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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, 2005.



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



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



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



The number of outstanding
shares of the Registrants Common Stock, par value $.002 per share, on November 7, 2005 was 68,680,233.



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##### Table of Contents



GENAERA CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED September 30, 2005



TABLE OF CONTENTS



|                               |  |                                                                                                  |  |     
|------------------------------ |  | ------------------------------------------------------------------------------------------------ |  | ----
|                               |  |                                                                                                  |  | Page
|PART I - FINANCIAL INFORMATION |  |                                                                                                 
|                               |  |                                                                                                 
|Item 1.                        |  | Financial Statements (unaudited):                                                                |  |     
|                               |  |                                                                                                 
|                               |  | Balance Sheets as of September 30, 2005 and December 31, 2004                                    |  | 3   
|                               |  |                                                                                                 
|                               |  | Statements of Operations for the three- and nine-month periods ended September 30, 2005 and 2004 |  | 4   
|                               |  |                                                                                                 
|                               |  | Statements of Cash Flows for the nine-month periods ended September 30, 2005 and 2004            |  | 5   
|                               |  |                                                                                                 
|                               |  | Notes to Financial Statements                                                                    |  | 6   
|                               |  |                                                                                                 
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations            |  | 12  
|                               |  |                                                                                                 
|Item 3.                        |  | Quantitative and Qualitative Disclosures about Market Risk                                       |  | 27  
|                               |  |                                                                                                 
|Item 4.                        |  | Controls and Procedures                                                                          |  | 27  
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                                 
|                               |  |                                                                                                 
|Item 1.                        |  | Legal Proceedings                                                                                |  | 28  
|                               |  |                                                                                                 
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                                      |  | 28  
|                               |  |                                                                                                 
|Item 3.                        |  | Defaults Upon Senior Securities                                                                  |  | 28  
|                               |  |                                                                                                 
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                              |  | 28  
|                               |  |                                                                                                 
|Item 5.                        |  | Other Information                                                                                |  | 28  
|                               |  |                                                                                                 
|Item 6.                        |  | Exhibits                                                                                         |  | 28  
|                               | 
|SIGNATURES                     |  | 29                                                                                              



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##### Table of Contents



PART I - FINANCIAL INFORMATION



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



GENAERA CORPORATION

BALANCE SHEETS

(Unaudited)

(In thousands, except per share data)



|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------ | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                                               |  | September 30, 2005 |          |   | December 31, 2004 |  
|ASSETS                                                                                                                                                                         |  |                    |          |   |                   |   |          |  
|Current assets:                                                                                                                                                                |  |                    |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                                      |  | $                  | 24,324   |   |                   | $ | 14,217   |  
|Short-term investments                                                                                                                                                         |  |                    | 12,851   |   |                   |   | 17,934   |  
|Prepaid expenses and other current assets                                                                                                                                      |  |                    | 1,813    |   |                   |   | 602      |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|Total current assets                                                                                                                                                           |  |                    | 38,988   |   |                   |   | 32,753   |  
|Fixed assets, net                                                                                                                                                              |  |                    | 797      |   |                   |   | 736      |  
|Other assets                                                                                                                                                                   |  |                    | 58       |   |                   |   | 59       |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|Total assets                                                                                                                                                                   |  | $                  | 39,843   |   |                   | $ | 33,548   |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                           |  |                    |          |   |                   |   |          |  
|Current liabilities:                                                                                                                                                           |  |                    |          |   |                   |   |          |  
|Accounts payable and accrued expenses                                                                                                                                          |  | $                  | 4,049    |   |                   | $ | 3,323    |  
|Accrued development expense  short-term (NOTE 6)                                                                                                                              |  |                    |         |   |                   |   | 563      |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                                      |  |                    | 4,049    |   |                   |   | 3,886    |  
|Other liabilities                                                                                                                                                              |  |                    | 1,785    |   |                   |   | 580      |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|Total liabilities                                                                                                                                                              |  |                    | 5,834    |   |                   |   | 4,466    |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|Commitments, contingencies and other matters (NOTE 6)                                                                                                                          |  |                    |          |   |                   |   |          |  
|Stockholders equity (NOTE 2):                                                                                                                                                 |  |                    |          |   |                   |   |          |  
|Common stock - $.002 par value per share; 100,000 shares authorized; 68,652 and 57,072 shares issued and outstanding at September 30,
2005 and December 31, 2004, respectively |  |                    | 137      |   |                   |   | 114      |  
|Additional paid-in capital                                                                                                                                                     |  |                    | 265,561  |   |                   |   | 242,145  |  
|Accumulated other comprehensive loss - unrealized loss on investments                                                                                                          |  |                    | (6       | ) |                   |   | (6       | )
|Accumulated deficit                                                                                                                                                            |  |                    | (231,683 | ) |                   |   | (213,171 | )
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|Total stockholders equity                                                                                                                                                     |  |                    | 34,009   |   |                   |   | 29,082   |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  
|Total liabilities and stockholders equity                                                                                                                                     |  | $                  | 39,843   |   |                   | $ | 33,548   |  
|                                                                                                                                                                               |  |                    |          |   |                   |   |          |  



See accompanying notes
to financial statements.



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GENAERA CORPORATION

STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)



|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                        |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                        |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004    |  
|Collaborative research agreement and grant revenues     |  | $                               | 14     |   |                                | $ | 672    |      |  | $ | 404     |   |  | $ | 844     |  
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Costs and expenses:                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Research and development                                |  |                                 | 6,541  |   |                                |   | 4,241  |      |  |   | 15,755  |   |  |   | 10,392  |  
|General and administrative                              |  |                                 | 1,176  |   |                                |   | 1,194  |      |  |   | 3,639   |   |  |   | 3,548   |  
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                        |  |                                 | 7,717  |   |                                |   | 5,435  |      |  |   | 19,394  |   |  |   | 13,940  |  
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Loss from operations                                    |  |                                 | (7,703 | ) |                                |   | (4,763 | )    |  |   | (18,990 | ) |  |   | (13,096 | )
|Interest income, net                                    |  |                                 | 177    |   |                                |   | 73     |      |  |   | 478     |   |  |   | 203     |  
|Loss on sale of equipment                               |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   | (118    | )
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                |  | $                               | (7,526 | ) |                                | $ | (4,690 | )    |  | $ | (18,512 | ) |  | $ | (13,011 | )
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss per share  basic and diluted                  |  | $                               | (0.13  | ) |                                | $ | (0.09  | )    |  | $ | (0.32   | ) |  | $ | (0.25   | )
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Weighted average shares outstanding  basic and diluted |  |                                 | 59,210 |   |                                |   | 52,607 |      |  |   | 57,851  |   |  |   | 52,012  |  
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



See accompanying notes
to financial statements.



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GENAERA CORPORATION

STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



|                                                                            |  |                                |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                            |  | Nine Months EndedSeptember 30, |        
|                                                                            |  | 2005                           |         |   | 2004 |  
|Cash Flows From Operating Activities:                                       |  |                                |         |   |      |   |         |  
|Net loss                                                                    |  | $                              | (18,512 | ) |      | $ | (13,011 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                               |  |                                | 250     |   |      |   | 267     |  
|Amortization of investment discounts/premiums                               |  |                                | 58      |   |      |   | (78     | )
|Compensation expense on option grants and equity awards                     |  |                                | 472     |   |      |   | 709     |  
|Loss on sale of fixed assets                                                |  |                                |        |   |      |   | 118     |  
|Changes in operating assets and liabilities:                                |  |                                |         |   |      |   |         |  
|Prepaid expenses and other assets                                           |  |                                | (1,210  | ) |      |   | (577    | )
|Accounts payable and accrued expenses                                       |  |                                | 726     |   |      |   | 192     |  
|Accrued development expenses                                                |  |                                | (563    | ) |      |   | (966    | )
|Other liabilities                                                           |  |                                | 1,205   |   |      |   | 95      |  
|                                                                            |  |                                |         |   |      |   |         |  
|Net cash used in operating activities                                       |  |                                | (17,574 | ) |      |   | (13,251 | )
|                                                                            |  |                                |         |   |      |   |         |  
|Cash Flows From Investing Activities:                                       |  |                                |         |   |      |   |         |  
|Purchase of investments                                                     |  |                                | (22,975 | ) |      |   | (27,857 | )
|Proceeds from maturities of investments                                     |  |                                | 28,000  |   |      |   | 22,500  |  
|Capital expenditures                                                        |  |                                | (311    | ) |      |   | (96     | )
|                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                         |  |                                | 4,714   |   |      |   | (5,453  | )
|                                                                            |  |                                |         |   |      |   |         |  
|Cash Flows From Financing Activities:                                       |  |                                |         |   |      |   |         |  
|Net proceeds from issuance of common stock                                  |  |                                | 22,927  |   |      |   | 19,930  |  
|Proceeds from exercise of stock options and warrants                        |  |                                | 40      |   |      |   | 1,793   |  
|                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by financing activities                                   |  |                                | 22,967  |   |      |   | 21,723  |  
|                                                                            |  |                                |         |   |      |   |         |  
|Net increase in cash and cash equivalents                                   |  |                                | 10,107  |   |      |   | 3,019   |  
|Cash and cash equivalents at beginning of period                            |  |                                | 14,217  |   |      |   | 6,625   |  
|                                                                            |  |                                |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                  |  | $                              | 24,324  |   |      | $ | 9,644   |  
|                                                                            |  |                                |         |   |      |   |         |  



See accompanying notes
to financial statements.



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NOTE 1. Basis of Presentation, Reclassification 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, 2004 balance sheet was derived from audited financial statements, however, certain
information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations. The Company
believes that the financial statements include all adjustments (consisting of normal and recurring adjustments) necessary to present fairly the results of operations, financial position 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, 2004. 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, 2004.



Certain prior year amounts have been reclassified to conform to the current
year presentation.



The Companys stock-based compensation
awards include stock options granted to employees, restricted stock granted to employees and stock options and restricted stock granted to non-employee service providers. The Company accounts for its 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,issued in March 2000. Under this method, compensation cost is recorded on the date of grant only if the current market price of
the underlying stock exceeded the exercise price. 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. With regard to stock option
grants to employees, the Company has adopted the disclosure only requirements of SFAS 123. The following table illustrates the effect on net loss 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, 2005 and 2004 (in thousands, except per share data).



|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                            |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                                                            |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004    |  
|Net loss, as reported                                                                                                       |  | $                               | (7,526 | ) |                                | $ | (4,690 | )    |  | $ | (18,512 | ) |  | $ | (13,011 | )
|Add: Stock-based employee compensation expense included in reported net loss                                                |  |                                 | 137    |   |                                |   | 322    |      |  |   | 417     |   |  |   | 597     |  
|Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all stock-based awards |  |                                 | (684   | ) |                                |   | (409   | )    |  |   | (1,786  | ) |  |   | (1,060  | )
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Pro forma net loss                                                                                                          |  | $                               | (8,073 | ) |                                | $ | (4,777 | )    |  | $ | (19,881 | ) |  | $ | (13,474 | )
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss per share  basic and diluted:                                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|As reported                                                                                                                 |  | $                               | (0.13  | ) |                                | $ | (0.09  | )    |  | $ | (0.32   | ) |  | $ | (0.25   | )
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Pro forma                                                                                                                   |  | $                               | (0.14  | ) |                                | $ | (0.09  | )    |  | $ | (0.34   | ) |  | $ | (0.26   | )
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



The resulting effect
on pro forma net loss and pro forma net loss 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



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estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:



|                                                                 |  |                                 |  |              
|---------------------------------------------------------------- |  | ------------------------------- |  | -------------
|                                                                 |  | Nine Months Ended September 30,
|                                                                 |  | 2005                            |  | 2004         
|Range of risk free interest rates                                |  | 3.70% - 4.51%                   |  | 3.04% - 3.96%
|Dividend yield                                                   |  | 0%                              |  | 0%           
|Volatility factor                                                |  | 125%                            |  | 121%         
|Weighted average expected life of options (in years)             |  | 5.0                             |  | 6.0          
|Weighted average fair value of options granted during the period |  | $1.70                           |  | $3.26        



On December 16,
2004, the FASB published SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS 123R). SFAS 123R requires that compensation cost related to share-based payment transactions be recognized in the financial statements. Share-based
payment transactions within the scope of SFAS 123R include stock options, restricted stock plans, performance-based awards, stock appreciation rights and employee share purchase plans. The provisions of SFAS 123R are effective as of the first annual
period that begins after June 15, 2005. Accordingly, the Company will implement the revised standard in the first quarter of fiscal year 2006. The implications of this revised standard will materially impact the Companys results of
operations in the first quarter of fiscal year 2006 and thereafter. If the Company had applied the provisions of SFAS 123R to the financial statements for the nine-month period ended September 30, 2005, the net loss would have increased by
approximately $1,369,000.



NOTE 2. Stockholders Equity



The changes in stockholders equity from December 31, 2004 to
September 30, 2005 are summarized as follows (in thousands):



|                                                                                     |  |                 |  |                           |     |                                      |   |         |                    |   |    |                            |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------ |  | --------------- |  | ------------------------- | --- | ------------------------------------ | - | ------- | ------------------ | - | -- | -------------------------- |  | - | -------- | - |  | - | ------- | -
|                                                                                     |  | Common Stock    |  | Additional Paid-inCapital |     | AccumulatedOtherCompre- hensive Loss |   |         | AccumulatedDeficit |   |    | TotalStock- holdersEquity | 
|                                                                                     |  | Numberof Shares |  | Amount                    |     |                                      |   |        
|Balance at December 31, 2004                                                         |  | 57,072          |  | $                         | 114 |                                      | $ | 242,145 |                    | $ | (6 | )                          |  | $ | (213,171 | ) |  | $ | 29,082  |  
|Exercise of stock options and compensation expense on option grants and stock awards |  | 180             |  |                           |    |                                      |   | 512     |                    |   |   |                            |  |   |         |   |  |   | 512     |  
|Common stock issued pursuant to private placement                                    |  | 11,400          |  |                           | 23  |                                      |   | 22,904  |                    |   |   |                            |  |   |         |   |  |   | 22,927  |  
|Net loss                                                                             |  |                |  |                           |    |                                      |   |        |                    |   |   |                            |  |   | (18,512  | ) |  |   | (18,512 | )
|                                                                                     |  |                 |  |                           |     |                                      |   |         |                    |   |    |                            |  |   |          |   |  |   |         |  
|Balance at September 30, 2005                                                        |  | 68,652          |  | $                         | 137 |                                      | $ | 265,561 |                    | $ | (6 | )                          |  | $ | (231,683 | ) |  | $ | 34,009  |  
|                                                                                     |  |                 |  |                           |     |                                      |   |         |                    |   |    |                            |  |   |          |   |  |   |         |  



NOTE 3. Common Stock



On January 21, 2004, the Company sold 4,950,500
shares of its common stock to four institutional investors in a private placement at a purchase price of $4.04 per share. Net proceeds to the Company from the offering totaled $19,925,000 after offering costs of approximately $75,000. The share
price was calculated based on a 10% discount to the five day moving average of the closing price of the Companys common stock on the Nasdaq SmallCap Market on January 20, 2004. In addition, warrants to purchase 990,100 shares of the
Companys common stock were issued to the institutional investors (see NOTE 4. Common Stock Warrants).



On November 8, 2004, the Company completed the sale of 4,183,422 shares of its common stock to unaffiliated institutional investors in a registered
direct offering, at a purchase price of $3.45 per share, for aggregate proceeds of approximately $13,500,000 after offering expenses ($66,000) and placement agency fees ($866,000). The shares were offered through a prospectus supplement pursuant to
the



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Companys effective shelf registration statement. The share price represented a 13% discount to the closing price on the Nasdaq SmallCap Market on
November 1, 2004.



On September 15, 2005, the Company
completed the sale of 11,400,000 shares of its common stock to unaffiliated institutional investors in a registered direct offering, at a purchase price of $2.15 per share, for aggregate proceeds of approximately $22,927,000 after offering expenses
($112,000) and placement agency fees ($1,471,000). The shares were offered through a prospectus supplement pursuant to the Companys effective shelf registration statement. The share price represented an 18% discount to the closing price on the
Nasdaq SmallCap Market on September 9, 2005. In addition, warrants to purchase 3,420,000 shares of the Companys common stock were issued to the institutional investors (see NOTE 4. Common Stock Warrants).



NOTE 4. 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 in which the holder may elect to receive, without the payment by the holder
of any additional consideration, the Companys common stock equal to the value of the warrant, also known as net exercise provisions. Of this total, warrants to purchase 1,500,000 shares were exercisable immediately. The remaining warrants to
purchase 500,000 shares were generally exercisable after 18 months from issuance, or beginning on November 23, 2004, or prior to November 23, 2004 if the holder exercised the warrants on a net exercise basis. In August 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 these warrants. Proceeds to the Company from the exercise of this warrant were $822,000. In
October 2003, Biotechnology Value Fund LP and associated entities and Ziff Asset Management, L.P. exercised their warrants to purchase 1,200,000 shares of the Companys common stock under the net exercise provisions of these warrants resulting
in the issuance of 892,361 shares of common stock. In December 2004, Ziff Asset Management, L.P. exercised their remaining warrants to purchase 200,000 shares of the Companys common stock at an exercise price of $1.37 per share, pursuant to
these warrants. Proceeds to the Company from the exercise of this warrant were $274,000. As a result of these transactions, no warrants under this grant were outstanding as of September 30, 2005.



In connection with its January 2004 private placement, the Company granted
warrants to purchase 990,100 shares of its common stock. The warrants have an exercise price of $5.38 per share and expire on January 23, 2009. The exercise price and the number of shares that may be purchased upon exercise of the warrants may
be adjusted from time to time as a result of a stock dividend, split or subdivision of shares, as well as a combination of shares or merger or consolidation. These warrants are still outstanding as of September 30, 2005.



In connection with its September 2005 registered direct offering, the Company
granted warrants to purchase 3,420,000 shares of its common stock. The warrants have an exercise price of $3.15 per share and expire on March 13, 2011 and are exercisable six months after issuance, or beginning on March 13, 2006. The
exercise price and the number of shares that may be purchased upon exercise of the warrants may be adjusted from time to time as a result of a stock dividend, split or subdivision of shares, as well as a combination of shares or merger or
consolidation.



NOTE 5. Collaboration Agreements



In April 2001, the Company entered into a research collaboration and
licensing agreement with MedImmune, Inc. (MedImmune) to develop and commercialize therapies related to the Companys IL9 program. MedImmune provided funding of $2,500,000 to the Company for research and development activities at the
Company over a two-year period from April 2001 to April 2003 (the R&D Funding). The R&D Funding was paid in eight quarterly installments and recognized by the Company as revenues



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on a straight-line basis over the two-year period. By the end of that two-year period, licensed technology had been transferred to MedImmune and MedImmune
assumed responsibility for development and commercialization efforts on the IL9 program. In addition to the R&D Funding, MedImmune also agreed to 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, 2005, the Company recognized $13,000 and $304,000 as revenue related to
external cost reimbursements, respectively. For the three- and nine-month periods ended September 30, 2004, the Company recognized $672,000 and $821,000 as revenue related to external cost reimbursements ($172,000 and $321,000) and milestone
payments ($500,000 and $500,000), respectively.



In September
2001, the Company received a contingent award of up to $1,700,000 from Cystic Fibrosis Foundation Therapeutics (CFFT), an affiliate of the Cystic Fibrosis Foundation, to support early clinical evaluation of LOMUCIN involving
patients with cystic fibrosis. In April 2005, the award was amended to provide up to $2,350,000 in milestone-driven, matching funds from CFFT to support a pivotal multi-center, randomized, double-blind, placebo-controlled Phase II clinical trial of
LOMUCIN in approximately 200 individuals with cystic fibrosis. Of a total grant of $2,863,000, $1,713,000 of grant support relating to the Phase II clinical evaluation of LOMUCIN was recorded as a long-term liability as of September 30, 2005.
The Company did not recognize this amount as revenue as it is refundable to CFFT upon marketing approval by the United States Food and Drug Administration (FDA) or if the Company elects not to enter Phase III clinical trials or not to
commercialize the product within two years of the satisfaction of development milestones, assuming the achievement of statistically significant results. CFFT is also due a royalty on net sales of any resultant product of up to 1.6% based upon the
amount of funding ultimately provided by CFFT.



In February
2002, the Company received a Phase II Small Business Innovative Research (SBIR) program grant from the National Institutes of Health (NIH) in the amount of $800,000 to support its aminosterol research program. The grant
originally extended over a two-year period, which ended in February 2004. In February 2004, the Company notified the NIH of a no-cost extension to the original budget period by twelve months. As a result of the notification, the grant was extended
to February 2005. The Company recognized $96,000 related to this grant in the nine-month period ended September 30, 2005. No revenue was recognized in the nine-month period ended September 30, 2004.



In April 2004, the Company received a Phase I SBIR program grant from the
National Institute of Diabetes and Digestive and Kidney Diseases of the NIH in the amount of $100,000 to support its trodusquemine (formerly trodulamine) program. The grant originally extended over a one-year period ending in March 2005. In March
2005, the Company notified the NIH of a no-cost extension to the original budget period by twelve months. As a result of the notification, the grant was extended to March 2006. The Company recognized no revenue related to this grant during the
three- and nine-month periods ended September 30, 2005 and 2004.



In September 2004, the Company received a Phase I SBIR program grant from the National Eye Institute of the NIH in the amount of $100,000 to support its aminosterols for age-related macular degeneration program. The grant originally
extended over a one-year period ending in August 2005. In August 2005, the Company notified the NIH of a no-cost extension to the original budget period by twelve months. As a result of the notification, the grant was extended to August 2006. The
Company recognized no revenue related to this grant during the three- and nine-month periods ended September 30, 2005 and 2004.



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NOTE 6. Commitments, Contingencies and Liquidity



Employment Agreements



The Company has employment agreements with certain officers and employees. Employees covered under employment contracts who are terminated without
cause are entitled to receive from the Company continuation of base pay for periods ranging from six months to twelve months. Continuation of pay for officers other than the Chief Executive Officer, whose severance is to be paid in one lump
sum, will cease upon the attainment of full time employment elsewhere.



During the nine-month period ended September 30, 2004, two executives ceased employment with the Company. As a result, the Company recorded $561,000 of continuing compensation and stock compensation expense for the nine-month period
ended September 30, 2004.



Manufacturing Agreement



In January 1999 and prior, the Company entered into several agreements with
Abbott Laboratories (Abbott) providing for the purchase of approximately $10,000,000 of bulk drug substance to be used in the manufacturing process for LOCILEX Cream. The Company renegotiated this agreement with Abbott in September 1999
after the FDA did not approve LOCILEX Cream, paying Abbott $4,200,000 at that time and receiving partial delivery of material. An additional $3,400,000 was due to Abbott and payable if the Company received 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 estimated
present value. As a result of the Companys financing activities during 2000 and 2001 and other cash inflows, $1,392,000 and $480,000 of this liability was payable and paid to Abbott on March 1, 2001 and 2002, respectively. No portion of
the liability was payable to Abbott on March 1, 2003, as the Company did not receive in excess of $10,000,000 of cash inflows during 2002. As a result of the Companys financing activities during 2003 and other cash inflows, $966,000 of
the liability was payable and paid to Abbott on March 1, 2004. The remaining amount of $563,000 was payable and paid to Abbott on March 1, 2005 as a result of the Companys financing activities during the year ended December 31,
2004.



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.



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.



The Company believes that its current cash and investments as of September 30, 2005 are sufficient to meet its research and development goals and sustain operations at least through the third quarter of 2006.



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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 was 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. On February 2, 2005, the parties entered into a settlement agreement. The settlement is on
terms that are not material to the Company and does not constitute an admission of wrongdoing or liability by the Company. On February 28, 2005, the Court entered the parties stipulated order dismissing the lawsuit with prejudice.



NOTE 7. Subsequent Event



On October 18, 2005, Roy C. Levitt, M.D., the Companys Chief
Executive Officer, resigned effective December 31, 2005. John L. Armstrong, Jr., the Companys President and Chief Operating Officer, will succeed Dr. Levitt as the Companys interim Chief Executive Officer. It is expected that
Dr. Levitt will complete his term on the Companys Board of Directors and continue as a consultant to the Company.



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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 pronouncement, 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.



We undertake no obligation (and expressly disclaim any such 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 United States Securities and Exchange Commission, all of which are
available in the SEC EDGAR database at www.sec.gov and from us.



Critical Accounting Policies and Estimates



The preparation of our financial statements in conformity with U.S. generally accepted accounting principles 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 that 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 at 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 research and development cost reimbursement contracts 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 when revenue
is recorded.



Research and Development Expenses



Research and development expenses include related
salaries, contractor fees and facility costs. Research and development expenses consist of independent research and development contract costs,



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contract manufacturing costs and costs associated with collaborative research and development arrangements. In addition, we fund research and development at
other research institutions under agreements that are generally cancelable. Research and development expenses also include external activities, such as investigator-sponsored trials. All such costs are charged to research and development expense
systematically as incurred, which may be measured by 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 research and development 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 (SFAS 123). Stock or other equity-based compensation for non-employees must be accounted for under
the fair-value-based method as required by SFAS 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 the fair value of either 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.



On December 16, 2004, the Financial Accounting Standards Board published
SFAS No. 123 (Revised 2004),Share-Based Payment (SFAS 123R). SFAS 123R requires that compensation cost related to share-based payment transactions be recognized in the financial statements. Share-based payment transactions
within the scope of SFAS 123R include stock options, restricted stock plans, performance-based awards, stock appreciation rights and employee share purchase plans. The provisions of SFAS 123R are effective as of the first annual period that begins
after June 15, 2005. Accordingly, the Company will implement the revised standard in the first quarter of fiscal year 2006. The implications of this revised standard will materially impact the Companys results of operations in the first
quarter of fiscal year 2006 and thereafter.



Risk Factors



Any investment in shares of our common stock involves a high degree of risk.
You should carefully consider each of 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, 2004.



Risks Related to Our Business



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, cash equivalents and short-term investments of $37.2 million at September 30, 2005. We believe these resources are sufficient to sustain operations and meet our research and development goals at least through the
third quarter of 2006. 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.



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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 from other parties 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 or technologies that we might otherwise seek to develop or commercialize ourselves, or seek other arrangements.



Our capital raising efforts may dilute stockholder interests.



If we raise additional capital by issuing equity securities or securities convertible into equity, the issuance may result in ownership dilution to our
stockholders and our share price may decline. The extent of such dilution will vary based upon the amount of capital raised.



Capital raising efforts through collaborations may eventually negatively impact our financial interests.



If we raise additional capital through collaborations and licensing we may
give up valuable rights in intellectual property and the value of our interest in the licensed products could be negatively impacted by competing strategic and financial interests of our collaborators or licensees. If we engage in collaborations, we
may receive lower consideration upon commercialization of such products than if we had not entered into such arrangements, or if we had entered into such arrangements at later stages in the product development process.



We expect to continue to incur substantial losses in the foreseeable future. We do not now
have, nor have we ever had, products available for commercial sale and we 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, 2005, we had an accumulated deficit of $231.7 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 are also 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.



Risks Related to Our Industry



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



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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.



Preclinical testing and
clinical development are long, expensive and uncertain processes. It may take us several years to complete our testing and failure can occur at any stage of testing. Success in preclinical testing and early clinical trials does not ensure that later
clinical trials will be successful. We may suffer significant setbacks in advanced clinical trials, even after promising results in earlier trials. We may not be able to enroll a sufficient number of patients to complete our clinical trials in a
timely manner. Based on results at any stage of clinical trials, we may decide to discontinue development of our product candidates.



Failure to recruit patients could delay or prevent clinical trials of our potential products, which could delay or prevent the development of potential products.



Identifying and qualifying patients to participate in
clinical trials of our potential products is critically important to our success. The timing of our clinical trials depends on the speed at which we can recruit patients to participate in testing our product candidates. We have experienced delays in
some of our clinical trials and we may experience similar delays in the future. If patients are unwilling to participate in our trials because of competitive clinical trials for similar patient populations, the timeline for recruiting patients,
conducting trials and obtaining regulatory approval of potential products will be delayed. These delays could result in increased costs, delays in advancing our product development, delays in testing the effectiveness of our technology or
termination of the clinical trials altogether.



Compliance with extensive
government regulations to which we are subject is expensive and time consuming, and may result in the delay, cessation or cancellation of product sales, introductions or modifications.



Extensive industry regulation has had, and will continue to have, a
significant impact on our business. Biopharmaceutical companies, like us, are subject to extensive, complex, costly and evolving regulation by the federal government, principally the FDA, and to a lesser extent by the U.S. Drug Enforcement
Administration (DEA) and foreign and state government agencies. The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and other domestic and foreign statutes and regulations govern or influence the testing,
manufacturing, packing, labeling, storing, record keeping, safety, approval, advertising, promotion, sale and distribution of our products. Under certain of these regulations, we and our contract suppliers and manufacturers could be subject to
periodic inspection of our or their respective facilities, procedures and operations and/or the testing of our products by the FDA, the DEA and other authorities, which conduct periodic inspections to confirm that we and our contract suppliers and
manufacturers are in compliance with all applicable regulations. The FDA also conducts pre-approval and post-approval reviews and plant inspections to determine whether our systems, or our contract suppliers and manufacturers processes,
are in compliance with current Good Manufacturing Practices (cGMP) and other FDA regulations.



We are dependent on receiving and maintaining FDA and other governmental approvals in order to produce and conduct clinical trials on our products. There
is always a risk that the FDA or other applicable governmental authorities will not approve our products, or will take post-approval action limiting, modifying or revoking our ability to manufacture or sell our products, or that the rate, timing and
cost of such approvals will adversely affect our product introduction plans or results of operations.



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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 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 develop this infrastructure
with inherent risks or 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 currently have collaborative
agreements with three primary collaborators: MedImmune, Inc., Ludwig Institute of Cancer Research (LICR) and Laboratorios Bago SA. 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. In addition,
a collaborator may decide to end a relationship with us.



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 that of our competitors.



We face formidable competition with respect to the products we are seeking to develop.



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. Most of these competitors have substantially greater financial, technical, manufacturing, marketing, distribution and other resources than we have. We may also face
competition from companies using different or advanced techniques that could render our future products obsolete. Accordingly, we must continue to devote substantial resources and efforts to research and development activities in order to maintain a
competitive position in our fields. Our efforts may not be successful.



Many companies are working to develop and market products intended for additional disease areas being targeted by us, including age-related macular degeneration (AMD), cancer and 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 AMD, anti-angiogenic agents are under development at a number of biopharmaceutical
companies, including Alcon, Inc., Bausch & Lomb, Inc., Eyetech Pharmaceuticals, Inc., Genentech, Inc., Miravant Medical Technologies, and QLT, Inc., as well as other large pharmaceutical companies. For cancer, anti-angiogenic agents are



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under development at a number of biopharmaceutical companies, including EntreMed, Inc., Genentech, Inc., and Imclone Systems, Inc., as well as other large
pharmaceutical companies. In the respiratory field, other biopharmaceutical companies also have reported the discovery of genes relating to asthma and other respiratory diseases, including Genentech, Inc., Amgen, Inc., Inspire Pharmaceuticals, Inc.
and Vertex Pharmaceuticals, Inc., as well as other large pharmaceutical companies. 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. 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 others are conducting research on compounds derived from animal host-defense systems.



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.



If we are unable to recruit and retain skilled employees, we may not be able to achieve
our objectives.



Retaining our current employees and
recruiting qualified scientific personnel to perform future research and development work will be critical to our success. In addition to pharmaceutical and specialized biotechnology companies, colleges, universities, governmental agencies and other
public and private research organizations can be expected to compete with us in recruiting highly qualified scientific personnel. Competition is intense for experienced scientists, and we may not be able to retain or recruit sufficient skilled
personnel to allow us to pursue collaborations and develop our products and core technologies to the extent otherwise possible.



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 manufacturing 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,



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we may be unable to successfully effect the transfer of the technology to the new contract manufacturer. Any such technology transfer may also 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.



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 would likely 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. 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; or
| | - |  | ------------------------------------------------------------------------



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



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



We own several patents and patent applications for the use of squalamine as
an anti-angiogenic, including methods for the treatment of cancer and neovascularization in the eye. One of these patents is to the compounds combination therapy with other anti-cancer agents and will expire in 2017 while another application
covers the treatment of age-related macular degeneration, retinopathy of prematurity and diabetic retinopathy that will expire in 2015. We also own patents covering methods and intermediates in the manufacturing process of squalamine and
trodusquemine that expire in 2017, 2018 and 2021. We own a composition of matter patent for the trodusquemine compound, which expires in 2014. We also own a patent for the use of trodusquemine as an anti-obesity agent and other indications that
expires in 2015. We own two patents for the use of anti-IL9 or anti-IL9 receptor antibodies for the treatment of asthma and related disorders that expire in 2016. We have recently received two U.S. patents covering methods for screening for
mucoregulator compounds and the composition of matter of a target for mucoregulators that both expire in 2019. We own a patent on the use of talniflumate and related mucoregulator compounds for treating various conditions where mucous is
overproduced, which expires in 2021.



The expiration date of
each of these patents is subject to extension depending upon the future research and development program timelines. We have filed several other applications across our research



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and development programs and intend to file additional applications, as appropriate, for patents on new compounds, products or processes discovered or
developed through the application of our technology.



We have
rights to several patents and patent applications under certain license agreements pursuant to which we expect to owe royalties on sales of products that incorporate issued valid patent claims. In particular, we have licensed from the Ludwig
Institute of Cancer Research specific technologies related to our IL9 program, the earliest of which expires in 2009. We have licensed from the Childrens Hospital of Philadelphia the composition of matter patent for the squalamine compound,
which expires in 2012. These patents are subject to extensions by their owners depending upon the future research and development program timelines. Additionally, certain of these agreements also provide that if we elect not to pursue the commercial
development of any licensed technology, or do not adhere to an acceptable schedule of commercialization, then our exclusive rights to such technology may terminate.



Third Party Intellectual Property Rights



We cannot be sure that our products do not infringe on the intellectual property rights of others and we may have infringement claims asserted against us.
These claims may harm our reputation, cost us money and prevent us from offering some products. Any claims or litigation in this area may be costly and could result in large awards against us and, whether we ultimately win or lose, could be
time-consuming, may injure our reputation, may result in costly delays or may require us to enter into royalty or licensing arrangements. If there is a successful claim of infringement against us or if we fail to develop non-infringing technology or
license the proprietary rights on a timely basis, our ability to use certain technologies, products, services and brand names may be limited and our business may be harmed.



Other Intellectual Property



We have trademark protection for the product candidate names EVIZON and LOMUCIN and are currently seeking U.S. registration of these
trademarks. 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 undertake certain
obligations including the payment of royalties on sales of any products that are covered by patent claims. If we do not meet those obligations, we may lose our rights. Additionally, some of these agreements also require that we develop the licensed
technology or meet certain milestones within a given timeframe. 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 have 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 at the Company
and were resolved. However, we may not prevail in any such disputes in the future.



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.



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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. In particular, it would be difficult to replace our President and Chief Operating Officer, John L. Armstrong, Jr. We entered
into an evergreen employment agreement with Mr. Armstrong, dated October 21, 2003, that is terminable by either party. This employment agreement contains non-competition and non-solicitation clauses. All of our executive officers have
executed individual employment agreements with us. 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.
| | - |  | -------------------------------------------------------------------------



We currently maintain primary products and completed operations liability insurance with per occurrence and aggregate coverage limits of $8.0 million. The
coverage limits of our insurance policies may be inadequate to fully protect us from liabilities we might incur in connection with clinical trials, manufacturing and marketing of our products. Product liability insurance is expensive and in the
future may not be available on commercially acceptable terms, or at all. A successful claim or claims brought against us in excess of our insurance coverage could materially harm our business and financial condition.



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.



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Risks Related to Our Stock



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;
| | - |  | ---------------------------------------------------



| |  |  | whether and when we achieve specified development or commercialization milestones;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | 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 2004, our stock price on the Nasdaq SmallCap Market fluctuated from a low
of $2.75 per share on August 12, 2004 to a high of $5.00 per share on January 27, 2004. During the nine-month period ended September 30, 2005, our stock price fluctuated from $1.45 to $3.50 per share, with an average price of
approximately $2.27. The volatility of our stock price is due to the volatility of our industry in general and does not appear to be connected to any event specific to us.



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.



We may be unable to maintain the standards for listing on the Nasdaq SmallCap Market,
which could adversely affect the liquidity of our common stock and could subject our common stock to the penny stock rules.



Our common stock is currently listed on the Nasdaq SmallCap Market. There are several requirements that we must satisfy in order for our common stock to
continue to be listed on the Nasdaq SmallCap Market. These requirements include, but are not limited to, maintaining a minimum per share price of our common stock of $1.00 and a minimum level of stockholders equity of $2.5 million. In the
future, we may not comply with all of these listing requirements, which might result in the delisting of our common stock. Delisting from the Nasdaq SmallCap Market could adversely affect the liquidity and the price of our common stock and could
have a long-term adverse impact on our ability to raise future capital through a sale of our common stock.



If our common stock were delisted, our common stock would be traded on an electronic bulletin board established for securities that are not included on
Nasdaq, traded on a national securities exchange or traded in quotations published by the National Quotation Bureau, Inc., commonly referred to as the pink sheets. If this occurs, it could be difficult to sell our securities or obtain
the same level of market information as to the price of our common stock as is currently available.



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In addition, if our common stock were delisted, it would be subject to the so-called penny
stock rules. The SEC has adopted regulations that define a penny stock to be any equity security that has a market price per share of less than $5.00, subject to certain exceptions, such as any securities listed on a national
securities exchange or quoted on Nasdaq. For any transaction involving a penny stock, unless exempt, the rules impose additional sales practice requirements on broker-dealers, subject to certain exceptions.



For transactions covered by the penny stock rules, a
broker-dealer must make a special suitability determination for the purchaser and must have received the purchasers written consent to the transaction prior to the transaction. The penny stock rules also require broker-dealers to
deliver monthly statements to penny stock investors disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Prior to the transaction, a
broker-dealer must provide a disclosure schedule relating to the penny stock market. In addition, the broker-dealer must disclose the following:



| |  |  | commissions payable to the broker-dealer and the registered representative; and
| | - |  | -------------------------------------------------------------------------------



| |  |  | current quotations for the security as mandated by the applicable regulations.
| | - |  | ------------------------------------------------------------------------------



If our common stock were delisted and determined to be a penny stock, a broker-dealer may find it more difficult to trade our common stock
and an investor may find it more difficult to acquire or dispose of our common stock in the secondary market.



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, 2005, there were outstanding options to purchase an aggregate of 5,344,250 shares of our common
stock at prices ranging from $0.40 per share to $11.63 per share, of which options to purchase approximately 2,190,500 shares were exercisable as of such date. As of September 30, 2005, there were outstanding warrants to purchase 4,627,266
shares of our common stock. Of this total, warrants to purchase 167,166 shares of our common stock are currently exercisable at $3.33 per share, subject to adjustment under the anti-dilution provisions of the warrants. Warrants to purchase 50,000
and 990,100 shares are currently exercisable at $3.79 and $5.38 per share, respectively. In September 2005, in connection with a registered direct offering of our common stock, we issued to institutional investors warrants to purchase 3,420,000
shares of our common stock at an exercise price of $3.15 per share, which are exercisable as of March 13, 2006. 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, 2005, 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.



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



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 make it more difficult to remove
management and could discourage third parties from seeking to obtain control, even



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though the price at which such third parties seek to acquire our common stock is in excess of the market price for our stock.



Results of Operations



Revenues



We have received no revenues to date from product sales. Revenues recorded to date 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, payable in eight
equal quarterly installments through April 2003 (the R&D Funding), plus it funds external cost reimbursements for our research and development activities. We could also receive up to $54.5 million based on successful completion of
future milestones. In August 2004, we received the first of such milestone payments as a result of the initiation of Phase I clinical trials. For the three- and nine-month periods ended September 30, 2005 we recognized $13,000 and $304,000 as
revenue related to external cost reimbursements, respectively. For the three- and nine-month periods ended September 30, 2004 we recognized $672,000 and $821,000 as revenue related to external cost reimbursements ($172,000 and $321,000) and
milestone payments ($500,000 and $500,000), respectively.



In
February 2002, the Company received a Phase II Small Business Innovative Research program grant from the NIH in the amount of $800,000 to support its aminosterol research program. The grant extended over a two-year period, which ended in February
2004. In February 2004, the Company notified the NIH of a no-cost extension of the original budget period by twelve months. As a result of the notification, the grant was extended through February 2005. The Company recognized $96,000 of revenue
related to this grant during the nine-month period ended September 30, 2005. No revenue related to this grant was recognized during the nine-month period ended September 30, 2004.



Research and Development Expenses



Our current research and development programs include squalamine (squalamine
lactate), which consists of EVIZON (squalamine lactate) for the treatment of AMD and squalamine for the treatment of cancer, LOMUCIN, IL9 and other programs, which consist of trodusquemine for the treatment of obesity, other aminosterols
for the treatment of inflammatory disorders and LOCILEX Cream for the treatment of infectious disease. The following table illustrates our research and development projects and the stage to which each has been developed:



|                     |  |                      |  |                
|-------------------- |  | -------------------- |  | ---------------
|                     |  | Development Stage    |  | Status         
|Squalamine:          |  |                      |  |                
|EVIZON (Squalamine) |  | Phase III            |  | Active         
|Squalamine           |  | Phase II             |  | Active         
|LOMUCIN             |  | Phase II             |  | Active         
|IL9 program          |  | Phase I              |  | Active(1)      
|Other programs:      |  |                      |  |                
|Trodusquemine        |  | Research/Preclinical |  | Active/Inactive
|Other Aminosterols   |  | Research             |  | Active         
|LOCILEX Cream        |  | Phase III            |  | Inactive       



|(1) | In April 2001, we entered into a collaborative agreement with MedImmune to develop and commercialize therapies related to our IL9 program.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------



Research and development expenses for each of our projects consist of both
direct and indirect expenses. Direct expenses include salaries and other costs of personnel, raw materials and supplies for each project. We also may incur third-party costs related to these projects, such as contract research, clinical development
and manufacturing costs and consulting costs. Indirect expenses include depreciation expense and the costs of operating and maintaining our facilities, property and equipment, to



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the extent used for our research and development projects, as well as the costs of general management of our research and development projects.



We recognized research and development expenses of $6.5 million and
$4.2 million in the three-month periods ended September 30, 2005 and 2004, respectively. We recognized research and development expenses of $15.8 million and $10.4 million in the nine-month periods ended September 30, 2005 and
2004, respectively. The following table illustrates research and development expenses (in thousands) incurred during the three- and nine-month periods ended September 30, 2005 and 2004 for our significant groups of research and development
projects.



|                            |  |                                 |       |                                |   |       |  |      |        |  |   |       
|--------------------------- |  | ------------------------------- | ----- | ------------------------------ | - | ----- |  | ---- | ------ |  | - | ------
|                            |  | Three Months EndedSeptember 30, |       | Nine Months EndedSeptember 30,
|                            |  | 2005                            |       | 2004                           |   | 2005  |  | 2004
|Squalamine program expenses |  | $                               | 5,537 |                                | $ | 3,304 |  | $    | 12,584 |  | $ | 7,152 
|LOMUCIN program expenses   |  |                                 | 258   |                                |   | 168   |  |      | 719    |  |   | 346   
|IL9 program expenses        |  |                                 | 59    |                                |   | 64    |  |      | 178    |  |   | 173   
|Other program expenses      |  |                                 | 30    |                                |   | 55    |  |      | 76     |  |   | 165   
|Indirect expenses           |  |                                 | 657   |                                |   | 650   |  |      | 2,198  |  |   | 2,556 
|                            |  |                                 |       |                                |   |       |  |      |        |  |   |       
|                            |  | $                               | 6,541 |                                | $ | 4,241 |  | $    | 15,755 |  | $ | 10,392
|                            |  |                                 |       |                                |   |       |  |      |        |  |   |       



Research and
development expenses have increased for the three-month period ended September 30, 2005, as compared to the same period in 2004, due primarily to increases in clinical trial costs ($2.7 million) and personnel costs ($0.2 million) related to our
squalamine program for the treatment of age-related macular degeneration. The increases in research and development expenses were partially offset by a decrease in development costs ($0.6 million) related to our squalamine program for the treatment
of age-related macular degeneration.



Research and development
expenses have increased for the nine-month period ended September 30, 2005, as compared to the same period in 2004, due primarily to increases in clinical trial costs ($5.8 million), manufacturing costs ($0.6 million) and personnel costs ($0.6
million) related to our squalamine program for the treatment of age-related macular degeneration, as well as an increase in clinical trial costs ($0.4 million) related to our LOMUCIN program. These increases were partially offset by a decrease
in indirect expenses due to the absence of continuing compensation and stock compensation expense relating to a former executive ($0.6 million) and a decrease in third-party contract development costs ($1.4 million) related to our squalamine program
for the treatment of AMD resulting from the progression of EVIZON through Phase II into Phase III clinical trials.



The costs incurred to date on each of our development projects are not reasonably estimable, because work on one program often supports or enhances
another program. For example, it is not possible to separate the time and resources spent in development of squalamine lactate as a product candidate to treat wet AMD and as a product candidate to treat cancer because: (i) early research and
development efforts devoted to cancer research led to development of Genaeras product candidate squalamine lactate (trade name EVIZONTM) for AMD; (ii) clinical trial work pursuant to Genaeras Investigational New Drug (IND) application for cancer forms part of the safety data base for the IND it filed with the FDA for wet AMD;
(iii) Genaeras manufacturing development for squalamine lactate supports both the AMD and cancer programs; and (iv) nonclinical testing conducted supports all regulatory filings and proposed indications for squalamine.



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. Due to the significant risks and uncertainties inherent in the preclinical and clinical studies associated with each of our research and development
programs, the cost to complete such programs, as well as the period in which net cash inflows from significant programs are expected to commence, are not reasonably estimable. Preclinical



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and clinical studies may yield varying results that could delay, limit or prevent a programs advancement through the various stages of product
development and significantly impact the costs to be incurred and the time involved in bringing a program to completion. Such delays, limitations or prevention of a programs advancement could harm our financial condition and operating results
and inhibit our ability to raise additional funds to support ongoing operations.



The nature of costs incurred in the future will also vary depending upon the stage of the product candidates development. Product candidates in the research stage often require significant laboratory work to
develop and prepare the product candidate for preclinical testing and for testing in humans. Costs for such work typically include Genaera staff, Genaera facilities, lab supplies and equipment and fees to contract research facilities supervised by
Genaera personnel. All products to be tested in humans require preclinical testing and often require additional nonclinical testing while clinical trials are in process to fulfill regulatory requirements. Preclinical and nonclinical work requires
expenditures for staffing and facilities at Genaera. Costs will also be incurred for work done by contract research facilities under Genaera supervision. Early stage products require development of manufacturing methods, supporting analytical and
research work and qualifying vendors, including contract manufacturers. Products in human testing, particularly later stage trials, require manufacturing more significant quantities of product. The costs of conducting clinical trials include fees to
contract research organizations to conduct the trials, payments to physicians and research centers, and payments for a wide range of services to prepare for clinical trials, support the trials and manage data gathered in the trials. Internal Genaera
costs for clinical trials include staffing and infrastructure to design, adapt and manage the trials, as well as managing vendors providing supporting services. Smaller but continuing costs throughout the clinical trials process also include quality
control and regulatory compliance activities conducted by Genaera staff and through contractors supervised by Genaera.



General and Administrative Expenses



We recognized general and administrative expenses of $1.2 million in the three-month periods ended September 30, 2005 and 2004. General and
administrative expenses consist principally of personnel costs, professional fees and public company expenses. General and administrative costs in the three-month period ended September 30, 2005 were approximately the same as with the
three-month period ended September 30, 2004. We recognized general and administrative expenses of $3.6 million and $3.5 million in the nine-month periods ended September 30, 2005 and 2004, respectively. General and administrative costs
increased in the nine-month period ended September 30, 2005, as compared to the same period in 2004, due to increases in personnel as a result of our expanded development efforts ($0.3 million) and increased professional fees ($0.1 million),
due to having to comply with various provisions of the Sarbanes-Oxley Act of 2002. This increase was partially offset by decreases in patent expenditures ($0.3 million).



Interest Income and Expense



We recognized interest income of $177,000 and $74,000 for the three-month periods ended September 30, 2005 and 2004, respectively. We recognized no
interest expense for the three-month period ended September 30, 2005 and interest expense of $500 in the same period in 2004. We recognized interest income of $478,000 and $206,000 for the nine-month periods ended September 30, 2005 and
2004, respectively. We recognized no interest expense for the nine-month period ended September 30, 2005 and $3,000 of interest expense in the same period in 2004. Interest income increased during the three- and nine-month periods ended
September 30, 2005, as compared to the same periods in 2004, due to higher investment interest yields.



Financial Condition, Liquidity and Capital Resources



Cash, cash equivalents and short-term investments were $37.2 million at September 30, 2005 as compared to $32.2 million at December 31, 2004. Our primary use of cash is to finance our research and
development operations.



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Current liabilities were $4.0 million and $3.9 million at September 30, 2005 and December 31,
2004, respectively. Current liabilities at December 31, 2004 included $0.6 million due to Abbott Laboratories under our agreement with them. Long-term liabilities at September 30, 2005 include $1.7 million of refundable grant support from
an affiliate of 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, 2005.



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 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. Additional factors that may impact our ability to raise capital
are described under Risk Factors.



Contractual Cash Obligations



The table below sets forth our contractual cash
obligations at September 30, 2005 (in thousands):



|                                                        |  |                  |       |                             |   |          |  |               |     |  |   |   |  |   |  
|------------------------------------------------------- |  | ---------------- | ----- | --------------------------- | - | -------- |  | ------------- | --- |  | - | - |  | - | -
|Contractual Cash Obligations                            |  | Total            |       | Cash Payments Due by Period
|                                                        |  | Less than 1 year |       | 1-3years                    |   | 4-5years |  | After 5 years
|Operating lease on building1                            |  | $                | 874   |                             | $ | 396      |  | $             | 478 |  | $ |  |  | $ | 
|Operating leases and maintenance contracts on equipment |  |                  | 163   |                             |   | 64       |  |               | 99  |  |   |  |  |   | 
|Clinical trial contracts                                |  |                  | 1,650 |                             |   | 1,650    |  |               |    |  |   |  |  |   | 
|Research and development contracts                      |  |                  | 101   |                             |   | 101      |  |               |    |  |   |  |  |   | 
|Manufacturing contracts                                 |  |                  | 841   |                             |   | 841      |  |               |    |  |   |  |  |   | 
|                                                        |  |                  |       |                             |   |          |  |               |     |  |   |   |  |   |  
|Total contractual cash obligations                      |  | $                | 3,629 |                             | $ | 3,052    |  | $             | 577 |  | $ |  |  | $ | 
|                                                        |  |                  |       |                             |   |          |  |               |     |  |   |   |  |   |  

---

|1 | The lease provides for escalations relating to increases in the Consumer Price Index not to exceed 7% but no less than 3.5% beginning in December 2002. We have
assumed an annual minimum lease payment escalation of 3.5% for the purposes of this table.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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, government agency, corporate and bank or institutional money market funds with investment standards comparable to our investment policy. The policy limits the amount of credit exposure we may
have to any one issue, issuer or type of investment other than U.S. government debt.



As of September 30, 2005, our portfolio investments consisted of $24.3 million in cash and cash equivalents and $12.9 million in U.S. Treasury or U.S government agency 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, 2005 would have decreased by approximately $181,000. This estimate assumes that the decrease occurred on the first day of 2005 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, 2005 would have increased by $181,000. This estimate assumes that the increase occurred on the first day of 2005 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, 2005, we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief Executive Officer and our Executive 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-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the Exchange Act), as of the end of the period covered by this report. Based upon this
evaluation, our Chief Executive Officer and our Executive Vice President and Chief Financial Officer concluded that, as of September 30, 2005, our disclosure controls and procedures were effective.



Our management, including our Chief Executive Officer and our Executive Vice
President and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all errors or fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met and our disclosure controls and procedures are designed to provide this reasonable assurance. Based upon the evaluation discussed above, our Chief Executive Officer and our Executive Vice President
and Chief Financial Officer concluded that, as of September 30, 2005, our disclosure controls and procedures were effective at providing such reasonable assurance. Because of inherent limitations in all control systems, no evaluation of control
can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.



(b) Internal control over financial reporting: There were no changes in our internal control over financial reporting during the fiscal quarter ended
September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



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##### Table of Contents

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 was 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. On February 2, 2005, the parties entered into a settlement agreement. The
settlement is on terms that are not material to the Company and does not constitute an admission of wrongdoing or liability by the Company. On February 28, 2005, the Court entered the parties stipulated order dismissing the lawsuit with
prejudice.



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------



None.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------



None.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------



None.



|ITEM 5. | OTHER INFORMATION
|------- | -----------------



None.



|ITEM 6. | EXHIBITS
|------- | --------



|     |  |                                                                                                                                                                                                                           
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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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##### Table of Contents



SIGNATURES



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



|                       |  |  |  |                     |  |                       |  |                                                                                                  
|---------------------- |  |  |  | ------------------- |  | --------------------- |  | -------------------------------------------------------------------------------------------------
|                       |  |  |  | GENAERA CORPORATION
|                       |  |  | 
|Date: November 9, 2005 |  |  |  | By:                 |  | /s/    JOHN A. SKOLAS
|                       |  |  |  |                     |  |                       |  | John A. Skolas                                                                                   
|                       |  |  |  |                     |  |                       |  | Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)



29



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##### Table of Contents



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