market for a number of reasons,            including:

|   |   |                                                                                                                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | the lack of adequate                        quality or sufficient prevention benefit, or unacceptable safety during                        preclinical studies or clinical trials;     |
|   |   |                                                                                                                                                                                   |
|   | • | their failure to                        receive necessary regulatory approvals;                                                                                                        |
|   |   |                                                                                                                                                                                   |
|   | • | the existence of                        proprietary rights of third parties; or                                                                                                        |
|   |   |                                                                                                                                                                                   |
|   | • | the inability to                        develop manufacturing methods that are efficient, cost-effective and                        capable of meeting stringent regulatory standards. |

26

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**We may fail to protect our            intellectual property or may infringe on the intellectual property rights of others,            either of which could harm our business.**

If we are unable to protect our            intellectual property, we may be unable to prevent other companies from using our            technology in competitive products. If we infringe on the intellectual property rights            of others, we may be prevented from developing or marketing our product candidates. We            rely on patent and other intellectual property protection to prevent our competitors            from manufacturing and marketing our product candidates. Given the rights retained and            licenses granted to the U.S. government with regard to our anthrax vaccine candidate,            to the extent that the U.S. government or foreign governments or organizations            procuring vaccines through treaties or agreements with the U.S. government constitute            the primary market for any of our products, the licenses granted by the U.S. government            may not provide us with a competitive advantage.

In addition, under our U.S.            government contracts, we have a duty to disclose each invention that we conceive or            reduce to practice in performing the agreement, and if we wish to retain title to such            invention, we must affirmatively elect to do so. If we fail to strictly follow these            disclosure requirements, the U.S. government could take title to such inventions and            preclude us from using them. For each invention to which we retain title, the U.S.            government has both a worldwide, irrevocable, royalty-free license to practice or have            practiced such invention on behalf of the U.S. government, and certain            “march-in” rights pursuant to which the U.S. government could require us to            license the invention that we own to third parties, including our            competitors.

Technology that we may acquire            or license in the future, if any, will be protected from unauthorized use by others            only to the extent that it is covered by valid and enforceable patents, or effectively            maintained as trade secrets and exclusively licensed to us. The patent positions of            pharmaceutical and biotechnology companies can be highly uncertain and involve complex            legal and factual questions. Accordingly, we cannot predict the scope and breadth of            patent claims that may be afforded to other companies’ patents. In addition, we            could incur substantial costs in litigation if we are required to defend against patent            suits brought by third parties, or if we initiate these suits, even in such instances            in which the outcome is favorable to us.

The degree of future protection            for our proprietary rights is uncertain, and we cannot ensure that:

|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | others will not                        independently develop similar or alternative technologies or duplicate any                        of our technologies;                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
|   | • | any patents issued                        to us or licensed from Kaketsuken or USAMRIID or other parties, or that we                        may license in the future, if any, will provide a basis for commercially                        viable products or will provide us with any competitive advantages or will                        not be challenged by third parties; |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
|   | • | we or any of our                        current or future licensors will adequately protect trade secrets;                        or                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                              |
|   | • | we will develop                        additional proprietary technologies that are patentable; or the patents of                        others will not have a material adverse effect on our business.                                                                                                                                                                          |

We cannot be certain that            patents issued to us in the future, if any, or that we may license in the future, if            any, will be enforceable and afford protection against competitors. In this regard, the            U.S. government has the right to use, for or on behalf of the U.S. government, any            technologies developed by us under our U.S. government contracts and we cannot prohibit            third parties, including our competitors, from using those technologies in providing            products and services to the U.S. government. Accordingly, under our license agreement            with USAMRIID granting us an exclusive license to commercialize the anthrax vaccine,            the U.S. government retains a license for any federal government agency to practice            USAMRIID’s anthrax-related inventions, by or on behalf of the government, thereby            allowing the use of the inventions in support of government contracts with other            parties, including our competitors.

Moreover, we could lose the            USAMRIID license if the U.S. government terminates the license if we or any of our            sublicensees:

|   |   |                                                                                                                                                                        |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | fail to diligently                        develop a vaccine product in accordance with the development plan described                        in the agreement;              |
|   |   |                                                                                                                                                                        |
|   | • | materially breach                        the agreement;                                                                                                                     |
|   |   |                                                                                                                                                                        |
|   | • | make a materially                        false statement (or fail to provide required information) in a plan or                        report required under the agreement; |
|   |   |                                                                                                                                                                        |
|   | • | fail to make                        payments required under the agreement; or                                                                                               |
|   |   |                                                                                                                                                                        |
|   | • | file for                        bankruptcy.                                                                                                                                 |

In addition, we cannot assure            you that our operations or technology will not infringe intellectual property rights of            others. The United States Patent and Trademark Office keeps United States patent            applications confidential while the applications are pending. As a result, we cannot            determine which inventions third parties claim in pending patent applications that they            have filed. We may need to engage in litigation to defend or enforce our patent and            license rights or to determine the scope and validity of the proprietary rights of            others. If we infringe the intellectual property of others, there can be no assurance            that we would be able to obtain licenses to use the technology on commercially            reasonable terms or at all. Failure to obtain licenses could force us to cease            development or sale of a product candidate.

27

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**We face competition from            several companies with greater financial, personnel and research and development            resources than ours.**

Our competitors are developing            product candidates which could compete with those we develop in the future. Our            commercial opportunities will be reduced or eliminated if our competitors develop and            market products for any of the diseases that we target that:

|   |   |                                                                              |
|--------|--------|-----------------------------------------------------------------------------------|
|   | • | are more                        effective;                                        |
|   |   |                                                                              |
|   | • | have fewer or less                        severe adverse side effects;            |
|   |   |                                                                              |
|   | • | are more adaptable                        to various modes of dosing;             |
|   |   |                                                                              |
|   | • | are easier to store                        or transport;                          |
|   |   |                                                                              |
|   | • | are easier to                        administer; or                               |
|   |   |                                                                              |
|   | • | are less expensive                        than the product candidates we develop. |

Even if we are successful in            developing effective products and obtain FDA and other regulatory approvals necessary            for commercializing them, our products may not compete effectively with other            successful products. Researchers are continually learning more about diseases, which            may lead to new technologies for treatment. Our competitors may succeed in developing            and marketing products either that are more effective than those that we may develop,            alone or with our collaborators, making our products obsolete, or that are marketed            before any products we develop are marketed.

Our competitors include fully            integrated pharmaceutical companies and biotechnology companies that currently have            drug and target discovery efforts, as well as universities and public and private            research institutions. Many of the organizations competing with us may have            substantially greater capital resources, larger research and development staffs and            facilities, greater experience in drug development and in obtaining regulatory            approvals, and greater marketing capabilities than we do.

**Natural disasters, including            earthquakes, may damage our facilities.**

Our corporate and manufacturing            facilities are primarily located in California. Our facilities in California are in            close proximity to known earthquake fault zones. As a result, our corporate, research            and manufacturing facilities are susceptible to damage from earthquakes and other            natural disasters, such as fires, floods and similar events. Although we maintain            general business insurance against fires and some general business interruptions, there            can be no assurance that the scope or amount of coverage will be adequate in any            particular case.

**Our use of hazardous            materials and chemicals require us to comply with regulatory requirements and exposes            us to potential liabilities.**

Our research and development may            involve the controlled use of hazardous materials and chemicals. We are subject to            federal, state, local and foreign laws governing the use, manufacture, storage,            handling and disposal of such materials. We cannot eliminate the risk of accidental            contamination or injury from these materials. In the event of such an accident, we            could be held liable for significant damages or fines. These damages could exceed our            resources and any applicable insurance coverage. In addition, we may be required to            incur significant costs to comply with regulatory requirements in the            future.

**We may become subject to            product liability claims, which could result in damages that exceed our insurance            coverage.**

We face an inherent risk of            exposure to product liability suits in connection with product candidates tested in            human clinical trials or sold commercially. We may become subject to a product            liability suit if any product candidate we develop causes injury, or if individuals            subsequently become infected or otherwise suffer adverse effects from our product            candidates. If a product liability claim is brought against us, the cost of defending            the claim could be significant and any adverse determination could result in            liabilities in excess of our insurance coverage. We maintained product liability            insurance, including clinical trial liability, in the amount of $10.0 million for our            programs up until March 2007, when the programs were suspended. We have an extended            reporting period for claims that may arise under this coverage. We cannot be certain            that additional insurance coverage, if required, could be obtained on acceptable terms,            if at all.

**We may be subject to claims            that our employees or we have wrongfully used or disclosed alleged trade secrets of            their former employers.**

As is commonplace in the            biotechnology industry, we employ individuals who were previously employed at other            biotechnology or pharmaceutical companies, including our competitors or potential            competitors. Although no claims against us are currently pending, we may be subject to            claims that these employees, or we, have inadvertently or otherwise used or disclosed            trade secrets or other proprietary information of their former employers. Litigation            may be necessary to defend against these claims. Even if we are successful in defending            against these claims, litigation could result in substantial costs and be a distraction            to management.

28

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**Our stockholders could            experience substantial dilution as a result of the issuance of additional shares of            common or preferred stock.**

Our Board of Directors has the            authority to establish the designation of almost 20,000,000 shares of preferred stock            that are convertible into common stock without any action by our stockholders, and to            fix the rights, preferences, privileges and restrictions, including voting rights, of            such shares. In February 2006, we raised net proceeds of $25.2 million through a            private placement of 3.5 million shares of common stock at $7.70 per share to a group            of accredited institutional investors. We also issued to the investors five-year            warrants initially exercisable to purchase 699,996 shares of common stock at an            exercise price of $9.24 per share. Because we did not file all of our delinquent            periodic reports with the SEC by January 31, 2007, the warrants became exercisable for            an additional 700,000 shares of common stock, at a price of $9.24 per share. We may            raise additional funds through public or private offerings of our preferred stock or            our common stock, or through issuance of debt securities that are convertible into            shares of our common stock. The issuance of additional shares of our common stock, or            conversion of preferred stock or debt securities into shares of common stock, would            further dilute the percentage ownership of our stockholders.

**Shares of our common stock            eligible for future sale may adversely affect the market for our common            stock.**

After we have filed all of our            outstanding periodic reports with the SEC, if at all, from time to time, certain of our            stockholders may be eligible to sell all or some of their shares of our common stock by            means of effective resale registration statements. We agreed to register for resale            under the Securities Act the shares of our common stock issuable upon conversion of the            Notes and the shares of our common stock issued in private placements of our common            stock in November 2004 and February 2006. We have agreed to file registration            statements for these shares within 30 days following the first date we become current            in our reporting requirements under the Exchange Act and to use our best efforts to            cause the registration statements to become effective in no event later than 120 days            after the filing of these registration statements. In addition, pursuant to Rule 144,            generally, a stockholder (or stockholders whose shares are aggregated) who has            satisfied a one year holding period may, under certain circumstances, sell within any            three month period a number of securities which does not exceed the greater of 1% of            the then outstanding shares of common stock or the average weekly trading volume of the            class during the four calendar weeks prior to such sale. Rule 144 also permits, under            certain circumstances, the sale of securities, without any limitation, by our            stockholders that are non-affiliates that have satisfied a two year holding period,            such as certain of those stockholders who purchased shares of our common stock in our            November 2004 private placement. Any substantial sale of our common stock under            effective resale registration statements or pursuant to Rule 144 or pursuant to any            resale prospectus may have a material adverse effect on the market price of our            securities.

**Our stock price is likely to            be volatile.**

Currently, our common stock is            traded OTC and is quoted on the OTC Pink Sheets LLC. Stocks traded OTC typically are            subject to greater volatility than stocks traded on stock exchanges, such as the Nasdaq            Global Market or the Nasdaq Capital Market, due to the fact that OTC trading volumes            are generally significantly less than on stock exchanges. This lower volume may allow a            relatively few number of stock trades to greatly affect the stock price. As such, the            trading price of our common stock has been and is likely to continue to be extremely            volatile. For example, between August 9, 2004 and March 31, 2007, the closing price of            our common stock, as quoted on the Pink Sheets, has ranged from a high of $18.55 per            share to a low of $1.24 per share.

Our stock price could continue            to be subject to wide fluctuations in response to a variety of factors,            including:

|   |   |                                                                                                                                                                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | timing and                        consistency of filing financial statements;                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                         |
|   | • | failure to win                        future government contracts and government activities relating to prior                        contracts;                                                                                              |
|   |   |                                                                                                                                                                                                                                         |
|   | • | adverse results or                        delays in clinical trials;                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                         |
|   | • | delays in our                        product development efforts;                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                         |
|   | • | real or perceived                        safety issues with any of our product candidates;                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                         |
|   | • | failure to obtain or                        maintain required regulatory approvals;                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                         |
|   | • | changes in financial                        estimates by securities analysts and our failure to meet or exceed such                        estimates;                                                                                        |
|   |   |                                                                                                                                                                                                                                         |
|   | • | rumors about our                        business prospects, product development efforts or the progress, timing and                        completion of our clinical trials;                                                                |
|   |   |                                                                                                                                                                                                                                         |
|   | • | new products or                        services offered by us or our competitors or announcements relating to                        product developments by our competitors;                                                                |
|   |   |                                                                                                                                                                                                                                         |
|   | • | issuances of debt or                        equity securities;                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                         |
|   | • | issuances of                        securities or the expectation of the issuance of securities as part of a                        merger or other strategic transaction;                                                                   |
|   |   |                                                                                                                                                                                                                                         |
|   | • | actual or expected                        sales by our stockholders of substantial amounts of our common stock,                        including shares issued upon exercise of outstanding options and warrants;                        and |

29

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|   |   |                                                                                  |
|--------|--------|---------------------------------------------------------------------------------------|
|   | • | other events or                        factors, many of which are beyond our control. |

In addition, the stock market in            general and biotechnology companies in particular, have experienced extreme price and            volume fluctuations that have often been unrelated or disproportionate to the operating            performance of these companies. Broad market and industry factors may negatively affect            the market price of our common stock, regardless of actual operating performance. In            the past, following periods of volatility in the market price of a company’s            securities, securities class action litigation has often been instituted against            companies. If we face securities litigation in the future, even if it is without merit            or unsuccessful, it would result in substantial costs and a diversion of management            attention and resources, which could have a material adverse effect on our            business.

**We have no history of paying            dividends on our common stock.**

We have never paid cash            dividends on our common stock and do not anticipate paying any cash dividends on our            common stock in the foreseeable future. We plan to retain any future earnings to            finance our growth. If we decide to pay dividends to the holders of our common stock,            such dividends may not be paid on a timely basis.

**Our charter documents and            Delaware law may discourage an acquisition of VaxGen.**

Provisions of our certificate of            incorporation, by-laws, and Delaware law could make it more difficult for a third party            to acquire us, even if doing so would be beneficial to our stockholders. We may issue            shares of preferred stock in the future without stockholder approval and upon such            terms as our board of directors may determine. Our issuance of this preferred stock            could have the effect of making it more difficult for a third party to acquire, or of            discouraging a third party from acquiring, a majority of our outstanding stock. Our            charter and by-laws also provide that special stockholders meetings may be called only            by our Chairman of the board of directors, by our Secretary at the written request of            the chairman or by our board of directors, with the result that any third-party            takeover not supported by the board of directors could be subject to significant delays            and difficulties.

**We are not compliant with            Section 404 under the Sarbanes-Oxley Act of 2002.**

Section 404 under the            Sarbanes-Oxley Act of 2002 requires that we perform an assessment of our internal            control over financial reporting, and engage our independent registered public            accounting firm to perform an audit of our internal control over financial reporting.            We were required to complete the assessment as to the adequacy of our internal control            reporting as of December 31, 2006, 2005 and 2004.

Although we completed our            assessments in 2006 and 2005, given our focus on completing and filing our financial            statements for those years, we did not have sufficient time nor did we provide            sufficient time to our independent registered public accounting firm to complete our            and their 2004 respective responsibilities before December 31, 2004. Our independent            registered public accounting firm concluded that we failed to complete the required            2004 assessment as to the effectiveness of our internal control over financial            reporting, and they were unable to complete their required audit of internal control            over financial reporting. Accordingly, they disclaimed an opinion as to the            effectiveness of our internal control over financial reporting for 2004.

We do not believe that the SEC            has provided guidance as to the effect of such a disclaimer. Having received such a            disclaimer, our Annual Report on Form 10-K for the year ended December 31, 2004, may be            deemed to be deficient by the SEC. If our 2004 10-K were deemed to be deficient, the            SEC may conclude that we are in violation of Sections 13 and 15(d) of the Exchange            Act.

**Our operating results may be            adversely impacted by recently adopted changes in accounting for stock            options.**

The Financial Accounting            Standards Board issued Statement of Financial Accounting Standards No. 123(R),            *Share-Based Payment*, or FAS 123R, in December 2004. FAS123R, which we            implemented effective January 1, 2006, requires all share-based payments to employees,            including grants of employee stock options, to be recognized in the statement of            operations based on their fair values. The future impact of FAS 123R cannot be            predicted at this time because it will depend on levels of share-based payments granted            in the future. We use the Black-Scholes option pricing model as allowed under FAS 123R            to determine the fair value.

**ITEM 2.            UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None

**ITEM 3.            DEFAULTS UPON SENIOR SECURITIES**

None.

**ITEM 4.            SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**ITEM 5.            OTHER INFORMATION**

None

30

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**ITEM 6.            EXHIBITS**

(a) Exhibits required by Item            601 of Regulation S-K:

The following exhibits are filed            as part of this report:

*(Note: Management contracts            and compensatory plans or arrangements are identified with a “+” in the            following list.)*

|                                   |   |                                                                                                                                                           |   |                                                 |   |                                |   |                                   |   |                                   |   |                                      |
|----------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------|--------|-------------------------------------|--------|----------------------------------------|--------|----------------------------------------|--------|-------------------------------------------|
|                                   |   |                                                                                                                                                           |   | **Incorporated by                        Reference** |   |                                |
| **Exhibit                        No.** |   | **Exhibit**                                                                                                                                                    |   | **Form**                                             |   | **File                        No.** |   | **Filing                        Date** |   | **Exhibit                        No.** |   | **Filed                        Herewith** |
|                                        |   |                                                                                                                                                                |   |                                                      |   |                                     |   |                                        |   |                                        |   |                                           |
| 10.1                                   |   | Salaries of Named                        Executive Officers. +                                                                                                 |   | 8-K                                                  |   | 0-26483                             |   | 02-07-07                               |   |                                   |   |                                      |
|                                   |   |                                                                                                                                                           |   |                                                 |   |                                |   |                                   |   |                                   |   |                                      |
| 10.2                                   |   | Bonuses, Stock                        Option Awards, Stock Option Exchange Program, and Retention Awards of Named                        Executive Officers. + |   | 8-K                                                  |   | 0-26483                             |   | 02-13-07                               |   |                                   |   |                                      |
|                                   |   |                                                                                                                                                           |   |                                                 |   |                                |   |                                   |   |                                   |   |                                      |
| 10.3                                   |   | Resignation Agreement between VaxGen, Inc and Lance K. Gordon, Ph.D.                        +                                                                  |   |                                                 |   |                                |   |                                   |   |                                   |   | X                                         |
|                                   |   |                                                                                                                                                           |   |                                                 |   |                                |   |                                   |   |                                   |   |                                      |
| 31.1                                   |   | Certification of Chief Executive Officer                                                                                                                       |   |                                                 |   |                                |   |                                   |   |                                   |   | X                                         |
|                                   |   |                                                                                                                                                           |   |                                                 |   |                                |   |                                   |   |                                   |   |                                      |
| 31.2                                   |   | Certification of Principal Financial Officer                                                                                                                   |   |                                                 |   |                                |   |                                   |   |                                   |   | X                                         |
|                                   |   |                                                                                                                                                           |   |                                                 |   |                                |   |                                   |   |                                   |   |                                      |
| 32.1                                   |   | Section 1350 Certification                                                                                                                                     |   |                                                 |   |                                |   |                                   |   |                                   |   | X                                         |

**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.

|                                               |                                                       |                                            |
|----------------------------------------------------|------------------------------------------------------------|-------------------------------------------------|
|                                               | **VaxGen,                        Inc.**                    |
|                                               |                                                       |                                            |
| *Dated:*                        September 20, 2007 | *By:*                                                      | */s/ James P.                        Panek*     |
|                                               |                                                       |                                            |
|                                               |                                                            |
|                                               |                                                       |                                            |
|                                               | James P.                        Panek                      |
|                                               | ***Chief                        Executive Officer***       |
|                                               | ***(Principal                        Executive Officer)*** |
|                                               |                                                       |                                            |
| *Dated:*                        September 20, 2007 | *By:*                                                      | */s/ Matthew J.                        Pfeffer* |
|                                               |                                                       |                                            |
|                                               |                                                            |
|                                               |                                                       |                                            |
|                                               | Matthew J.                        Pfeffer                  |
|                                               | ***Chief                        Financial Officer***       |
|                                               | ***(Principal                        Financial Officer)*** |

31

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