##### Table of Contents

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SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



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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 September 30, 2003.



or



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



| | For the Transition Period from
 to
.
| | ------------------------------------



Commission File No. 0-19651



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GENAERA CORPORATION

(Exact name of registrant as specified in its charter)



|Delaware                                                       |  | 13-3445668                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification Number)



|5110 Campus Drive                        |  |           
|---------------------------------------- |  | ----------
|Plymouth Meeting, Pennsylvania           |  | 19462     
|(Address of principal executive offices) |  | (Zip Code)



610-941-4020

(Registrants telephone number, including area code)



---



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



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



The number of outstanding shares of the Registrants Common Stock, par value $.002 per share, on November 7, 2003 was 44,944,852.



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##### Table of Contents

GENAERA CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2003



TABLE OF CONTENTS



|                             |  |                                                                                                  |  | Page
|---------------------------- |  | ------------------------------------------------------------------------------------------------ |  | ----
|                            
|PART IFINANCIAL INFORMATION
|                             |  |                                                                                                 
|Item 1.                      |  | Financial Statements (unaudited):                                                                |  |     
|                             |  |                                                                                                 
|                             |  | Balance Sheets as of September 30, 2003 and December 31, 2002                                    |  | 3   
|                             |  |                                                                                                 
|                             |  | Statements of Operations for the three- and nine-month periods ended September 30, 2003 and 2002 |  | 4   
|                             |  |                                                                                                 
|                             |  | Statements of Cash Flows for the nine-month periods ended September 30, 2003 and 2002            |  | 5   
|                             |  |                                                                                                 
|                             |  | Notes to Financial Statements                                                                    |  | 6   
|                             |  |                                                                                                 
|Item 2.                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations            |  | 13  
|                             |  |                                                                                                 
|Item 3.                      |  | Quantitative and Qualitative Disclosures about Market Risk                                       |  | 24  
|                             |  |                                                                                                 
|Item 4.                      |  | Controls and Procedures                                                                          |  | 24  
|                            
|PART IIOTHER INFORMATION   
|                             |  |                                                                                                 
|Item 1.                      |  | Legal Proceedings                                                                                |  | 25  
|                             |  |                                                                                                 
|Item 2.                      |  | Changes in Securities and Use of Proceeds                                                        |  | 25  
|                             |  |                                                                                                 
|Item 3.                      |  | Defaults Upon Senior Securities                                                                  |  | 25  
|                             |  |                                                                                                 
|Item 4.                      |  | Submission of Matters to a Vote of Security Holders                                              |  | 25  
|                             |  |                                                                                                 
|Item 5.                      |  | Other Information                                                                                |  | 25  
|                             |  |                                                                                                 
|Item 6.                      |  | Exhibits and Reports on Form 8-K                                                                 |  | 25  
|                             | 
|SIGNATURES                   |  | 27                                                                                              



2



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##### Table of Contents

PART IFINANCIAL INFORMATION



|ITEM 1. |  | FINANCIAL STATEMENTS
|------- |  | --------------------



GENAERA CORPORATION

BALANCE SHEETS

(Unaudited)

(Amounts in thousands, except per share data)



|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  | September 30, 2003 |          |   | December 31, 2002 |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | - | ----------------- | -
|ASSETS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |                    |          |   |                   |  
|Current assets:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |                    |          |   |                   |  
|Cash and cash equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  | $                  | 1,256    |   |                   | $
|Short-term investments (NOTE 2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |                    | 6,986    |   |                   |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |                    | 409      |   |                   |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                    |          |   |                   |  
|Total current assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                    | 8,651    |   |                   |  
|Fixed assets, net                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  |                    | 1,179    |   |                   |  
|Other assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  |                    | 64       |   |                   |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                    |          |   |                   |  
|Total assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | $                  | 9,894    |   |                   | $
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                    |          |   |                   |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                    |          |   |                   |  
|Current liabilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                    |          |   |                   |  
|Accounts payable and accrued expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  | $                  | 1,079    |   |                   | $
|Note payable (NOTE 2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |                    |         |   |                   |  
|Other current liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |                    |         |   |                   |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                    |          |   |                   |  
|Total current liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |                    | 1,079    |   |                   |  
|Accrued development expenselong-term (NOTE 7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  |                    | 1,529    |   |                   |  
|Other liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  |                    | 464      |   |                   |  
|Series A redeemable convertible preferred stock (liquidation value of $1,117 at December 31, 2002) (NOTE
4)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |                    |         |   |                   |  
|Commitments, contingencies and other matters (NOTE 7)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |                    |          |   |                   |  
|Stockholders equity (NOTE 3):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  |                    |          |   |                   |  
|Preferred stock$.001 par value per share; 9,211 shares authorized; none and 0.888 shares issued and outstanding as Series A
redeemable convertible preferred stock at September 30, 2003 and December 31, 2002, respectively; 10.0 shares issued and outstanding as Series B convertible preferred stock at September 30, 2003 and December 31, 2002 (liquidation value of $10,000);
none issued and outstanding as Series C-1 convertible preferred stock at September 30, 2003 and December 31, 2002; 2.5 shares and none issued and outstanding as Series C-2 convertible preferred stock at September 30, 2003 and December 31, 2002,
respectively, (liquidation value of $2,500) |  |                    |         |   |                   |  
|Common stock$.002 par value per share; 75,000 shares authorized; 39,483 and 35,666 shares issued and outstanding at
September 30, 2003 and December 31, 2002, respectively                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |                    | 79       |   |                   |  
|Additional paid-in capital                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    | 197,705  |   |                   |  
|Accumulated other comprehensive incomeunrealized gain on investments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |                    |         |   |                   |  
|Accumulated deficit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    | (190,962 | ) |                   |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                    |          |   |                   |  
|Total stockholders equity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    | 6,822    |   |                   |  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                    |          |   |                   |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | $                  | 9,894    |   |                   | $
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |                    |          |   |                   |  



See accompanying notes
to financial statements.



3



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##### Table of Contents

GENAERA CORPORATION

STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in thousands, except per share data)



|                                                                                                                                                                                         |  | Three Months EndedSeptember 30, |        |   | Nine Months Ended September 30, |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------- | -
|                                                                                                                                                                                         |  | 2003                            |        |   | 2002                            |  
|Collaborative research agreement and grant revenues                                                                                                                                      |  | $                               | 124    |   |                                 | $
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  
|Costs and expenses:                                                                                                                                                                      |  |                                 |        |   |                                 |  
|Research and development                                                                                                                                                                 |  |                                 | 1,555  |   |                                 |  
|General and administrative                                                                                                                                                               |  |                                 | 656    |   |                                 |  
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  
|                                                                                                                                                                                         |  |                                 | 2,211  |   |                                 |  
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  
|Loss from operations                                                                                                                                                                     |  |                                 | (2,087 | ) |                                 |  
|Interest income                                                                                                                                                                          |  |                                 | 17     |   |                                 |  
|Interest expense                                                                                                                                                                         |  |                                 | (1     | ) |                                 |  
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  
|Net loss                                                                                                                                                                                 |  |                                 | (2,071 | ) |                                 |  
|Dividends on preferred stock, including amount attributable to a beneficial conversion feature of $2,945 and $3,050 for the three
and nine months ended September 30, 2003, respectively |  |                                 | 2,945  |   |                                 |  
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  
|Net loss applicable to common stockholders                                                                                                                                               |  | $                               | (5,016 | ) |                                 | $
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  
|Net loss applicable to common stockholders per sharebasic and diluted                                                                                                                   |  | $                               | (0.13  | ) |                                 | $
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  
|Weighted average shares outstandingbasic and diluted                                                                                                                                    |  |                                 | 37,453 |   |                                 |  
|                                                                                                                                                                                         |  |                                 |        |   |                                 |  







See accompanying notes to financial statements.



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##### Table of Contents

GENAERA CORPORATION

STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in thousands)



|                                                                                                   |  | Nine Months Ended September 30, |        
|-------------------------------------------------------------------------------------------------- |  | ------------------------------- | -------
|                                                                                                   |  | 2003                            |        
|Cash Flows From Operating Activities:                                                              |  |                                 |        
|Net loss                                                                                           |  | $                               | (5,057 
|Adjustments to reconcile net loss to net cash used in operating activities:                        |  |                                 |        
|Depreciation and amortization                                                                      |  |                                 | 384    
|Amortization of investment discounts/premiums                                                      |  |                                 | (56    
|Compensation expense on option grants and equity awards                                            |  |                                 | 194    
|Gain on sale of fixed assets                                                                       |  |                                 | (257   
|Changes in operating assets and liabilities:                                                       |  |                                 |        
|Increase in prepaid expenses and other assets                                                      |  |                                 | (223   
|Decrease in accounts payable and accrued expenses                                                  |  |                                 | (223   
|Decrease in accrued development expenses                                                           |  |                                 |       
|Increase in other liabilities                                                                      |  |                                 | 232    
|                                                                                                   |  |                                 |        
|Net cash used in operating activities                                                              |  |                                 | (5,006 
|                                                                                                   |  |                                 |        
|Cash Flows From Investing Activities:                                                              |  |                                 |        
|Purchase of investments                                                                            |  |                                 | (15,750
|Proceeds from maturities of investments                                                            |  |                                 | 16,850 
|Proceeds from sales of fixed assets                                                                |  |                                 | 257    
|Capital expenditures                                                                               |  |                                 | (21    
|                                                                                                   |  |                                 |        
|Net cash provided by investing activities                                                          |  |                                 | 1,336  
|                                                                                                   |  |                                 |        
|Cash Flows From Financing Activities:                                                              |  |                                 |        
|Payment on note payable                                                                            |  |                                 | (2,500 
|Proceeds from issuance of common stock                                                             |  |                                 |       
|Proceeds from exercise of stock options and warrants                                               |  |                                 | 1,136  
|Proceeds from issuance of Series C-1 and C-2 convertible preferred stock                           |  |                                 | 4,922  
|                                                                                                   |  |                                 |        
|Net cash provided by financing activities                                                          |  |                                 | 3,558  
|                                                                                                   |  |                                 |        
|Net decrease in cash and cash equivalents                                                          |  |                                 | (112   
|Cash and cash equivalents at beginning of period                                                   |  |                                 | 1,368  
|                                                                                                   |  |                                 |        
|Cash and cash equivalents at end of period                                                         |  | $                               | 1,256  
|                                                                                                   |  |                                 |        
|Supplemental Cash Flow Information:                                                                |  |                                 |        
|Cash paid during the period for interest                                                           |  | $                               | 76     
|                                                                                                   |  |                                 |        
|Cash paid during the period for income taxes                                                       |  | $                               |       
|                                                                                                   |  |                                 |        
|Supplemental Schedule of Non-Cash Investing & Financing Activities:                                |  |                                 |        
|Conversion of Series A redeemable convertible preferred stock into common stock                    |  | $                               | 1,151  
|                                                                                                   |  |                                 |        
|Issuance of warrants in connection with issuance of Series C-1 and C-2 convertible preferred stock |  | $                               | 1,200  
|                                                                                                   |  |                                 |        
|Conversion of Series C-1 convertible preferred stock into common stock                             |  | $                               | 2,500  
|                                                                                                   |  |                                 |        



See accompanying notes
to financial statements.



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##### Table of Contents

GENAERA CORPORATION

NOTES TO FINANCIAL STATEMENTS



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NOTE 1. Basis of Presentation and Stock-Based Compensation



The accompanying financial statements of Genaera Corporation
(Genaera or the Company) are unaudited and have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC) for interim financial statements. The
December 31, 2002 balance sheet was derived from audited financial statements, however, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant to SEC rules and regulations. The Company believes that the financial statements include all adjustments of a normal and recurring nature necessary to present fairly
the results of operations, financial position, changes in stockholders equity and cash flows for the periods presented. Results of operations for interim periods are not necessarily indicative of those to be achieved for full fiscal years.
These financial statements should be read in conjunction with the financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2002. There have been no material changes in
accounting policies from those stated in the Companys Annual Report on Form 10-K for the year ended December 31, 2002.



The Company accounts for its fixed-plan stock options under the intrinsic-value-based method set forth by Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations including Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for Certain Transactions
involving Stock Compensation, an Interpretation of APB No. 25, issued in March 2000. Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (SFAS 123), established
accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described
above, and has adopted only the disclosure requirements of SFAS 123. The following table illustrates the effect on net loss applicable to common stockholders if the fair-value-based method had been applied to all outstanding and unvested stock-based
awards for the three- and nine-month periods ended September 30, 2003 and 2002 (in thousands, except per share amounts).



|                                                                                                                                                        |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | -
|                                                                                                                                                        |  | 2003                            |        |   | 2002                           |  
|Net loss applicable to common stockholders, as reported                                                                                                 |  | $                               | (5,016 | ) |                                | $
|Add: Stock-based employee compensation expense included in reported net loss applicable to common stockholders, net of related tax
effects              |  |                                 | 16     |   |                                |  
|Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all stock-based awards, net
of related tax effects |  |                                 | (328   | ) |                                |  
|                                                                                                                                                        |  |                                 |        |   |                                |  
|Pro forma net loss applicable to common stockholders                                                                                                    |  | $                               | (5,328 | ) |                                | $
|                                                                                                                                                        |  |                                 |        |   |                                |  
|Net loss applicable to common stockholders per sharebasic and diluted:                                                                                 |  |                                 |        |   |                                |  
|As reported                                                                                                                                             |  | $                               | (0.13  | ) |                                | $
|                                                                                                                                                        |  |                                 |        |   |                                |  
|Pro forma                                                                                                                                               |  | $                               | (0.14  | ) |                                | $
|                                                                                                                                                        |  |                                 |        |   |                                |  



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##### Table of Contents

GENAERA CORPORATION

NOTES TO FINANCIAL STATEMENTS



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The resulting effect on pro forma net loss applicable to common stockholders and pro forma net loss
applicable to common stockholders per share disclosed above may not be representative of the effects on a pro forma basis in future years. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions:



|                                                                 |  | 2002        |  | 2003       
|---------------------------------------------------------------- |  | ----------- |  | -----------
|Range of risk free interest rates                                |  | 3.89%4.94% |  | 3.04%3.38%
|Dividend yield                                                   |  | 0%          |  | 0%         
|Volatility factor                                                |  | 110%        |  | 99%        
|Weighted average expected life of options (in years)             |  | 7.8         |  | 4.4        
|Weighted average fair value of options granted during the period |  | $2.59       |  | $2.14      



On April 22, 2003, the
FASB determined that stock-based compensation should be recognized as a cost in the financial statements and that such cost be measured according to the fair value of the stock options. The FASB has not as yet determined the methodology for
calculating fair value and plans to issue an exposure draft early next year. The Company will continue to monitor communications on this subject from the FASB in order to determine the impact on the Companys financial statements.



NOTE 2. Note Payable



In June 2003, the Companys note payable matured and was not refinanced. The Company used its collateralized cash to
satisfy the outstanding balance of $2,500,000 plus $6,000 of accrued but unpaid interest through maturity.



NOTE 3. Stockholders Equity



The changes in stockholders equity from December 31, 2002 to September 30, 2003 are summarized as follows (in thousands):



|                                                                                                              |  | Common Stock    |  | Additional Paid-in Capital |    |  | Accumulated Other Compre- hensive Income |         |   | Accumulated Deficit |   |    | Total Stock- holders Equity | 
|------------------------------------------------------------------------------------------------------------- |  | --------------- |  | -------------------------- | -- |  | ---------------------------------------- | ------- | - | ------------------- | - | -- | ---------------------------- | 
|                                                                                                              |  | Numberof Shares |  | Amount                     |    |  |                                          |        
|Balance at December 31, 2002                                                                                  |  | 35,666          |  | $                          | 71 |  | $                                        | 187,258 |   |                     | $ | 1  |                              | 
|Exercise of stock options and compensation expense on option grants and stock awards                          |  | 176             |  |                            | 1  |  |                                          | 508     |   |                     |   |   |                              | 
|Series C-1 and C-2 convertible preferred stock and common stock warrants issued pursuant to private placement |  |                |  |                            |   |  |                                          | 4,922   |   |                     |   |   |                              | 
|Beneficial conversion feature related to the issuance of Series C-1 and C-2 convertible preferred stock       |  |                |  |                            |   |  |                                          | 3,050   |   |                     |   |   |                              | 
|Discount on Series C-1 and C-2 convertible preferred stock                                                    |  |                |  |                            |   |  |                                          | (3,050  | ) |                     |   |   |                              | 
|Conversion of Series C-1 preferred stock                                                                      |  | 2,500           |  |                            | 5  |  |                                          | (5      | ) |                     |   |   |                              | 
|Exercise of common stock warrants issued pursuant to private placement                                        |  | 600             |  |                            | 1  |  |                                          | 821     |   |                     |   |   |                              | 
|Conversion of Series A preferred stock                                                                        |  | 541             |  |                            | 1  |  |                                          | 1,150   |   |                     |   |   |                              | 
|Dividends on Series A preferred stock                                                                         |  |                |  |                            |   |  |                                          |        |   |                     |   |   |                              | 
|Amortization of beneficial conversion                                                                         |  |                |  |                            |   |  |                                          | 3,050   |   |                     |   |   |                              | 
|Comprehensive loss:                                                                                           |  |                 |  |                            |    |  |                                          |         |   |                     |   |    |                              | 
|Net loss                                                                                                      |  |                |  |                            |   |  |                                          |        |   |                     |   |   |                              | 
|Carrying value adjustment                                                                                     |  |                |  |                            |   |  |                                          |        |   |                     |   | (1 | )                            | 
|                                                                                                              |  |                 |  |                            |    |  |                                          |         |   |                     |   |    |                              | 
|Total comprehensive loss                                                                                      |  |                |  |                            |   |  |                                          |        |   |                     |   |   |                              | 
|                                                                                                              |  |                 |  |                            |    |  |                                          |         |   |                     |   |    |                              | 
|Balance at September 30, 2003                                                                                 |  | 39,483          |  | $                          | 79 |  | $                                        | 197,705 |   |                     | $ |   |                              | 
|                                                                                                              |  |                 |  |                            |    |  |                                          |         |   |                     |   |    |                              | 





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##### Table of Contents

GENAERA CORPORATION

NOTES TO FINANCIAL STATEMENTS



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NOTE 4. Preferred Stock



The Companys certificate of incorporation provides the board of directors the power to issue shares of preferred stock
without stockholder approval. This preferred stock could have voting rights, including voting rights that could be superior to that of the Companys common stock, and the board of directors has the power to determine these voting rights. As of
September 30, 2003, the Companys board of directors has designated 80,000 shares of preferred stock as Series A redeemable convertible preferred stock (the Series A Preferred Stock), 10,000 shares of preferred stock as Series B
convertible preferred stock (the Series B Preferred Stock) 2,500 shares of preferred stock as Series C-1 convertible preferred stock (the Series C-1 Preferred Stock) and 2,500 shares of preferred stock as Series C-2
convertible preferred stock (the Series C-2 Preferred Stock) (the Series C-1 Preferred Stock and the Series C-2 Preferred Stock collectively the Series C Preferred Stock).



On June 30, 2003, Genentech, Inc., the sole holder of Series A Preferred
Stock, consented to amend and restate the Series A Preferred Stock Certificate of Designations, Preferences and Rights to allow its earlier conversion. Genentech then immediately elected to convert all of its outstanding and issued 888 shares of
Series A Preferred Stock plus $263,000 of accrued but unpaid dividends as of the conversion date into 540,375 shares of the Companys common stock at a 5-day trailing average market price of $2.13 as defined in the original Certificate of
Designations. As a result of this conversion, there are no longer any shares of Series A Preferred Stock outstanding.



In connection with an agreement with MedImmune, Inc. (as described in NOTE 6. Collaboration Agreements), 10,000 shares of Series B Preferred
Stock were issued in April 2001 and are outstanding as of September 30, 2003.



In May 2003, the Company designated 2,500 shares of its previously authorized 9,211,031 shares of preferred stock, par value $.001, as Series C-1 Preferred Stock and 2,500 shares as Series C-2 Preferred Stock. Prior
to November 23, 2004, the Series C-1 Preferred Stock is convertible in whole or in part, at the holders option, into shares of the Companys common stock at a conversion rate of 1,000 shares of common stock for each share of Series C-1
Preferred Stock if the trailing 20-day average stock market price per share of the Companys common stock is greater than $3.00 (subject to adjustment). The Series C-2 Preferred Stock is convertible prior to November 23, 2004 in whole or in
part, at the holders option, into shares of the Companys common stock at a conversion rate of 1,000 shares of common stock for each share of Series C-2 Preferred Stock if the trailing 20-day average stock market price per share of the
Companys common stock is greater than $4.00 (subject to adjustment). After November 23, 2004, the Series C Preferred Stock is convertible, in whole or in part, at the holders option, into 1,000 shares of the Companys common stock
per share of Series C Preferred Stock. After May 23, 2006, the Series C Preferred Stock is convertible, in whole or in part, at the Companys option, at a conversion rate of 1,000 shares of the Companys common stock per share of Series C
Preferred Stock. The Series C Preferred Stock shall be automatically converted or redeemed upon the occurrence of a change of control, as defined in the corresponding Certificates of Designations, Preferences and Rights of each class of the Series C
Preferred Stock as (i) any sale, exchange, conveyance or other disposition of capital stock of the Company in a transaction or series of related transactions in which more than forty percent of the voting power of the Company is disposed and the
Company is a party to such transaction(s), (ii) upon the sale of all or substantially all of the assets of the Company, or (iii) the consolidation, merger or similar transaction of the Company into or with any other entity or entities (other than a
consolidation, merger or similar transaction which the Company is a party to such transaction(s) and in which the stockholders of the Company immediately prior to such consolidation, merger or similar transaction will own at least sixty percent of
the voting power of the combined or surviving entity by virtue of their ownership of



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GENAERA CORPORATION

NOTES TO FINANCIAL STATEMENTS



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shares of capital stock of the Company). The conversion or redemption will be either (i) at a conversion rate of
1,000 shares of the Companys common stock per share of Series C Preferred Stock or (ii) into cash at a redemption price of $1,000 per share of Series C Preferred Stock, at the holders option, plus accrued and unpaid cumulative dividends
to the date of redemption. Upon the holders receipt of a notice of redemption from the Company, the Series C Preferred Stock may be converted into the Companys common stock, at the holders option, in accordance with the conversion
rate above. The maximum aggregate number of common shares initially issuable upon a conversion of all of the shares of the Series C Preferred Stock is 5,000,000 shares. Holders of the Series C Preferred Stock have no rights to dividends other than
the right to participate in any dividends that may be declared on the Companys common stock. With respect to liquidation and dividend rights, the Series C Preferred Stock ranks senior to the Companys common stock and junior to the
outstanding shares of the Companys Series A and Series B Preferred Stock. In the event of the Companys liquidation, dissolution or winding up, the Series C Preferred Stock has a liquidation preference of $1,000 per share plus accumulated
and unpaid cumulative dividends on such preferred stock up to the date of liquidation (as adjusted for any recapitalizations, stock combinations, stock dividends, stock splits or similar transactions). Holders of Series C Preferred Stock may vote on
every matter put to a vote of the Companys common stockholders, except for any matter reserved solely for the vote of the holders of any series of preferred stock other than the Series C-1 Preferred Stock or Series C-2 Preferred stock.



In May 2003, the Company completed the sale of a total of
5,000 shares of Series C Preferred Stock (consisting of 2,500 shares of Series C-1 Preferred Stock and 2,500 shares of Series C-2 Preferred Stock) and warrants to purchase 2,000,000 shares of the Companys common stock at an exercise price per
share of $1.37 to Biotechnology Value Fund LP and associated entities and to Ziff Asset Management L.P. in a private placement pursuant to a purchase agreement (the Preferred Stock and Warrant Purchase Agreement) for gross proceeds of
$5,000,000, before offering costs. The Preferred Stock and Warrant Purchase Agreement was subsequently amended and the Certificate of Designations, Preferences and Rights of each of the Series C-1 Preferred Stock and Series C-2 Preferred Stock was
amended and restated in June 2003 to amend one of the conversion factors and clarify voting rights and the distribution of certain shares among the investors. Due to the sale of the shares of Series C Preferred Stock with a conversion price that was
below the quoted market price of the Companys common stock at the time of sale and the issuance of warrants, the Company calculated a beneficial conversion feature of $3,050,000 which represents the excess of the fair value of the preferred
stock issued ($6,850,000) over the proceeds allocable to the preferred stock ($3,800,000). The value of the preferred stock issued was estimated based on the conversion feature and the value of the warrants issued was estimated using a Black-Scholes
model and the amount of the proceeds allocable to the Series C Preferred Stock and warrants was based on the relative fair values of the securities. The proceeds allocable to the warrants were $1,200,000. The Company began amortizing the value of
the beneficial conversion feature as a preferred stock dividend over the 18-month period from the date of issuance of the Series C Preferred Stock to the date on which the Series C Preferred Stock is first known to be convertible. All of the
preferred stock became convertible before the end of this 18-month period as the Companys stock price met defined thresholds, therefore the unamortized amount of the beneficial conversion feature was recognized as a dividend in the three-month
period ended September 30, 2003. During the three and nine months ended September 30, 2003, the Company has recognized approximately $2,945,000 and $3,050,000 respectively, of the beneficial conversion feature as a deemed dividend to preferred
stockholders.



On August 26, 2003, Biotechnology Value Fund LP
and associated entities and Ziff Asset Management L.P., elected to convert all of their outstanding and issued 2,500 shares of Series C-1 Preferred Stock into 2,500,000 shares of the Companys common stock at a price of $1.00 as defined in the
original Certificate of Designations. As a result of these conversions, there are no longer any shares of Series C-1 Preferred Stock outstanding.



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GENAERA CORPORATION

NOTES TO FINANCIAL STATEMENTS



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NOTE 5. Common Stock Warrants



In connection with its May 2003 private placement, the Company granted warrants to purchase 2,000,000 shares of its common
stock at an exercise price of $1.37 per share. These warrants expire on May 23, 2008 and contain certain provisions under which the holder may elect to receive, without the payment by the holder of any additional consideration, a number of shares of
the Companys common stock equal to the value of the warrant, also known as net exercise provisions. Of this total, warrants to purchase 1.5 million shares are exercisable immediately. The remaining warrants to purchase 500,000 shares are
generally exercisable after 18 months from issuance, or beginning on November 23, 2004, or prior to November 23, 2004 if the holder exercises the warrants on a net exercise basis.



On August 26, 2003, Ziff Asset Management, L.P., exercised its warrant to purchase 600,000 shares of the Companys
common stock at an exercise price of $1.37 per share, pursuant to a warrant issued in connection with May 2003 private placement. Proceeds to the Company from the exercise of this warrant were approximately $822,000.



NOTE 6. Collaboration Agreements



In April 2001, the Company entered into a research collaboration and
licensing agreement with MedImmune to develop and commercialize therapies related to the Companys IL9 program. MedImmune provided funding of $2,500,000 for research and development activities at the Company through April 2003 (the
R&D Funding), which has been recognized by the Company as revenues on a straight-line basis over the two-year period. In addition to the R&D Funding, MedImmune also will reimburse the Company for certain external costs incurred
by the Company in connection with the IL9 research plan, which will be recognized by the Company as revenues when the related expenses are incurred. For the three- and nine-month periods ended September 30, 2003, the Company recognized $3,000 and
$651,000 as revenue related to the R&D Funding (none and $370,000) and external cost reimbursements ($3,000 and $281,000), respectively. For the three- and nine-month periods ended September 30, 2002, the Company recognized $349,000 and
$1,202,000 as revenue related to the R&D Funding ($315,000 and $935,000) and external cost reimbursements ($34,000 and $267,000), respectively.



In September 2001, the Company received a contingent award of up to $1,700,000 from an affiliate of the Cystic Fibrosis Foundation (CFF) to
support early clinical evaluation of LOMUCIN
involving patients with cystic fibrosis. This award has been granted and shall be paid to the Company from time to time upon the achievement of certain development milestones. In April 2003, CFF further defined the development milestones under this
same award. Of this grant, $403,000 was received as of September 30, 2003 and was recorded as a long-term liability. The Company did not recognize this amount as revenue because it is refundable to the CFF upon marketing approval by the FDA or if
the Company elects not to enter Phase 3 clinical trials or to commercialize the product within two years of the satisfaction of development milestones. The CFF is also due a royalty on net sales of any resultant product up to 1% based upon the
amount of funding ultimately provided by the CFF.



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GENAERA CORPORATION

NOTES TO FINANCIAL STATEMENTS



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NOTE 7. Commitments, Contingencies and Liquidity



Manufacturing Agreement



In January 1999 and prior, the Company entered into several agreements with
Abbott Laboratories providing for the purchase of approximately $10,000,000 of bulk drug substance to be used in the

manufacturing process for LOCILEX Cream. As FDA approval of LOCILEX Cream did not occur, the Company renegotiated this
agreement with Abbott in September 1999 (the Abbott Settlement), paying Abbott $4,200,000 at that time and receiving partial delivery of material. An additional $3,400,000 is due to Abbott and payable if the Company receives in excess of
$10,000,000 of additional funds (as defined in the agreement) in any year beginning in 2000, in which case the Company must pay 15% of such excess over $10,000,000 to Abbott. The Company recorded this conditional obligation as a liability in 1999 at
its then present value. As a result of the Companys financing activities during 2000 and other cash inflows, $1,392,000 of this liability was payable and paid to Abbott on March 1, 2001. As a result of the Companys financing activities
during 2001 and other cash inflows, $480,000 of this liability was payable and paid to Abbott on March 1, 2002. The remaining amount of $1,529,000 due to Abbott is included in long-term liabilities as of September 30, 2003, as the Company did not
receive in excess of $10,000,000 of cash inflows during 2002 or the nine-month period ended September 30, 2003.



Liquidity



The Company has not generated any revenues from product sales and has funded operations primarily from the proceeds of public and private placements of
its securities. Substantial additional financing will be required by the Company in the near-term to fund its continuing research and development activities. No assurance can be given that any such financing will be available when needed or that the
Companys research and development efforts will be successful. In the absence of raising additional funds or significantly reducing expenses, the Company believes it has sufficient resources to sustain operations into 2004.



The Company regularly explores alternative means of financing its operations
and seeks funding through various sources, including public and private securities offerings and collaborative arrangements with third parties. The Company currently does not have any commitments to obtain additional funds and may be unable to
obtain sufficient funding in the future on acceptable terms, if at all. If the Company cannot obtain funding, it will need to delay, scale back or eliminate research and development programs or enter into collaborations with third parties to
commercialize potential products or technologies that it might otherwise seek to develop or commercialize independently, or seek other arrangements. If the Company engages in collaborations, it will receive lower consideration upon commercialization
of such products than if it had not entered into such arrangements or if it entered into such arrangements at later stages in the product development process.



Litigation



On August 4, 2003, a lawsuit was filed against the Company by Perceptive Life Sciences Master Fund, LTD in the United States District Court for the
Eastern District of Pennsylvania alleging the existence and subsequent breaches of certain contractual obligations by the Company in connection with its sale of shares of Series C Preferred Stock in May 2003. The plaintiff is seeking monetary
damages from the Company or a judgment by the court that the Company should specifically perform the terms of an alleged agreement related to such sale. The Company believes that this lawsuit is without merit and intends to defend it vigorously.



NOTE 8. Realignments of Operations



On August 14, 2002, the Company announced that it implemented a realignment
of operations intended to focus resources on its most advanced product development programs and reduce expenses. Under the realignment plan, the Company reduced its headcount by approximately 35%, or 23 employees,



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GENAERA CORPORATION

NOTES TO FINANCIAL STATEMENTS



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primarily impacting unsupported preclinical research programs. All of the employees affected by the workforce
reduction were offered severance and outplacement support. The Company recorded a nonrecurring charge of $506,000 in 2002, of which $498,000 and $8,000 were recorded in Research and Development Expense and General and Administrative Expense,
respectively. As of June 30, 2003, the Company has paid $499,000 in cash severance and outplacement support against this accrual. The remaining accrual of $7,000 was reversed during the three months ended June 30, 2003 because all cash severance and
outplacement support payments had been satisfied.



On November
7, 2002, the Company announced a further realignment of operations in order to continue its cost containment efforts. Under this realignment plan, the Company reduced its headcount by approximately 32%, or 11 employees. All of the employees affected
by the workforce reduction were offered severance and outplacement support. The Company recorded a nonrecurring charge of $317,000 in 2002, of which $183,000 and $134,000 were recorded in Research and Development Expense and General and
Administrative Expense, respectively. As of March 31, 2003, the Company had paid the entire $317,000 accrued for cash severance and outplacement support.



NOTE 9. Subsequent Events



On October 2, 2003, Biotechnology Value Fund LP and associated entities and Ziff Asset Management L.P., elected to convert all of their holdings of Series
C-2 convertible preferred stock into common stock of the Company. Pursuant to the terms of the Series C-2 convertible preferred stock issued in the Companys May 2003 private placement, the holders of such shares converted 2,500 shares of
Series C-2 convertible preferred stock into 2,500,000 shares of newly-issued common stock of the Company. As a result of this transaction, no shares of Series C-2 convertible preferred stock are outstanding.



On October 6, 2003, MedImmune Ventures, Inc. elected to convert all of its
holdings of Series B convertible preferred stock into common stock of the Company. Pursuant to the terms of the Series B convertible preferred stock, the holder of such shares converted 10,000 shares of Series B convertible preferred stock into
2,000,000 shares of newly-issued common stock of the Company. As a result of this transaction, no shares of Series B convertible preferred stock are outstanding.



On October 23, 2003, Biotechnology Value Fund LP and associated entities and Ziff Asset Management, L.P., exercised, on a
net exercise basis, warrants to purchase 1,200,000 shares of the Companys common stock at an exercise price of $1.37 per share, pursuant to the terms of the warrants issued in connection with the May 2003 private placement. The Company issued
892,361 shares of common stock pursuant to the net exercise provisions of these warrants.



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|ITEM 2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
|------- |  | --------------------------------------------------------------------------

|OPERATIONS |  | 
|---------- |  | 



Forward Looking Statements



Our disclosure and analysis in this Quarterly Report on Form 10-Q contains some forward-looking statements. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the
fact that they do not relate strictly to historical or current facts. Such statements may include words such as anticipate, estimate, expect, project, intend, plan,
believe, hope, and other words and terms of similar meaning. In particular, these include, among others, statements relating to present or anticipated scientific progress, development of potential pharmaceutical products,
future revenues, capital expenditures, research and development expenditures, future financing and collaborations, personnel, manufacturing requirements and capabilities, the impact of new accounting pronouncements, and other statements regarding
matters that are not historical facts or statements of current condition.



There are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements, including those addressed below under Risk Factors Related
to Our Business.



We undertake no obligation to
publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in our filings
with the U.S. Securities and Exchange Commission.



Critical Accounting
Policies and Estimates



The preparation of our financial
statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results
could differ materially from those estimates. The following are critical accounting policies important to our financial condition and results of operations presented in our financial statements and require management to make judgments, assumptions
and estimates that are inherently uncertain:



Revenue Recognition



Contract revenue for research and development is recorded
as earned based on the performance requirements of the contract. Non-refundable contract fees for which no further performance obligations exist, and for which there is no continuing involvement by us, are recognized on the earlier of when the
payments are received or when collection is assured. Revenue from non-refundable upfront license fees and certain guaranteed payments where we continue involvement through development collaboration is recognized on a straight-line basis over the
development period. Revenue associated with performance milestones is recognized based upon the achievement of the milestones, as defined in the respective agreements. Revenue under R&D cost reimbursement contracts or government grants is
recognized as the related costs are incurred. Advance payments received in excess of amounts earned are classified as liabilities until earned. Payments received that are refundable also are classified as liabilities until the refund provision
expires. We make an estimate as to the appropriate deferral period for recognition of revenue on any collaborative fees received. Changes in these estimates, due to the evolution of the development program, can have a significant effect on the
timing of revenue recorded.



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Research and Development Expenses



Research and development expenses include related salaries, contractor fees, and facility costs. R&D expenses consist of
independent R&D contract costs, contract manufacturing costs and costs associated with collaborative R&D arrangements. In addition, we fund R&D at other research institutions under agreements that are generally cancelable. R&D
expenses also include external activities such as investigator-sponsored trials. All such costs are charged to R&D expense systematically as incurred, which may be measured by percentage of completion, contract milestones, patient enrollment or
the passage of time. At the initiation of certain contracts, we must make an estimate as to the duration and expected completion date of the contract, which may require a change due to accelerations, delays or other adjustments to the contract
period or work performed. Changes in these estimates could have a significant effect on the amount of R&D costs in a specific period.



Stock-Based Compensation



We account for stock-based employee compensation under the intrinsic value-based method set forth by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. Effective January 1, 1996, we adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation. Stock or other equity-based compensation for non-employees must be accounted for under the fair value-based method as required by SFAS No. 123 and Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments
that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and other related interpretations. Under this method, the equity-based instrument is valued at either the fair value of the consideration
received or the equity instrument issued on the date of grant. The resulting compensation cost is recognized and charged to operations over the service period, which is usually the vesting period. Estimating the fair value of equity securities
involves a number of judgments and variables that are subject to significant change. A change in the fair value of the estimate could have a significant effect on the amount of compensation cost.



Risk Factors Related to Our Business



Any investment in shares of our common stock involves a high degree of risk.
You should carefully consider the following risk factors, together with the other information presented in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2002.



If we do not raise additional capital, we may not be able to continue our research and
development programs and may never commercialize any products.



We maintained cash and investments of $8.2 million at September 30, 2003. At September 30, 2003, we had current liabilities of $1.1 million and long-term liabilities of $2.0 million. In May 2003, we completed the sale of 5,000 shares of our
Series C convertible preferred stock and 2 million common stock warrants for gross proceeds of $5.0 million. We believe these resources are sufficient to meet our research and development goals and sustain operations into 2004. However, we will need
to raise substantial additional funds in the future to continue our research and development programs and to commercialize our potential products. If we are unable to raise additional funds, we may be unable to complete our development activities
for any of our proposed products.



We regularly explore
alternative means of financing our operations and seek funding through various sources, including public and private securities offerings, collaborative arrangements with third parties and other strategic alliances and business transactions. We
currently do not have any commitments to provide us additional funds, and may be unable to obtain sufficient funding in the future on acceptable terms, if at all. If we cannot obtain funding, we will need to delay, scale back or eliminate research
and development programs or enter into collaborations with third parties to commercialize potential products



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or technologies that we might otherwise seek to develop or commercialize ourselves, or seek other arrangements. If we
raise additional capital by issuing equity or securities convertible into equity, our stockholders may experience dilution and our share price may decline. Any debt financing may result in restrictions on spending or payment of dividends. If we
engage in collaborations, we will receive lower consideration upon commercialization of such products than if we had not entered into such arrangements, or if we entered into such arrangements at later stages in the product development process.



We expect to continue to incur substantial losses in the foreseeable
future and may never generate revenues or become profitable.



To date, we have engaged primarily in the research and development of drug candidates. We have not generated any revenues from product sales and have incurred losses in each year since our inception. As of September 30, 2003, we had an
accumulated deficit of approximately $191.0 million.



Our
proposed products are in a relatively early developmental stage and will require significant research, development and testing. We must obtain regulatory approvals for any proposed product prior to commercialization of the product. Our operations
also are subject to various competitive and regulatory risks. As a result, we are unable to predict when or if we will achieve any product revenues or become profitable. We expect to experience substantial losses in the foreseeable future as we
continue our research, development and testing efforts.



Development and
commercial introduction of our products will take several more years and may not be successful.



We are dedicating substantially all of our resources to research and development, do not have any marketed products, and have not generated any product
revenue. Because substantially all of our potential products currently are in research, preclinical development or the early and middle stages of clinical testing, revenues from sales of any products will not occur for at least the next several
years, if at all. Our technologies are relatively new fields and may not lead to commercially viable pharmaceutical products. Before we can commercially introduce any products, we will likely incur substantial expense for, and devote a significant
amount of time to, preclinical testing and clinical trials. We cannot apply for regulatory approval of our potential products until we have performed additional research and development testing and demonstrated in preclinical testing and clinical
trials that our product candidates are safe and effective for use in humans. Some of our product candidates are in the early stages of research and development, and we may abandon further development efforts on these product candidates before they
reach clinical trials. Conducting clinical trials is a lengthy, time-consuming and expensive process. Our clinical trials may not demonstrate the safety and efficacy of our potential products, and we may encounter unacceptable side effects or other
problems in the clinical trials. Should this occur, we may have to delay or discontinue development of the potential products. Further, even if we believe that any product is safe or effective, we may not obtain the required regulatory approvals, be
able to manufacture our products in commercial quantities or be able to market any product successfully.



If we do not obtain required regulatory approvals, we will not be able to commercialize any of our product candidates.



Numerous governmental authorities, including the Food and Drug Administration, or FDA, in the United States, regulate our
business and activities. Federal, state and foreign government agencies impose rigorous preclinical and clinical testing and approval requirements on our product candidates. In general, the process of obtaining government approval for pharmaceutical
products is time consuming and costly.



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Governmental authorities may delay or deny the approval of any of our drug candidates. In addition,
governmental authorities may enact new legislation or regulations that could limit or restrict our efforts. A delay or denial of regulatory approval for any of our drug candidates, such as that which occurred for LOCILEX Cream, will have a material adverse effect on our business. Even if we
receive approval of a product candidate, approval may be conditioned upon certain limitations and restrictions as to the drugs used and may be subject to continuous review. If we fail to comply with any applicable regulatory requirements, we could
be subject to penalties, including warning letters, fines, withdrawal of regulatory approval, product recalls, operating restrictions, injunctions, and criminal prosecution.



We expect to rely on third parties to market any products we develop and expect to rely on third parties in connection with the
development of our products; if these parties do not perform as expected, we may never successfully commercialize our products.



We do not have our own sales and marketing staff. In order to successfully develop and market our future products, we must enter into marketing and
distribution arrangements with third parties. We also expect to delegate the responsibility for all, or a significant portion, of the development and regulatory approval for certain products to third parties. If these parties do not develop an
approvable or marketable product or do not market a product successfully, we may never generate revenue or become profitable. Additionally, we may be unable to enter into successful arrangements with other parties for such products.



We do not have control over the amount and timing of resources to be devoted
to our products by our collaborative partners. Our collaborators may not place a high priority on their contractual arrangements with us. Collaborators may develop products independently or through third parties that could compete with our proposed
products. For example, GlaxoSmithKline, a current collaborative partner, which entered into an agreement with us relating to the development of LOCILEX Cream, maintains a significant presence in the antibiotic area and currently sells a topical antibiotic product indicated for the treatment of
certain skin infections. In addition, a collaborator may decide to end a relationship with us. For example, in December 2000, Genentech provided notice to us of its election to terminate the collaboration agreement covering the IL9 antibody
development program and related respiratory technology.



We
also may decide to establish our own sales force to market and sell certain products. Although some members of our management have limited experience in marketing pharmaceutical products, we have no experience with respect to marketing our products.
If we choose to pursue this alternative, we will need to spend significant additional funds and devote significant management resources and time to establish a successful sales force. This effort may not be successful. Moreover, because our
financial resources are limited, our sales and marketing expenditures in this area would likely be modest compared to our competitors.



We face formidable competition with respect to the products we are seeking to develop and the recruitment of highly trained personnel.



The pharmaceutical industry is characterized by intense competition. Many
companies, research institutions and universities are conducting research and development activities in our fields of interest. Some of these companies are currently involved in research and development activities focused on the pathogenesis of
disease, and the competition among companies attempting to find genes responsible for disease is intense. In addition, we are aware that research on compounds derived from animal host-defense systems is being conducted by others. We also may face
competition from companies using different or advanced techniques that could render our future products obsolete. Most of these competitors have substantially greater financial, technical, manufacturing, marketing, distribution and other resources
than we have.





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Many companies are working to develop and market products intended for the additional disease areas being
targeted by us, including cancer, age-related macular degeneration (AMD) and chronic obstructive respiratory diseases. A number of major pharmaceutical companies have significant franchises in these disease areas, and can be expected to invest
heavily to protect their interests. With respect to cancer and AMD, anti-angiogenic agents are under development at a number of companies. In the respiratory field, other biopharmaceutical companies also have reported the discovery of genes relating
to asthma and other respiratory diseases.



Many of the
companies developing or marketing competing products have significantly more experience than we do in undertaking preclinical testing and human clinical trials of new or improved therapeutic products and obtaining regulatory approvals of such
products. Some of these companies may be in advanced phases of clinical testing of various drugs that may be competitive with our proposed products.



We expect technological developments in the biopharmaceutical field to occur at a rapid rate and expect competition to intensify as advances in this field
are made. Accordingly, we must continue to devote substantial resources and efforts to research and development activities in order to maintain a competitive position in this field. Our efforts may not be successful.



Colleges, universities, governmental agencies and other public and private
research organizations are becoming more active in seeking patent protection and licensing arrangements to collect royalties for use of technology that they have developed, some of which may be directly competitive with our technology. In addition,
these institutions, along with pharmaceutical and specialized biotechnology companies, can be expected to compete with us in recruiting highly qualified scientific personnel.



If we do not develop and maintain relationships with contract manufacturers, we may not successfully commercialize our products.



We currently do not have the resources, facilities,
or technical capabilities to manufacture any of our proposed products in the quantities and quality required for commercial sale. We have no plans to establish a manufacturing facility. We expect to depend upon contract manufacturers for commercial
scale manufacturing of our proposed products in accordance with regulatory standards. For example, we are currently working with outside contractors for the chemical production of squalamine. This dependence on contract manufacturers may restrict
our ability to develop and deliver products on a timely, profitable and competitive basis especially because the number of companies capable of producing our proposed products is limited. These contract manufacturers generally have multiple projects
and they may give ours a lower priority. As a result of contract manufacture mishaps, our product could be lost or delivered late, delaying our clinical and preclinical programs, or may not be produced in accordance with all current applicable
regulatory standards. Product not produced in accordance with all current applicable regulatory standards may lead to adverse outcomes for patients and/or product recalls. Furthermore, the development of a robust, low-cost manufacturing process for
the commercial production of squalamine and other proposed products will require significant time and expenditure by us. We may be unable to maintain arrangements with qualified outside contractors to manufacture materials at costs that are
affordable to us, if at all.



Contract manufacturers may
utilize their own technology, our technology, or technology acquired or licensed from third parties in developing a manufacturing process. In order to engage another manufacturer, we may need to obtain a license or other technology transfer from the
original contract manufacturer. Even if a license is available from the original contract manufacturer on acceptable terms, we may be unable to successfully effect the transfer of the technology to the new contract manufacturer. Any such technology
transfer also may require the transfer of requisite data for regulatory purposes, including information contained in a proprietary drug master file held by a contract manufacturer. If we rely on a contract manufacturer that owns the drug master
file, our ability to change contract manufacturers may be more limited.



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We depend on our intellectual property and, if we are unable to protect our intellectual property, our business may
be harmed.



Patents



Our success depends, in part, on our ability to develop and maintain a strong
patent position for our products and technologies, both in the United States and other countries. As with most biotechnology and pharmaceutical companies, our patent position is highly uncertain and involves complex legal and factual questions.
Without patent and other protections, other companies could offer substantially identical products for sale without incurring the sizeable development and testing costs that we have incurred. As a result, our ability to recover these expenditures
and realize profits upon commercialization likely would be diminished.



The process of obtaining patents can be time consuming and expensive. Even after significant expenditure, a patent may not issue. We can never be certain that we were the first to develop the technology or that we were the first to file a
patent application for the particular technology because U.S. patent applications are maintained in secrecy by the U.S. Patent and Trademark Office until a patent issues, and publications in the scientific or patent literature concerning new
technologies occur some time after actual discoveries of the technologies are made.



We cannot be certain that:



| |  |  | patents will issue from any of our patent applications;
| | - |  | -------------------------------------------------------



| |  |  | our patent rights will be sufficient to protect our technology;
| | - |  | ---------------------------------------------------------------



| |  |  | others may not file patents ahead of us in time and prevent the issuing of our patent claims;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | others will not design around the patented aspects of our technology;
| | - |  | ---------------------------------------------------------------------



| |  |  | our patents will not be successfully challenged or circumvented by our competitors; or
| | - |  | --------------------------------------------------------------------------------------



| |  |  | an adverse outcome in a suit challenging our patents would not subject us to significant liabilities to third parties, require rights to be licensed from third parties, or require
us to cease using such technology.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The cost of
litigation related to patents can be substantial, regardless of the outcome.



Other Intellectual Property



In
order to protect our proprietary technology and processes, we also rely on trade secrets and confidentiality agreements with our employees, consultants, outside scientific collaborators, and other advisors. We may find that these agreements have
been breached, or that our trade secrets have otherwise become known or independently developed or discovered by our competitors.



Certain of our exclusive rights to patents and patent applications are governed by contract. Generally, these contracts require that we pay royalties on
sales of any products that are covered by patent claims. If we are unable to pay the royalties, we may lose our patent rights. Additionally, some of these agreements also require that we develop the licensed technology under certain timelines. If we
do not adhere to an acceptable schedule of commercialization, we may lose our rights.



Potential Ownership Disputes



Disputes may arise as to
the ownership of our technology. Most of our research and development personnel previously worked at other biotechnology companies, pharmaceutical companies, universities, or research institutions. These entities may raise questions as to when
technology was developed, and assert rights to the technology. These kinds of disputes have occurred in the past and were resolved. However, we may not prevail in any such disputes.



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Similar technology ownership disputes may arise in the context of consultants, vendors or third parties,
such as contract manufacturers. For example, our consultants are employed by or have consulting agreements with third parties. There may be disputes as to the capacity in which consultants are operating when they make certain discoveries. We may not
prevail in any such disputes.



If we cannot recruit and retain qualified
management, we may not be able to successfully develop and commercialize our products.



We depend to a considerable degree on a limited number of key personnel. Most significant responsibilities have been assigned to a relatively small number
of individuals. All of our executive officers have executed individual employment agreements with Genaera. We do not maintain key man insurance on any of our employees. The loss of certain management and technical personnel could
adversely affect our ability to develop and commercialize products.



We
are subject to potential product liability claims that could result in significant costs.



We are subject to significant potential product liability risks inherent in the testing, manufacturing and marketing of human therapeutic products,
including the risk that:



| |  |  | our proposed products cause some undesirable side effects or injury during clinical trials;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | our products cause undesirable side effects or injury in the market; or
| | - |  | -----------------------------------------------------------------------



| |  |  | third parties that we have agreed to indemnify incur a related liability.
| | - |  | -------------------------------------------------------------------------



While we carry insurance, this coverage is expensive and we may be unable to maintain adequate coverage on acceptable terms.



If we do not receive adequate third-party reimbursement for any of our drug candidates,
some patients may be unable to afford our products and sales could suffer.



In both the United States and elsewhere, the availability of reimbursement from third-party payers, such as government health administration authorities, private health insurers and other organizations, can impact
prescription pharmaceutical sales. These organizations are increasingly challenging the prices charged for medical products and services, particularly where they believe that there is only an incremental therapeutic benefit that does not justify the
additional cost. If any of our products ever obtain marketing approval, coverage and reimbursement may not be available for these products, or, if available, may not be adequate. Without insurance coverage, many patients may be unable to afford our
products, in which case sales of the products would be adversely affected.



There also has been a trend toward government reforms intended to contain or reduce the cost of health care. In certain foreign markets, pricing or profitability of prescription pharmaceuticals is subject to
government control. In the United States, there have been a number of federal and state proposals to implement similar government control. We expect this trend to continue, but we cannot predict the nature or extent of any reform that results. These
reforms could adversely affect our ability to obtain financing for the continued development of our proposed products or market any of our products that are successfully developed. Furthermore, reforms could have a broader impact by limiting overall
growth of health care spending, such as Medicare and Medicaid spending, which could also adversely affect our business.



The FDA has deemed our NDA for LOCILEX Cream to be not approvable, and the product may never be approved.



In July 1999, we received notification from the FDA that our New Drug Application, or NDA, for LOCILEX Cream had been deemed not approvable. LOCILEX Cream, a topical cream antibiotic for the treatment of
infection in diabetic foot ulcers, had been our lead product development candidate. As a result of the FDAs decision, near-term commercialization of LOCILEX Cream will not occur, and we will generate no revenues from LOCILEX Cream in the near future, if ever.



In order to again seek approval of LOCILEX Cream, the FDA has indicated that we must conduct further development
activities, including clinical and manufacturing activities. As a result of its review of manufacturing of the cream product, the FDA issued certain observations of deficiencies in compliance with their current good manufacturing procedures
regulations. The Company will need to initiate new manufacturing relationships to conduct further development activities. Any additional manufacturing batches of the active ingredient and cream product that must be manufactured must meet strict
product specifications in compliance with FDA-determined current good manufacturing practices. The time required to conduct such further clinical and manufacturing development efforts may be lengthy and costly, and the results may ultimately prove
unsuccessful.



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Our stock price is extremely volatile, and your investment in our stock could decline in value. We may become
involved in securities class action litigation.



The
market prices and trading volumes for securities of biopharmaceutical and biotechnology companies, including ours, have historically been, and will likely continue to be, highly volatile. Future events affecting our business, or that of our
competitors, may have a significant impact on our stock price. Among these events are the following:



| |  |  | product testing results from us or our competitors;
| | - |  | ---------------------------------------------------



| |  |  | technological innovations by us or our competitors;
| | - |  | ---------------------------------------------------



| |  |  | new commercial products from us or our competitors;
| | - |  | ---------------------------------------------------



| |  |  | regulatory developments in the United States and foreign countries;
| | - |  | -------------------------------------------------------------------



| |  |  | developments concerning proprietary rights, including patents;
| | - |  | --------------------------------------------------------------



| |  |  | regulatory actions;
| | - |  | -------------------



| |  |  | litigation;
| | - |  | -----------



| |  |  | economic and other external factors or other disasters or crises;
| | - |  | -----------------------------------------------------------------



| |  |  | period-to-period fluctuations in our financial results; and
| | - |  | -----------------------------------------------------------



| |  |  | the general performance of the equity markets and, in particular, the biotechnology sector of the equity markets.
| | - |  | -----------------------------------------------------------------------------------------------------------------



In the past, following periods of volatility in the market price of a
particular companys securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation of this type is often extremely expensive and diverts
managements attention and resources.



The exercise of options and
warrants and other issuances of shares will likely have a dilutive effect on our stock price.



As of September 30, 2003, there were outstanding options to purchase an aggregate of approximately 3,961,000 shares of our common stock at prices ranging
from $0.40 per share to $16.75 per share, of which options to purchase 2,522,244 shares were exercisable as of such date. As of September 30, 2003, there were outstanding warrants to purchase 1,617,166 shares of our common stock. Of this total,
warrants to purchase 167,166 shares of our common stock are currently exercisable at $3.50 per share and warrants to purchase 50,000 shares are currently exercisable at $3.79 per share, all subject to adjustment under the anti-dilution provisions of
the warrants. In May 2003, in connection with a private placement of our Series C convertible preferred stock, we issued warrants to purchase 2,000,000 shares of our common stock at an exercise price of $1.37 per share, of which 600,000 have been
exercised and 900,000 are exercisable as of September 30, 2003 and the remaining warrants to purchase 500,000 shares of our common stock are exercisable 18 months after issuance beginning on November 23, 2004 and may be exercised immediately if the
holder elects to receive, without the payment by the holder of any additional consideration, a number of shares of our common stock equal to the value of the warrants, also known as net exercise provisions. On October 23, 2003, Biotechnology Value
Fund LP and associated entities and Ziff Asset Management, L.P., exercised, on a net exercise basis, 1,200,000 of the remaining warrants issued in connection with May 2003 private placement at an exercise price of $1.37 per share. Total common stock
issued pursuant to the net exercise provisions of these warrants was 892,361 shares. In connection with an April 2002 private placement of our common stock, we granted to the placement agent warrants to purchase 100,000 shares of our common stock at
an exercise price of $2.75 per share. As of September 30, 2003, these warrants have not yet been issued.



The exercise of options and warrants at prices below the market price of our common stock could adversely affect the price of our common stock. Additional
dilution may result from the issuance of shares of our capital stock in connection with collaborations or manufacturing arrangements or in connection with other financing efforts.



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Our certificate of incorporation and Delaware law contain provisions that could discourage a takeover.



Our certificate of incorporation provides our board
of directors the power to issue shares of preferred stock without stockholder approval. This preferred stock could have voting rights, including voting rights that could be superior to that of our common stock. In addition, Section 203 of the
Delaware General Corporation Law contains provisions that impose restrictions on stockholder action to acquire control of us. The effect of these provisions of our certificate of incorporation and Delaware law provisions could discourage third
parties from seeking to obtain control, even though the price at which such third parties seek to acquire our common stock is in excess of the market price for our stock.



If our Board of Directors effects a reverse stock split, as approved by our stockholders at our last Annual Meeting, there can be no
assurance that the total market capitalization of our common stock (the aggregate value of all our common stock at the then market price) after the reverse stock split will be equal to or greater than the total market capitalization before the
reverse stock split or that the per share market price of our common stock following the reverse stock split will either equal or exceed the current per share market price.



At the 2003 Annual Meeting of Stockholders held on May 15, 2003, our stockholders approved a potential amendment to our
Second Restated Certificate of Incorporation to effect, at the future election of our Board of Directors, a reverse stock split at one of the five following ratios: one-for-five; one-for-ten; one-for-fifteen; one-for-twenty; or one-for-twenty-five.
As of September 30, 2003, our Board of Directors has not yet elected to effect any such reverse stock split. There can be no assurance that the market price per new share of our common stock after a reverse stock split, if effected, will remain
unchanged or increase in proportion to the reduction in the number of old shares of our common stock outstanding before the reverse stock split. For example, based on the last reported bid price of our common stock on June 27, 2003 of $1.85 per
share, if the Board of Directors decided to implement the reverse stock split and selects a reverse stock split ratio of one-for-five, there can be no assurance that the post-split market price of our common stock would be $9.25 per share or
greater. Accordingly, the total market capitalization of our common stock after the proposed reverse stock split may be lower than the total market capitalization before the proposed reverse stock split and, in the future, the market price of our
common stock following the reverse stock split may not exceed or remain higher than the market price prior to the proposed reverse stock split.



If our Board of Directors effects a reverse stock split, as approved by our stockholders at our last Annual Meeting, the resulting per share stock price may not
attract institutional investors or investment funds and may not satisfy the investing guidelines of such investors and, consequently, the trading liquidity of our common stock may not improve.



While the Board of Directors believes that a higher stock price may help
generate investor interest, there can be no assurance that a reverse stock split will result in a per share price that will attract institutional investors or investment funds or that such share price will satisfy the investing guidelines of
institutional investors or investment funds. As a result, the trading liquidity of our common stock may not necessarily improve.



If our Board of Directors effects a reverse stock split, as approved by our stockholders at our last Annual Meeting, a decline in the market price of our common
stock after the reverse stock split may result in a greater percentage decline than would occur in the absence of a reverse stock split, and the liquidity of our common stock could be adversely affected following such a reverse stock split.



If a reverse stock split is effected and the market
price of our common stock declines, the percentage decline may be greater than would occur in the absence of a reverse stock split. The market price of our common stock will, however, also be based on our performance and other factors, which are
unrelated to the number of shares outstanding. Furthermore, the liquidity of our common stock could be adversely affected by the reduced number of shares that would be outstanding after the reverse stock split.



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Results of Operations



Revenues



We have received no revenues to date from product sales. Our revenues have consisted principally of revenues recognized under collaborations with third
parties. In April 2001, we entered into a research collaboration and licensing agreement with MedImmune Inc. to develop and commercialize therapies related to our IL9 program. MedImmune provided funding of $2.5 million for our research and
development activities, payable in eight equal quarterly installments, plus external cost reimbursement for our research and development activities through April 2003. In February 2002, we were awarded a Phase II Small Business Innovation Research
program grant of $800,000 from the National Institutes of Health to support our aminosterol program. For the three-month period ended September 30, 2003, we recognized $124,000 as revenue related to grant support ($121,000) and external cost
reimbursements ($3,000). For the nine-month period ended September 30, 2003, we recognized $1.0 million as revenue related to the contractual R&D funding ($370,000), grant support ($349,000) and external cost reimbursements ($281,000). For the
three-month period ended September 30, 2002, we recognized $349,000 as revenue related to the contractual R&D funding ($315,000) and external cost reimbursements ($34,000). For the nine-month period ended September 30, 2002, we recognized $1.2
million as revenue related to the contractual R&D funding ($935,000) and external cost reimbursements ($267,000).



Research and Development Expenses



We recognized research and development expenses of $1.6 million and $2.7 million for the three-month periods ended September 30, 2003 and 2002,
respectively. We recognized research and development expenses of $4.5 million and $9.2 million for the nine-month periods ended September 30, 2003 and 2002, respectively. Research and development expenses consist principally of personnel costs,
contract research, development and manufacturing costs and facility costs. Research and development expenses decreased for the three- and nine-month periods ended September 30, 2003, as compared to the same periods in 2002, due to reduced
manufacturing and development efforts ($120,000 and $948,000, respectively), the absence of the one-time accrual of severance and related costs associated with our realignment of operations in August of 2002 ($498,000 and $498,000, respectively), as
well as reduced continuing payroll and related costs associated with our realignments of operations in 2002 ($414,000 and $1.9 million, respectively). The level of research and development expenses in future periods will depend principally upon the
progress of our research and development programs and our capital resources.



General and Administrative Expenses



We
recognized general and administrative expenses of $656,000 and $657,000 for the three-month periods ended September 30, 2003 and 2002, respectively. We recognized general and administrative expenses of $1.5 million and $2.4 million for the
nine-month periods ended September 30, 2003 and 2002, respectively. General and administrative expenses consist principally of personnel costs, professional fees and public company expenses. General and administrative expenses for the three-month
period ended September 30, 2003 were consistent with the same period in 2002. General and administrative expenses decreased for the nine-month period ended September 30, 2003, as compared to the same period in 2002, due principally to reduced
payroll and related costs associated with our realignment of operations in 2002 ($402,000), cost containment initiatives and gains from the sale of excess research equipment ($290,000).



Other Income and Expense



We recognized interest income of $17,000 and $61,000 for the three-month periods ended September 30, 2003 and 2002, respectively. We recognized interest
expense of $1,000 and $36,000 for the three-month periods ended September 30, 2003 and 2002, respectively. We recognized interest income of $63,000 and $214,000 for the nine-month periods ended September 30, 2003 and 2002, respectively. We
recognized interest expense of $65,000 and $122,000 for the nine-month periods ended September 30, 2003 and 2002, respectively. Interest income is primarily comprised of income generated from cash and



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investments. Interest expense during the nine-month period ended September 30, 2003 was primarily comprised of expense
related to our indebtedness to a bank. Interest income for the three- and nine-month periods ended September 30, 2003 decreased, as compared to the same period in 2002, due to declining investment interest yields and lower average investment
balances. Interest expense for the three- and nine-month periods ended September 30, 2003 decreased, as compared to the same period in 2002, as a result of the maturity and satisfaction of our indebtedness to a bank in June 2003.



Financial Condition, Liquidity and Capital Resources



Cash and short-term investments were $8.2 million at September 30, 2003 as
compared to $9.4 million at December 31, 2002. The primary use of cash was to finance our research and development operations.



Current liabilities were $1.1 million and $3.9 million at September 30, 2003 and December 31, 2002, respectively. In June 2003, our note payable matured
and was not refinanced. We used the collateralized cash to satisfy the outstanding balance of $2.5 million plus $6,000 of unpaid accrued interest. Long-term liabilities include $1.5 million due to Abbott Laboratories under our 1999 settlement
agreement with them and $403,000 received as a contingent award from the Cystic Fibrosis Foundation.



Our capital expenditure requirements will depend upon numerous factors, including the progress of our research and development programs, the time and cost
required to obtain regulatory approvals, our ability to enter into additional collaborative arrangements, the demand for products based on our technology, if and when such products are approved, and possible acquisitions of products, technologies
and companies. We had no significant commitments for capital expenditures as of September 30, 2003.



In the absence of raising additional funds or significantly reducing expenses, we have sufficient resources to sustain operations into 2004. We will need
to raise substantial additional funds in the future to continue our research and development programs and to commercialize our potential products. If we are unable to raise such funds, we may be unable to complete our development activities for any
of our proposed products.



We regularly explore alternative
means of financing our operations and seek funding through various sources, including public and private securities offerings and collaborative arrangements with third parties. We currently do not have any commitments to obtain additional funds and
may be unable to obtain sufficient funding in the future on acceptable terms, if at all. If we cannot obtain funding, we will need to delay, scale back or eliminate research and development programs or enter into collaborations with third parties to
commercialize potential products or technologies that we might otherwise seek to develop or commercialize ourselves, or seek other arrangements. If we engage in collaborations, we will receive lower consideration upon commercialization of such
products than if we had not entered into such arrangements, or if we entered into such arrangements at later stages in the product development process.



Contractual Cash Obligations



The table below sets forth our contractual cash obligations at September 30, 2003 (in thousands):



|                                                        |  |       |       | Cash Payments Due by Period
|------------------------------------------------------- |  | ----- | ----- | ---------------------------
|Contractual Cash Obligations                            |  | Total |       | Less than 1 year           
|Abbott settlement1                                      |  | $     | 1,529 |                            
|Operating lease on building2                            |  |       | 1,617 |                            
|Operating leases and maintenance contracts on equipment |  |       | 285   |                            
|Clinical trial contracts                                |  |       | 593   |                            
|Research and development contracts                      |  |       | 107   |                            
|Manufacturing contracts                                 |  |       | 14    |                            
|                                                        |  |       |       |                            
|Total contractual cash obligations                      |  | $     | 4,145 |                            
|                                                        |  |       |       |                            

---

|1 | Payable if we receive in excess of $10 million of additional funds in any year beginning in
2000, in which case 15% of such excess over $10 million shall be payable to Abbott.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 | The lease provides for annual escalations relating to increases in the Consumer Price Index not to exceed 7% but no less than 3.5%. We have assumed an annual minimum
lease payment escalation of 3.5% for the purposes of this table beginning in December 2003.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|ITEM  3. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- |  | ----------------------------------------------------------



We are exposed to risks associated with interest rate changes. Our exposure to market risk for changes in interest rates relates primarily to our
investment portfolio. We invest in only U.S. government debt instruments that meet high quality credit standards, as specified in our investment policy. The policy also limits the amount of credit exposure we may have to any one issue, issuer or
type of investment.



As of September 30, 2003, our portfolio
investments consisted of $1.2 million in cash and $7.0 million in U.S government debt instruments having a maturity of less than one year. Due to the nature of our investment portfolio, management believes that a sudden change in interest rates
would not have a material effect on the value of the portfolio. Management estimates that if the average annualized yield of our investments had decreased by 100 basis points, our interest income for the nine-month period ended September 30, 2003
would have decreased by approximately $63,000. This estimate assumes that the decrease occurred on the first day of 2003 and reduced the annualized yield of each investment instrument by 100 basis points. Correspondingly, if the average annualized
yield of our investments had increased by 100 basis points, our interest income for the nine-month period ended September 30, 2003 would have increased by $64,000. This estimate assumes that the increase occurred on the first day of 2003 and
increased the annualized yield of each investment instrument by 100 basis points. The impact on our future interest income will depend largely on the gross amount of our investment portfolio.



We do not currently have any significant direct foreign currency exchange
rate risk.



|ITEM  4. |  | CONTROLS AND PROCEDURES
|-------- |  | -----------------------



(a) Evaluation of disclosure controls and procedures: For the quarterly period ended September 30, 2003, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief
Executive Officer and our Senior Vice President and Chief Financial Officer (the principal financial and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-14 and
15d-14 under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon this evaluation, our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that, as of
September 30, 2003, our disclosure controls and procedures were adequate to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the rules and forms of the Securities and Exchange Commission.



(b) Changes in internal control over financial reporting: Our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer determined that there were no changes in our internal
control over financial reporting during the quarterly period ended September 30, 2003, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



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PART IIOTHER INFORMATION



|ITEM 1. |  | LEGAL PROCEEDINGS
|------- |  | -----------------



On August 4, 2003, a lawsuit was filed against the Company by Perceptive Life Sciences Master Fund, LTD in the United States District Court for the Eastern District of Pennsylvania alleging the existence and subsequent breaches of certain
contractual obligations by the Company in connection with its sale of shares of Series C Preferred Stock in May 2003. The plaintiff is seeking monetary damages from the Company or a judgment by the court that the Company should specifically perform
the terms of an alleged agreement related to such sale. The Company believes that this lawsuit is without merit and intends to defend it vigorously.



|ITEM 2. |  | CHANGES IN 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.



|ITEM 6. |  | EXHIBITS AND REPORTS ON FORM 8-K
|------- |  | --------------------------------



(a) Exhibits



|     | 
|---- | 
|31.1 | 
|     | 
|31.2 | 
|     | 
|32.1 | 
|     | 
|32.2 | 



(b) Reports on Form
8-K



We filed a Current Report on Form 8-K on July 3, 2003
incorporating a press release regarding the early conversion of Series A convertible preferred stock by Genentech into common stock.



We filed a Current Report on Form 8-K on August 4, 2003 incorporating a press release regarding the results of our Phase I/II clinical trial of squalamine
for the treatment of age-related macular degeneration.



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We filed a Current Report on Form 8-K on August 12, 2003 incorporating a press release regarding a grant
received by the University of California, Los Angeles (UCLA) Medical Center and Jonsson Comprehensive Cancer Center funding further investigation of the potential for squalamine as a treatment for breast cancer.



We filed a Current Report on Form 8-K on August 12, 2003 incorporating a
press release regarding our financial results for the quarter ended June 30, 2003.



We filed a Current Report on Form 8-K on August 22, 2003 incorporating a press release regarding the resignation of Senior Vice President and Chief Financial Officer, Christopher P. Schnittker.



We filed a Current Report on Form 8-K on August 27, 2003 regarding the
conversion of all of the Series C-1 preferred stock by its holders into common stock as well as the exercise of 600,000 warrants to purchase common stock by Ziff Asset Management, L.P.



We filed a Current Report on Form 8-K on September 9, 2003 incorporating a press release regarding the resignation of
Michael R. Dougherty as a member the Board of Directors.



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SIGNATURES



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



|      |  |                  |  | GENAERA CORPORATION
|----- |  | ---------------- |  | -------------------
|      |  |                  |  |                    
|Date: |  | November 7, 2003 |  |                    
|      |  |                  |  |                    
|      |  |                  |  |                    





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EXHIBIT INDEX



|Exhibit No. |  | Description                                                                                                                                                                                                               
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            | 
|31.1        |  | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, as adopted pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
|            | 
|31.2        |  | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, as adopted pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
|            | 
|32.1        |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002                                                                         
|            | 
|32.2        |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002                                                                         



|
|





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